Financial services firms are making changes to their compensation practices to better align pay practices with risk management concerns, the Institute of International Finance reports.

The IIF said Monday that firms are reforming compensation schemes in line with the principles published by the IIF in July 2008 and by the Financial Stability Forum that said its principles “aim to ensure effective governance of compensation, alignment of compensation with prudent risk taking, and effective supervisory oversight and stakeholder engagement in compensation.”

The trade association released a report on compensation practices carried out by the consultancy firm Oliver Wyman, which found wide agreement that compensation incentives should not induce risk-taking in excess of the firm’s own risk appetite, and significant support for the view that compensation should include a component reflecting the firm’s overall results in line with sound risk management and business goals.

It also found that firms are actually changing their practices to align with principles established by the IIF. Klaus-Peter Mueller, chairman of the supervisory board at Commerzbank AG, noted that the majority of firms surveyed are moving towards full alignment with the IIF principles. “The consensus around the direction of change in industry compensation practices is unprecedented and provides a solid basis for the initiatives underway in the financial services industry,” he said.

The IIF said that a lot of work still remains to be done to fully reform compensation structures, but it noted that today’s report showed that a number of firms have already developed systematic approaches towards reflecting risk in performance measurement, handling deferred compensation mechanisms and establishing sound governance standards for the overall compensation process.

The survey, which involved firms in North America, in Europe, and Asia conducted during a three-month period just ended, found that 98% of respondents agree that compensation structures may have been one of several factors underlying the current market crisis.

Josef Ackermann, chairman of the board of directors of the IIF, chairman of the management board and the group executive committee of Deutsche Bank AG, said, “The message today is that progress is being made in reforming compensation in firms across our industry. The leading edge of these efforts reflects the first of the IIF’s principles, which stresses that compensation incentives should be based on actual performance and should be aligned with shareholder interests and long-term, firm-wide profitability, taking into account overall risk and the cost of capital.”

“The industry broadly recognizes that compensation structures in the past had shortcomings. It is necessary for firms to put in place practices that are more appropriately aligned to the current and prospective needs of our industry and to the exigencies of market stability,” Ackermann added.

Rick Waugh, president and CEO of Scotiabank and the co-chairman of a special IIF steering committee on the implementation of market best practices, said, “At a number of firms there has been a culture that has fostered employee bonus expectations that are not consistent with long-term performance, with current conditions in the market or with sound risk management practices. We are now seeing a whole range of fundamental changes in industry practices that are principles based and that is very encouraging.”

IE