How to Incentivise Sales for Financial Services Industry – Part 1
The impact of the 2007-2008 financial crash has been both significant and far-reaching. Myriad arrears of the financial services sector have been affected, including products sold, capital adequacy and resilience, and how customers are treated. Incentivising sales has been an area of specific concern for European and UK regulator, including the European Securities and Markets Authority, European Banking Authority, and Financial Conduct Authority, due to the mis-selling of financial products.
In this article, we look at what the current guidance is, what it means, and how financial institutions have responded to it. The specific focus is on the UK, but similar trends are seen across Europe.
This could get dry and dusty, but it is important to recognize where the change in sales incentive plan design originates.
Central to the direction of travel are two key themes – focus on customer trust in financial services institutions and management of risk to those institutions:
- Customer trust. For example, from the Financial Conduct Authority (FCA)’s Final Guidance document (2013)
‘We know that the way sales staff are paid influences how and what they sell to consumers. Equally, we recognize that firms may want to incentivize their staff to sell. We do not have a problem with incentive schemes, but they must never be at the customer’s expense and the risks need to be managed properly. Consumers must be confident they are being sold a product for the right reasons.’
- Risk management. For example, from EBA’s Capital Requirements Directive (CRD IV)
‘Institutions’ remuneration policies for staff members whose professional activities have material impact on the institutions’ risk profile shall ensure that remuneration is consistent with sound and effective risk management and provides an incentive for prudent and sustainable risk taking.’
Across Europe, individual countries have developed their own guidelines. In the UK it is the FCA that has developed its guidance throughout the 2010s, building on earlier work delivered by its predecessor the Financial Services Authority.
What does the guidance mean?
The FCA guidelines provide helpful definitions of what compliant and non-compliant sales incentive plans look like:
Examples of compliant plan design would be:
- Linear calculation of payout such as no accelerators for over performance
- Consideration of the long-term impact on the client, such as using customer feedback as part of the assessment of performance. Many companies are now using Net Promoter Scores as part of a Balanced Scorecard, for example.
- Use of qualitative criteria to calculate payout. Effectively this means using a wider assessment of contribution including performance ratings.
- Using a common method of incentive calculation across the salesforce.
- Using volume as a performance measure rather than profit margin.
- Use of organization measures.
Examples of non-compliant behavior would be:
- Differential rates of commission for different products which in the past have had the effect of selling the higher-value product rather than the product which best suits the need of the customer.
- Increased commission rates linked to marketing events.
- Selling of products with higher returns.
- Use of thresholds which have the effect of pushing the seller to reach a higher level of commission.
- Additional remuneration for add-on features by which customers are encouraged to buy higher value products with features they don’t need.
- Reduction of base pay if targets are not achieved.
- Commission rate acceleration as more product is sold.
Essentially all of these examples raise the potential for the seller to act more in their own interests than the customer’s, with the increased chance of mis-selling.
How have companies responded?
The financial services sector is a diverse one, with a complex mix of sub-sectors. Responses have been nuanced, depending on what an organization is selling and how. Here are some of the main trends we’ve observed:
- The FCA guidance is termed compliant and non-compliant, so the reality is that if you are in breach of the guidelines, the FCA is looking to prosecute and impose a fine if the firm is found in breach. The more high-profile the institution, the faster it has moved to be compliant. So, household name retail banks have been relatively quick to redesign incentives and become compliant. Smaller institutions have been less quick to introduce change. For more specialized firms, like Broking and FX, the concept of proportionality has meant that only recently are many firms introducing incentive plans that are more compliant.
- The speed with which organizations have become compliant has varied. Many organizations have introduced a program of gradual change; balancing the need to comply with the probability of being investigated by the regulator. At the same time, they are trying to remain attractive to new talent and maximize short-term profitability. Some companies want to be seen to be complying and see compliance in itself as a competitive advantage.
- A shift in the style of incentive plans from product-led commission plans to target-driven sales bonus plans.
- A common response to the challenge has been the development of a team-based bonus pool, replacing individual commission for product sales. The size of the bonus pool is determined most frequently by team/company revenue performance. The individual share of the bonus pool is guided by individual contribution, with calculation based as much on qualitative as qualitative measures.
- Businesses used to rely on the incentive plan itself to manage individual behavior, with “measurement drives performance” a common mantra. Broadly speaking, the new approach has been for management to exercise more discretion. This means that managers have to do more managing. As a result, many companies have had to review their performance management processes and upskill managers to ensure a fair process.
- Restructuring of the compensation package. The balance between base and variable is changing. Historically, top performers could be expected to earn up to 10x on target variable. Under the new guidelines there would be a 50/50 base variable structure with the opportunity to earn a maximum of 2x or 3x variable; with total target cash a vital consideration.
- Payout cycles are also getting longer. Where payout used to be weekly, monthly is more common. Where monthly payout was the practice, quarterly payout is more widely seen. This is largely because judging team performance makes sense over a longer period to iron out inconsistencies in shorter timescale performance.
- Finally, the use of malus and clawback clauses in incentive plans is now more pertinent. Payout can be reduced for errors in calculation, substantiated complaints, and compliance shortfalls. For some firms, a compliance/customer complaint threshold has been introduced. If this threshold is exceeded, IE compliance failures or substantiated customer complaints, the bonus can be reduced or withheld.
The impact of evolving regulatory guidance has been widespread but tempered by the scale of the regulators’ ability to investigate and business’ relative fear of sanctions. The effects are there to be seen across all aspects of sales incentive design, from pay mix to performance measures to upside and payout cycles.
We’ve also seen a renewed emphasis on the importance of sales performance management. Something we expect to continue as the focus on customer, fairness and equality doubles down.
From the FCA’s 2019/20 business plan:
“Through our supervision of firms, we will review their remuneration and recognition practices to ensure that approaches to rewarding and incentivizing all staff reinforce healthy cultures and do not drive behaviors that would lead to harm to consumers or markets. We also want to take a broader look at the role that bonuses play in driving behaviors and other nonfinancial motivating factors.”