Conduct Risk: Compensation

Conduct Risk: Compensation

Nicolas Corry, Managing Director,

It’s the time of year when the compensation for Financial professionals is brought sharply into focus. Regulators are driving for compensation to be linked to long term profitability and conduct, recognising that hard pay out structures and incentive schemes may encourage short termism. However significant gap risk persists. Sell side staff increasingly find that their compensation is pushed further down the line, with lengthy vesting periods, and the threat of claw backs to pay should staff be found guilty of wrongdoing (malus).

Across the street from the Traders and Investment Bankers, who capture most of the headlines, there are market participants with compensation models that are moving sharply in the opposite direction. Interdealer Brokers are a prime example of parties who’s compensation model is becoming harder. Their pay model has moved from salary plus bonus to one that is “eat what you kill”. Salaries have been switched for draws which are effectively small bonus advances, with quarterly bonuses determined from high hard percentages ranging from 35% – 65% of profit generated. This juxtaposition heightens the risk of trading staff directing business, and over trading, with the goal of sharing revenue generated with the broker.

Joint Ventures also pose a risk where other parties in a JV are compensated in a hard manner for business brought in. An example may be a broker, or hedge fund, charged with sourcing “cheap” packages of securities. Trading staff may be lured into turning a blind eye to less profitable, or even loss making trades at the expense of the trading book, if they are able to monetise activity through their relationship with a party within the JV who’s payout structure is hard.

We recommend our customers identify businesses using Interdealer Brokers (wide-spread) and Joint Ventures. They should establish what line of sight Front Office Management have over trading activity, and whether reviews/monitoring are in place to identify broker concentration risk, whether traders are awarding excess brokerage and whether this is appropriate. In the case of Joint Ventures, control functions should review the terms to judge whether there are opportunities for parties to extract up front revenue under the terms of the arrangement.