BENEFITS &COMPENSATION

INTERNATIONALT O TA L R E M U N E R AT I O N A N D

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REMUNERATION GOVERNANCEAmidst the international furore, why wereno changes implemented simultaneouslyin the GCC? Most of the initial regulatoryactivity was primarily across the UK,mainland Europe and the USA as being the parts of theworld impacted most severely by the banking crisis.

It is now clear that the GCC’s banks were far lessaffected by the global crisis than their sector peerselsewhere. Thus, the Central Banks of the GCC foundthemselves in the somewhat fortuitous position of beingable to wait and learn from the regulatory developmentsthat occurred elsewhere in the world. However,following the October 2009 meeting of the G20politicians in Pittsburgh, it was agreed that all G20nations would issue new rules governing compensationin banks.

The Kingdom of Saudi Arabia, as the sole nation in theMiddle East represented in the G20, issued its version ofthe rules via the Saudi Arabian Monetary Agency (SAMA)on 3 May 2010, thereby setting a precedent for otherGCC countries. Indeed, at the end of May, the Qatar Central Bank (QCB) released a draft circular on‘Rewards and Incentive Policies’ for banks.

As emerging economies, there are some clearadvantages for GCC nations from being seen as having aregulatory framework that is aligned with the majorfinancial centres of the world. These advantages,coupled with a likely regional desire to avoid anysignificant macro competitive advantage being createdfor one or more of the GCC nations from regulatorychange, lead me to believe this regulatory trend is set tocontinue around the region.

BANKING PAY REGULATIONS AND GUIDELINESWhile each set of regulations within the GCC isstructured and communicated differently, there areseveral common themes, in line with the manyinternational guidelines and regulations introduced overthe last two years, which together address three mainareas (see FIGURE 1 overleaf).

Governance of PayThe key governance-orientated elements of theregulations set out a broader and more extensive role

The GCC – the governance legacy of the global banking crisis

Alasdair Walls

As a member of Hay Group’s Middle East Executive Reward Team, Alasdair Walls advisescompanies on all aspects of executive remuneration, including executive reward strategy

development, the communication of executive reward and executive pay practice corporategovernance. He joined Hay Group at the beginning of the year, having previously worked for both

Kepler Associates and Deloitte in London, where he supported organizations across the UK,mainland Europe and the Middle East. Mr Walls has a BSc in Psychology from the University of Bath

and studied Corporate Finance at London Business School.

As the recession recedes across the countries of the Gulf Cooperative Council (GCC), many companies arenow focused on recovery and growth. Even in the lightof current fears of a ‘double-dip’ in the global economy,many GCC companies – including banks – hope that theworst is now behind them and that events such as thecollapse of Lehman Brothers will prove to be but adistant memory.

However, while economic recovery may seem on thenear-horizon, the legacy impact of the global financialcrisis and turmoil within the banking sector on rewardpractices and corporate governance is still far-reaching.Within the GCC, it seems that the evolution of rewardand governance in the banking sector is only justbeginning, yet it is an issue that is gaining momentumacross the region.

INTERNATIONAL REGULATORY DEVELOPMENTS In the aftermath of the banking crisis, there were severalmajor responses around the world. Some of these wereimmediate and appeared to be short-term, knee-jerkreactions, such as the rapid introduction of one-offlevies for banks on bonus payments in the UK and theUSA. Even in the light of the anti-avoidance measures,these sparked some interesting short-term debatesaround banking pay practices, such as contractualchanges translating ‘bonus’ into ‘salary’ and whethercompanies should ‘off-shore’ entire trading teams toavoid such penal treatment.

Other changes appeared to be more long term in nature, for example the introduction of governanceguidelines and regulations relating to the structure of reward, governance practices and the role of ‘risk’ within performance management, such as the Financial Services Authority’s (FSA) code forremuneration practices in the banking sector and the Financial Services Act 2010 in the UK; the Troubled Asset Relief Program (TARP) and SEC regulatorychanges in the USA; and the Committee of EuropeanBanking Supervisors’ high-level principles forremuneration policies in Europe, to name but a few.

Indeed, it has been impossible to avoid the internationalmedia coverage of widespread regulatory change as theglobal response to the banking crisis has evolved overthe last two years; the Middle East is no exception.

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out that banks should adjust profit for the full range ofidentifiable risks when measured for the purpose ofincentives. Lastly, the time horizon of performancemeasurement is a common issue raised by the variouscommunications from the regulators with anexpectation that performance will no longer focussimply on short-term profitability but will be measuredcomprehensively over multiple periods.

While such regulations and guidelines can clearly onlybe viewed as a positive step forward for the bankingsector within the GCC, questions from within the localbanking sector have been raised about how and whetherregulators have considered, or fully understood, the far-reaching implications of the measures that wereintroduced. There are a number of cultural challengesinherent in the introduction and implementation ofthese regulations – many of which local banks are nowin the midst of trying to address.

THE FUTURE SHAPE OF REWARDWhile the banks incorporated in the region are clearlyall at different stages in their consideration of both localand international regulatory change and its impact ontheir own reward and performance managementpolicies and practices and in their approach toremuneration governance and the likely culturalchanges that will be required, we are also beginning tosee something of a ‘ripple effect’ from the regulatorychange in the region on the evolution of executivereward practices across general industry outside thebanking arena. Some of these changes relate togovernance; others to the reward philosophies, policiesand practices being adopted across general industry.

In terms of remuneration governance, more and morecompanies are establishing Remuneration Committeesto provide independent supervision of reward decision-making processes. While in various countries, such as Qatar and the United Arab Emirates,recent regulations have required the establishment of Remuneration Committees in listed companies, weare even seeing this trend evolving in the privatecompany environment – including some family-ownedbusinesses and government-owned enterprises. In thelight of the evolution of the governance frameworksacross many companies, feedback received in themarket suggests that non-executive directors are findingtheir roles increasingly burdensome in terms of the timecommitments required in the role. As such, we arewitnessing the emergence of a new non-executivedirector market in the GCC with new pressures for theintroduction of competitive fee levels and best practicefee structures. Led by the banking sector in response torecent regulations, this is already an issue receivingmuch attention from boards around the region acrossgeneral industry.

We are also seeing a growing interest from companiesoutside banking in long-term incentives (LTIs) andconsideration of the benefits that could be gained fromthe use of some form of bonus deferral. A number ofcompanies have identified the strengths of linking theuse of long-term incentives to their succession planningpolicies to help encourage retention of their key talentand high-potential employees, thereby supporting thedevelopment of the next generation of leadership.Furthermore, there is a growing view that a long-term

for the board of directors requiring them to beultimately responsible for determining and monitoringcompensation practices. There is a general requirementfor banks to operate a remuneration committee withclear guidance on the constitution and role of thesecommittees, and regulators expect a greater role for therisk and control functions in the context of reward,namely through the provision of formal reports from therisk function setting out its assessment of the risksundertaken to deliver performance by management.These reports will aim to provide assurance thatmanagement has operated within the risk appetite ofthe bank. Finally, banks will be expected to demonstrategreater disclosure of pay policies within their annualreport and accounts.

Reward CompositionIn terms of composition of reward, the key themesrelate to ensuring an appropriate ratio between fixedand variable pay; aligning the time horizon of rewardwith the profile of risks undertaken to deliver theperformance to which the reward relates; ensuring thatbonus pools are funded by way of overall, risk-adjustedbank performance; encouraging the use of share-basedpayments; requiring the use of annual bonus deferral;and, finally, obtaining guidance to ensure that theincentive arrangements for control functions aredetermined independently from the businesses to whichthey are aligned in order to help support theindependence and objectivity of the control functions.

Performance MeasurementAs seen elsewhere in the world, a fundamental area oflocal regulatory change relates to performancemeasurement within banks. The issue that underpins allthe regulations in this area is that effective riskmanagement should sit at the heart of any bankingreward framework and incentive portfolio. As such,SAMA and QCB guidelines require banks to ensure theyoperate formalized performance measurement systemscapturing risk and individual contribution as well asdivisional and overall bank performance. Banks areexpected to use a wider range of performancemeasures, including the risk and quality of the businesstaken onto the books. The regulations quite rightly set

FIGURE 1 Common Themes of BankingPay Regulation

Regulations

Governanceof pay

Performancemeasurement

Rewardcomposition

incentive can be used to provide advantages over andabove those of simply delivering a retention tool, withmany companies now taking a more robust approach toperformance management and aiming, for example, toencourage a group focus on corporate performance andto reinforce value-creating decision-making over thelonger term. While there are some legal restrictionsacross the region that could be considered barriers toencouraging employee ownership, some companies areeven trying to gain the benefits of aligning the interestsof executives with those of shareholders by replicatingthe financial effects for both participants andstakeholders of an equity-based LTI scheme. While, forthe most part, these typically emerge as phantom equityplans (whether stock or options), the concept of usingequity in incentives and linking the level of reward tothe value created for shareholders is increasinglyattracting interest.

It is difficult to ignore the pressures on listed companiesfor greater disclosure of remuneration arrangements;the effect this is having on companies outside banking;and the attention that such issues are receiving from thestock exchanges and regulators around the region. It islikely that publicly disclosed information, whileculturally not readily accepted at this time, will beimposed upon the banks, putting pressure on them to

lead the way in this area. As regulatory and governancepressures increase in the GCC over the coming years,requirements for greater levels of disclosure acrossgeneral industry are an inevitable outcome – along withthe subsequent pressures on market pay competivenessthat we have witnessed over the last decade in the West.

CONCLUSIONThe regulation and governance of reward in the GCC areclearly here to stay as the countries within their frontierand emerging markets prepare for the next stage ofeconomic growth and development. While not withoutits ‘teething’ problems and transitional issues forcompanies and regulators alike, the resulting evolutionof both reward and governance frameworks isinevitable. Companies that try to ignore these pressureswill inevitably be left behind by their more sophisticatedpeers in the region.

Indeed, it will be interesting to observe how GCCcompanies react to these emerging governance and regulatory pressures over the medium term; how they exploit their fortuitous position of having heldoff jumping on the ‘international governancebandwagon’; and whether they will seek to learn fromboth the mistakes and successes of the West in this areain future. Ω

Copyright © Pension Publications Limited 2010.

Reproduced for Benefits & Compensation International, Volume 40, Number 4, November 2010.Published by Pension Publications Limited, London, England.

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