10th in a series

T his Eurosif sector report has been compiled using research by CA Cheuvreux. It describes the majorenvironmental, social and governance (ESG) challenges facing the European banking industry and theassociated risks and opportunities these pose for long-term returns.

BANKING OVERVIEW ● The European Banking sector consists of 6,600 banks, with total

assets of more than €23 trillion. The top 300 listed banksrepresent nearly 80% of the sector and account for about15% of the major European index benchmarks. Banks directlyaccount for about 5% of European GDP, their indirect impactis 50% and they are a key contributor to employment, growthand stability across the European Union. Chart 1 reflects theirimportance to the economy by showing the marketcapitalisation and total assets for the top 20 European banks.

● Four major bank business profiles have been identified: - Retail Banks (RB) refer to banking institutions that handle

transactions directly with consumers, rather than withcorporations or other banks. This is a very mature businessin Europe, and contributes to over 50% of European banks’

profits. Key drivers in this sector are loyalty and mobility.- Commercial Banks (CB) carry out traditional corporate

lending activities and credit facilitation through a widerange of products. This is a competitive business segmentthat is highly exposed to economic cycles where access tocapital and geographical representation are key issues.

- Investment Banks (IB) carry out all financial market-relatedactivities notably trading in securities, managing corporatemergers and acquisitions, originating, underwriting andsyndicating both equity and debt, and insuring bonds (e.g.selling credit default swaps).

- Wealth Management (WM) is an investment advisorydiscipline that incorporates financial planning, investmentportfolio management and a number of aggregatedfinancial services.

CASE STUDY: REMUNERATION IN THE BANKING SECTOR

0

20 000

40 000

60 000

80 000

100 000

120 000

140 000

Hsbc

Holdin

gs

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tander

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ibas

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anco

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it SpA

Credit

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sa S

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pa

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ank

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tland

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s Ban

king G

roup P

LC

Societe

Gen

erale

Standar

d Char

tere

d

Credit

Agricole

Nordea

Ban

k

Deuts

che

Bank

AG

Sberban

k

Natio

nal Ban

k of G

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e SA

Dansk

e Ban

k A/S

Svensk

a Han

delsban

ken A

B

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0

500 000

1 000 000

1 500 000

2 000 000

2 500 000

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Market Cap. Total Assets

BANKING TRENDS● Commercial Banks. A key issue is the ability of commercial banks

to charge the right price for credit. Using lending for clientacquisitions distorts a key function of commercial banking, asprice cannot guide capital allocation. The apparent aggregationof commercial and investment banking allows for cross-subsidisation between lending and needs to be reassessed.

● Investment Banks. Investment banks are highly sensitive tomarket cycles and volatility. (Human) capital, funding andliquidity are the key features embedded in a structured riskmanagement model. This industry will be the most profoundlyaffected by a tighter regulatory environment, and this will leadto lower leverage and ultimately higher capital charges, whichwill structurally lower return on equity levels.

● Wealth Management. This model could change, with two driversbeing introduced: 1) segregation between asset managers (AM) andnetworks; and 2) the separation of passive and active AM, whichshould help clients select the right product at the right price.

● Stronger financial regulation is high on the world agenda. As shown in Chart 2, banks have been significantly impacted bythe crisis; in some cases, losses have approached their requiredTier 1 capital levels. Thus, world and EU leaders utilised the G20summits to push for tighter rules. Nevertheless, should thecurrent regulation efforts fail to shift banks' models towards anapproach favouring stable economic growth, the ultimate threatis a Glass-Steagall1 type of reform. Bank performances shouldnow be primarily assessed in relation to risk profiles and be morefocused on the long term.

● Retail Banks. The crisis has increased concentration and marketstrength for retail banks, which are highly exposed to economiccycles. However, the crisis context has also led to reducedpressure from the European Commission's (EC) antitrust rulesand consumer protection laws. Players such as telecomcompanies, media groups and retailers are showing renewedinterest in providing financial services.

Eurosif wishes to acknowledge the support and direction provided by the Bank Sector Report Steering Committee:Bank Sarasin

Domini Social InvestmentsFundación Ecología y Desarollo (ECODES)

IDEAMLiving Planet Fund Management Company S.A.

Oddo SecuritiesPictet Asset Management

Triodos Bank

La ruche - 84 quai de Jemmapes • 75010 Paris, FranceTel : +33 (0)1 40 20 43 38

contact@eurosif.org • www.eurosif.org

9 quai Paul Doumer • 92920 Paris La Défense FranceTel: +33 1 41 89 74 69

svoisin@cheuvreux.com • www.cheuvreux.com

Des

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Chart 1: Top 20 European Banks - Market cap vs total assets (2008)

September 2009

Banking

This sector report has been compiled by :

1 The Glass-Steagall act was a 1933 United States national law separating investment banking and commercial banking firms.4/5 http://www.marisec.org/shippingfacts/worldtrade/

Chart 2: Cost of the Crisis

The financial crisis exposed the inherent weaknesses of theremuneration system used by banks. This system rewardedexecutives for behaviour that encouraged excessive risk-taking inorder to earn bonuses that were dependent on an assessment ofshort-term performance which failed to account for long term risks. However, given the EU's failure to adopt a coordinated approach tothe issue of remuneration, the best path to reform may in fact bemarket-based, with shareholder and government involvement wherenecessary. In our view, UBS and Credit Suisse's recent implementationof remuneration policies designed to encourage long-termperformance supports this argument.

Remuneration Example - UBS

UBS's new model tackles head-on the primary issue for any reform ofbank's remuneration policies, namely the payment of bonuses basedon performance that is neither transparent nor sustainable over thelong term. The new plan introduces a bonus/malus system underwhich a maximum of one-third of the bonus can be paid out in cashat year-end, subject to positive business development. The remainderwill be held for five years in escrow in a bonus account. Should UBS'ssubsequent performance be poor, a negative award, or "malus", canresult and the bonus account will decline, reducing any subsequentawards paid out.

Remuneration Example – Credit Suisse

Credit Suisse's (CS) plan does not include a malus/bonus system butuses debt rather than capital to remunerate employees. Under CS'sscheme, employees of the Investment Banking business will receivethe majority of their deferred bonuses in the form of partner assetfacility awards (PAF). The PAF awards are indexed to a specified poolof illiquid assets based on the most illiquid loans and bonds on CreditSuisse's balance sheet. PAF holders will realise potential gains if assetsin the pool are liquidated at prices above the initial fair market value.However, PAF holders cannot receive any payments for at least fiveyears after the awards are granted, at which point participants willreceive an annual cash payment.

ConclusionIn our view, both shareholders and regulators should welcomethe Credit Suisse plan, as it potentially removes risky assets fromthe balance sheet and preserves capital, while introducing thisrisk directly into executive pay over the long term. Furthermore,long-term participants have the opportunity to gain some upsidein the event that the toxic assets6 return to value. Both the UBSand Credit Suisse remuneration structures have raised the bar interms of challenging remuneration committees to meet theneeds and objectives of shareholders and regulators. However,while we welcome these two remuneration plans, we areconcerned by the potential lack of incentives for independentbanks to adopt similar policies.

Both President Nicolas Sarkozy of France and Chancellor AngelaMerkel of Germany have publically stated their view thatunlimited bonuses contributed to the excessive risk taking bybanks and there is now growing impetus for greater internationalcoordination to establish a common consensus on how bonusesare paid. The G20 summit in Pittsburgh in September 2009 thusoffers an opportunity for France and Germany to convince theworld's largest economies that mandatory bonus limits areneeded to prevent the continuation of excessive risk taking bybanks.7

However, despite the new momentum, a consensus on limitingbonuses may not be achievable and it is possible that the mostviable solution may come via tougher controls on capitalrequirements and a formal consensus on requiring bonuses tobe based on long-term performance. This would allow nationalregulators to use Basel II to require financial institutions thatcontinue to operate inappropriate remuneration policies thatencourage unnecessary risk to set aside additional capital. Thelinking of risky remuneration practices to increased capitalrequirements would be a direct incentive for boards toimplement long-term-oriented and sensible remunerationpolices. However, defining relative risk tolerance levels willremain a key challenge.

6 The UK government has requested that the bulk of the bonus pool (GBP950m) paid to executives at RBS in 2008 be in the form of subordinated debt rather than capital and that this should be staggeredover three years with a 100% claw-back provision.

7 Particularly bonuses paid to traders who are able to take on significant risks. The proposed revision of IAS 39 would also allow bonus pools paid to traders to be triggered only if the trade was priced atmarket value as this would ensure that the P&L was eligible for immediate bonus payments.

KEY CHALLENGESENVIRONMENTAL, SOCIAL AND GOVERNANCE ISSUES BUSINESS RISKS & OPPORTUNITIES● The crisis has revealed the importance of the systemic responsibilities

for Retail, Commercial and Investment Banks. A major sustainableobjective is to prevent these risks from spreading from a specific bankto the entire sector and to the rest of the economy. In terms of ESGresearch, it calls for specific screening of systemic vs. specific risks.

● Risk management and transparency (CB & IB). It is essential tomeasure board expertise and accountability in order to ensure thatthe appropriate level of expertise is in place to manage State-drivenfunding and risk control. Furthermore, the movement towardsincreased EU-level regulation and supervision of hedge funds andtax havens is evidence of the shift towards more transparency.

● Responsible remuneration (RB, CB & IB). Variableremuneration (bonus), along with unsustainable business targets,may lead to irresponsible commercial practices. This is a key issuethat is being addressed by regulators but has been tackled bysome banks, such as UBS and Credit Suisse. (see case study oninnovative remuneration plans at the end of this report)

● Democratic accountability (RB, CB & IB). Improving the EU'sLamfalussy approach2 and its extension to banking is a keyelement in achieving the dynamic global economy anticipated inthe Lisbon treaty.

● Supervisory rules. A post G20 summit rolling programme ofregulatory processes should establish a more consistent set ofsupervisory rules. The Financial Stability Board (FSB) is tobecome the G20 arm for enhancing and enforcing prudentialand governance rules. In addition, in May 2009, the EC issueda communication outlining a proposal for stronger Europeanfinancial supervision.

● Capital requirements. EU legislative proposals to addressliquidity risk and excessive leverage (Autumn 2009) will lead to

further constrained capital bases and ongoing deleveraging.Leveraging ratios will be more limited in the future to preventsystemic risk –a sustainable limitation may be within the 20-25% range. Capital requirements for trading activities will bedramatically increased.

● Trading activities. Capital used for trading activities ratherthan credit businesses may be subject to further control andrequirements and ultimately, the EU may see some sort of Tobintax3 to pay for the systemic risk embedded in these activities.

● Customer protection issues (RB & WM) include pricing,transparency, cost of products, banking mobility, advertising andmarketing of credit products, pre-contractual information to beprovided, ways to assess product suitability, borrowercreditworthiness, advice standards, responsible borrowing and issuesrelating to the framework for credit intermediaries (e.g. disclosure,registration, licensing and supervision).

● The systemic risk of product responsibility (RB, CB & IB) isillustrated via sales practices that may push lenders to hand outmoney without properly assessing borrowers' ability to pay it back, ashighlighted by the US sub-prime mortgage crisis.

● Tax havens and banking secrecy (WM, CB & IB). Longconsidered as the black hole of the economy, tax havens and bankingsecrecy practices are now under strong regulatory pressure.

● A shift in banking services towards improved consumerbenefits? The EU Commission, Parliament and industry arecurrently discussing how to improve consumer protection andchoice in retail banking and insurance services.

● Complex hybrid financial products. Control of and transparencyon derivatives and complex structured products are key stepstowards ensuring financial stability.

● Banking secrecy rules: The G20 endorsement of the OECD list ofcountries compliant with international tax disclosure requirementsmay put pressure on profitability and could lower the value of somewealth management segments.

Systemic ESG issuesResponsible Lending& Financial Product

Distribution

● Customer retention and satisfaction (Retail) is a keyintangible asset for major banks, especially in the context ofregulatory pressure for price transparency and client mobility.However, the level of clients’ capital is difficult to measure due tothe lack of relevant reporting on dedicated key performanceindicators (KPIs). Pricing premiums, in the context of regulatorypressure, could become an important indicator of performance.

● The commitment to transparency (All) requires providingstakeholders with consistent and relevant disclosure andbeing receptive to their needs for specialised information.Commercial confidentiality should not be used as an excuseto deny stakeholders access to information.

● While CSR performance in this sector is seldom taken intoaccount by clients as a factor determining their choice of retailbank, pricing and the quality of service remain key in terms ofappeal for customers.

● However, implementing CSR measures may be a tangible meansof retaining customers over time.Specific ESG Issue

StakeholderSatisfaction

● The Banks’ license to operate lies with their social responsibilities infacilitating the financing of the economy through lending to retailand corporate banks. It also has indirect consequences onemployment.

● Access to credit and credit database transparency (Retail).These are key performance indicators of a bank’s contribution toqualitative economical growth. Some banks may allow people inlow-income brackets access to financial services. Furthermore,facilitating cross-border access to credit databases may improveaccess to finance for some categories of borrowers. However thesedatabases do not necessarily result in a more responsible credit andfinancial market.

● Restructuring and relocation of jobs (All). EU banks haveshifted rapidly from being major recruiters to a slightly negative

redundancy trend, with substantial labour-related consequences inthe UK (a cut of about 5% in total banking headcount) as well asthe Netherlands and Spain.

● State aid counterparties (All). The conditions that accompanyany state aid measures must be clear and transparent in order toallow the market to understand the expected labour-relatedconcessions. Banks that are bailed out by governmentscannot, in some cases, lay off employees at the same time aspaying a dividend to shareholders.

● Civil society campaigns (WM, CB & IB) aimed at engagingbanks’ civil responsibility (e.g. regarding investments in companiesthat manufacture cluster bombs) highlight the leverage that financialinstitutions have to facilitate international agreements and theirresponsibility in protecting civilians in developing countries.

● Banks' tighter credit standards, despite governmentintervention, have contributed to the substantial macroeconomicslowdown and an increase in corporate defaults. The creditsituation, however, is likely to stabilise.

● Credit cycle: this is one of the most significant downturns incredit cycle history, albeit to a lesser extent in Europe. Constrainedcapital bases and deleveraging are likely to tighten credit terms.However, banks are set to receive further support from nationalregulators to improve access to credit locally. For example, creditto local businesses is to be excluded from the calculation ofleverage ratios.

● Staff costs (CB, IB & WM) are being scrutinised as there ispotential room for improvement after five years of solid hiring.However, the favourable ageing pyramid could offset both thelabour-related impact and the cost of restructuring.

● Microfinance only represents a fraction of European banks'activities and, although some banks are active in this field, thissegment cannot, at this stage, be a substitute for the traditionalcredit model with regards to improving access to credit.

Specific ESG IssueSocial Impact

● The indirect environmental impact of banks’ activities is fargreater than the direct impact. For example scope 3 CO2

emissions4 for the banking sector (e.g. linked to credits) represent alarge proportion of the direct and indirect carbon footprint of allother sectors.

● Environmental impact of business (CB & IB) can be mitigatedby considering externalities via risk screening and by pricing their fairprice in transactions. The Equator Principles, the Principles forResponsible Investments (for WM) and the more recent ClimatePrinciples5 represent advanced indicators for measuring the

implementation of a consistent approach. This may lead to best-in-classand exclusion policies being created on the basis of these principles.

● The commitment to ‘do no harm’ (WM, CB & IB) meanspreventing and minimising the detrimental environmental and/orsocial impact of portfolios and operations. Solutions in this respectrequire the creation of policies, procedures and standards based onthe precautionary principle in order to minimise environmentaland social harm, improve social and environmental conditionswhere banks and their clients operate and avoid involvement intransactions that undermine sustainability.

● Reputational risk is viewed as one of the drivers for investment and commercial banks to further consider the environmentaland social impact of their transactions. Proactive managementcan thus help anticipate future regulation.

● Implementation of environmental and social risk screeningmay affect corporate relationships and business volumes in theshort term, specifically in project finance, export finance andpotentially corporate finance when the use of proceeds isknown. Nevertheless, it reduces banks' legal and financial

liability and exposure to reputational risk and builds a positiveimage that partly offsets post-crisis image disaffection forbanks.

● The cost of implementing ESG risk screening measures ismarginal while relevant models are far from beingstandardised. Further integration into risk models affectingBasel ratios will probably not be immediate.

Systemic & SpecificESG Issue

EnvironmentManagement

● Human capital attraction and retention (All). Banks’ ability toattract, retain and motivate employees can be measured through:1) remuneration policies; 2) employee productivity; and 3) cultureand training. Post crisis, the banks sector has become less appealingfor new recruits to work in and is likely to suffer as a result.

● Managing ageing (Retail). Managing the reversed age pyramidin the sector is a challenge that can be tackled by ensuring thelong-term employability of staff (including trainees), as well astransmitting experience to the new generation of employees.

● Restructuring is likely to be scrutinised by governments forbanks that have benefited from state aid, thus potentiallyincreasing the cost of any layoff plans.

● There will most likely be pressure on operating costs whilevisibility on earnings and balance sheets is improving.Operating expenses are likely to be kept under tight controlduring the downtrend in the credit cycle, limiting both jobopportunities and skill development.

Specific ESG IssueHuman capitalmanagement

2 The Lamfalussy Process is an approach to the development of financial service industry regulations used by the European Union. It is composed of four "levels," each focusing on a specific stage

of the implementation of legislation. http://ec.europa.eu/internal_market/securities/lamfalussy/index_en.htm3 A Tobin tax is a tax on foreign currency exchanges. Named after the economist James Tobin, the tax is intended to put a penalty on short-term speculation in currencies.

Systemic ESG IssuesRisk Control

and Transparency

4 Scope 3 emissions include all indirect emissions. The latter stem from sources that are not owned or controlled by a company, but which occur as a result of its overall activity.

5 www.equator-principles.com, www.unpri.org, www.theclimateprinciples.org

10th in a series

T his Eurosif sector report has been compiled using research by CA Cheuvreux. It describes the majorenvironmental, social and governance (ESG) challenges facing the European banking industry and theassociated risks and opportunities these pose for long-term returns.

BANKING OVERVIEW ● The European Banking sector consists of 6,600 banks, with total

assets of more than €23 trillion. The top 300 listed banksrepresent nearly 80% of the sector and account for about15% of the major European index benchmarks. Banks directlyaccount for about 5% of European GDP, their indirect impactis 50% and they are a key contributor to employment, growthand stability across the European Union. Chart 1 reflects theirimportance to the economy by showing the marketcapitalisation and total assets for the top 20 European banks.

● Four major bank business profiles have been identified: - Retail Banks (RB) refer to banking institutions that handle

transactions directly with consumers, rather than withcorporations or other banks. This is a very mature businessin Europe, and contributes to over 50% of European banks’

profits. Key drivers in this sector are loyalty and mobility.- Commercial Banks (CB) carry out traditional corporate

lending activities and credit facilitation through a widerange of products. This is a competitive business segmentthat is highly exposed to economic cycles where access tocapital and geographical representation are key issues.

- Investment Banks (IB) carry out all financial market-relatedactivities notably trading in securities, managing corporatemergers and acquisitions, originating, underwriting andsyndicating both equity and debt, and insuring bonds (e.g.selling credit default swaps).

- Wealth Management (WM) is an investment advisorydiscipline that incorporates financial planning, investmentportfolio management and a number of aggregatedfinancial services.

CASE STUDY: REMUNERATION IN THE BANKING SECTOR

0

20 000

40 000

60 000

80 000

100 000

120 000

140 000

Hsbc

Holdin

gs

Banco

San

tander

SA

BNP Par

ibas

SA

Barcla

ys

BBVA (B

anco

Bilb

ao)

UBS AG

Unicred

it SpA

Credit

Suisse

Group

Inte

sa S

anpao

lo S

pa

Royal B

ank

Of Sco

tland

Lloyd

s Ban

king G

roup P

LC

Societe

Gen

erale

Standar

d Char

tere

d

Credit

Agricole

Nordea

Ban

k

Deuts

che

Bank

AG

Sberban

k

Natio

nal Ban

k of G

reec

e SA

Dansk

e Ban

k A/S

Svensk

a Han

delsban

ken A

B

Mark

et

Cap

. (�

m)

0

500 000

1 000 000

1 500 000

2 000 000

2 500 000

3 000 000

To

tal A

ssets

(�m

) 2008

Market Cap. Total Assets

BANKING TRENDS● Commercial Banks. A key issue is the ability of commercial banks

to charge the right price for credit. Using lending for clientacquisitions distorts a key function of commercial banking, asprice cannot guide capital allocation. The apparent aggregationof commercial and investment banking allows for cross-subsidisation between lending and needs to be reassessed.

● Investment Banks. Investment banks are highly sensitive tomarket cycles and volatility. (Human) capital, funding andliquidity are the key features embedded in a structured riskmanagement model. This industry will be the most profoundlyaffected by a tighter regulatory environment, and this will leadto lower leverage and ultimately higher capital charges, whichwill structurally lower return on equity levels.

● Wealth Management. This model could change, with two driversbeing introduced: 1) segregation between asset managers (AM) andnetworks; and 2) the separation of passive and active AM, whichshould help clients select the right product at the right price.

● Stronger financial regulation is high on the world agenda. As shown in Chart 2, banks have been significantly impacted bythe crisis; in some cases, losses have approached their requiredTier 1 capital levels. Thus, world and EU leaders utilised the G20summits to push for tighter rules. Nevertheless, should thecurrent regulation efforts fail to shift banks' models towards anapproach favouring stable economic growth, the ultimate threatis a Glass-Steagall1 type of reform. Bank performances shouldnow be primarily assessed in relation to risk profiles and be morefocused on the long term.

● Retail Banks. The crisis has increased concentration and marketstrength for retail banks, which are highly exposed to economiccycles. However, the crisis context has also led to reducedpressure from the European Commission's (EC) antitrust rulesand consumer protection laws. Players such as telecomcompanies, media groups and retailers are showing renewedinterest in providing financial services.

Eurosif wishes to acknowledge the support and direction provided by the Bank Sector Report Steering Committee:Bank Sarasin

Domini Social InvestmentsFundación Ecología y Desarollo (ECODES)

IDEAMLiving Planet Fund Management Company S.A.

Oddo SecuritiesPictet Asset Management

Triodos Bank

La ruche - 84 quai de Jemmapes • 75010 Paris, FranceTel : +33 (0)1 40 20 43 38

contact@eurosif.org • www.eurosif.org

9 quai Paul Doumer • 92920 Paris La Défense FranceTel: +33 1 41 89 74 69

svoisin@cheuvreux.com • www.cheuvreux.com

Des

igne

r: C

atsa

ï - w

ww

.cat

sai.n

et /

The

view

s in

thi

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cum

ent

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ot n

eces

saril

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pres

ent

the

view

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Euro

sif

mem

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iate

s. T

his

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shou

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Chart 1: Top 20 European Banks - Market cap vs total assets (2008)

September 2009

Banking

This sector report has been compiled by :

1 The Glass-Steagall act was a 1933 United States national law separating investment banking and commercial banking firms.4/5 http://www.marisec.org/shippingfacts/worldtrade/

Chart 2: Cost of the Crisis

The financial crisis exposed the inherent weaknesses of theremuneration system used by banks. This system rewardedexecutives for behaviour that encouraged excessive risk-taking inorder to earn bonuses that were dependent on an assessment ofshort-term performance which failed to account for long term risks. However, given the EU's failure to adopt a coordinated approach tothe issue of remuneration, the best path to reform may in fact bemarket-based, with shareholder and government involvement wherenecessary. In our view, UBS and Credit Suisse's recent implementationof remuneration policies designed to encourage long-termperformance supports this argument.

Remuneration Example - UBS

UBS's new model tackles head-on the primary issue for any reform ofbank's remuneration policies, namely the payment of bonuses basedon performance that is neither transparent nor sustainable over thelong term. The new plan introduces a bonus/malus system underwhich a maximum of one-third of the bonus can be paid out in cashat year-end, subject to positive business development. The remainderwill be held for five years in escrow in a bonus account. Should UBS'ssubsequent performance be poor, a negative award, or "malus", canresult and the bonus account will decline, reducing any subsequentawards paid out.

Remuneration Example – Credit Suisse

Credit Suisse's (CS) plan does not include a malus/bonus system butuses debt rather than capital to remunerate employees. Under CS'sscheme, employees of the Investment Banking business will receivethe majority of their deferred bonuses in the form of partner assetfacility awards (PAF). The PAF awards are indexed to a specified poolof illiquid assets based on the most illiquid loans and bonds on CreditSuisse's balance sheet. PAF holders will realise potential gains if assetsin the pool are liquidated at prices above the initial fair market value.However, PAF holders cannot receive any payments for at least fiveyears after the awards are granted, at which point participants willreceive an annual cash payment.

ConclusionIn our view, both shareholders and regulators should welcomethe Credit Suisse plan, as it potentially removes risky assets fromthe balance sheet and preserves capital, while introducing thisrisk directly into executive pay over the long term. Furthermore,long-term participants have the opportunity to gain some upsidein the event that the toxic assets6 return to value. Both the UBSand Credit Suisse remuneration structures have raised the bar interms of challenging remuneration committees to meet theneeds and objectives of shareholders and regulators. However,while we welcome these two remuneration plans, we areconcerned by the potential lack of incentives for independentbanks to adopt similar policies.

Both President Nicolas Sarkozy of France and Chancellor AngelaMerkel of Germany have publically stated their view thatunlimited bonuses contributed to the excessive risk taking bybanks and there is now growing impetus for greater internationalcoordination to establish a common consensus on how bonusesare paid. The G20 summit in Pittsburgh in September 2009 thusoffers an opportunity for France and Germany to convince theworld's largest economies that mandatory bonus limits areneeded to prevent the continuation of excessive risk taking bybanks.7

However, despite the new momentum, a consensus on limitingbonuses may not be achievable and it is possible that the mostviable solution may come via tougher controls on capitalrequirements and a formal consensus on requiring bonuses tobe based on long-term performance. This would allow nationalregulators to use Basel II to require financial institutions thatcontinue to operate inappropriate remuneration policies thatencourage unnecessary risk to set aside additional capital. Thelinking of risky remuneration practices to increased capitalrequirements would be a direct incentive for boards toimplement long-term-oriented and sensible remunerationpolices. However, defining relative risk tolerance levels willremain a key challenge.

6 The UK government has requested that the bulk of the bonus pool (GBP950m) paid to executives at RBS in 2008 be in the form of subordinated debt rather than capital and that this should be staggeredover three years with a 100% claw-back provision.

7 Particularly bonuses paid to traders who are able to take on significant risks. The proposed revision of IAS 39 would also allow bonus pools paid to traders to be triggered only if the trade was priced atmarket value as this would ensure that the P&L was eligible for immediate bonus payments.