FirstRand exposes a vulnerability in South Africa’s financial system

Most of the largest companies have allocated share awards at Covid-knockdown prices to their executives. Assuming economic conditions and share prices trend back towards normal over the next few years, those share awards will become extremely valuable.

And then it will become very obvious that we weren’t all in this together. In the medium- to longer term executives of listed companies will emerge considerably better off than most of us.

Covid and executive opportunism will have aggravated inequality.

That FirstRand’s remuneration plan scored an unprecedented 56.7% opposition from shareholders is an indication that even large institutional shareholders are weary of the usual self-serving explanations for executive largesse.

Read: FirstRand hopes to return to dividends next year

FirstRand’s explanation was self-serving, but the accompanying narrative provided at last week’s AGM by its remuneration committee chair Louis von Zeuner was particularly forceful.

Remarkably, at various stages during the meeting members of the FirstRand board seemed to suggest that failure to compensate executives for the Covid-induced hit to their long-term bonuses could affect South Africa’s financial system.

“FirstRand is a large systemic institution and the custodian of billions of rands of savings of the South African public and business community with a customer base of eight million,” said Von Zeuner in response to questions about the innovative ‘Covid instrument’ that will compensate executives for the Covid-related impact on their long-term incentives.

For example CEO Allan Pullinger received a R19.3 million boost to his 2020 reward thanks to the Covid-instrument.

This makes up for much of the lapse in long-term awards that were made during 2017 but not for the absence of short-term bonuses in 2020. The long-term incentives lapsed because of the economic fallout from Covid-19 and the consequent lockdown, which meant that return on equity in the 12 months ended June 2020 was far short of the target needed.

Lip service

As Tracey Davies, director of non-profit shareholder activism organisation Just Share, pointed out to those attending the AGM: the thinking behind the Covid instrument appeared to be at odds with commitments made by FirstRand earlier in the year, when President Cyril Ramaphosa asked business leaders to make sacrifices given what was at stake.

Eight months later there’s little sign of sacrifice from the bank’s executives.

Or almost any other executive of a listed company for that matter.

No doubt, like all the rest of us, the executives have taken a hit. How sustained and how hard will only be known a few years down the track. But it’s worth noting that the FirstRand share price has already recovered significantly from the worst of its early Covid knock and next year’s earnings should benefit from the non-repeat of the “conservative front-loading of impairment charges”, which accounted for much of the earnings knock in 2020.

This means the Covid-instrument share-based awards allocated during the last few months are already looking considerably more valuable.

The difficulty for shareholders and probably a vast chunk of FirstRand’s eight million customers is the sense of entitlement that underpins the creation of the Covid instrument.

Executives evidently believe they are entitled, not just to generous levels of guaranteed pay, but to long- and short-term bonuses, regardless of what happens. In this world a bonus is no longer something over and above normal expected payment; it is a part of the expected payment.

Tall-order jobs

“This is an institution that is complex and important to the broader SA economy and the skills set to run a business of this nature is limited,” said Von Zeuner.

Implicit in Von Zeuner’s explanation for the Covid instrument was the suggestion that if FirstRand’s senior executives are not compensated for the Covid hit to their remuneration, they will accept the apparently limitless number of job offers available to them – not only from South African financial institutions “but even global institutions”.

When asked by Just Share’s Emma Schuster if FirstRand would share the information that Von Zeuner referred to when talking about fears of senior executives leaving the group, the remuneration committee chair seemed to bristle – as though he suspected Just Share wasn’t entirely buying the explanation.

He launched into an aside on the group’s integrity. “Our value system and integrity are not negotiable.”

As proof of that integrity Von Zeuner pointed out: “We didn’t change the vesting rules.”

Remarkably, the remuneration committee has the discretion to alter the vesting rules to ensure executives get paid bonuses regardless of what happens. (Changing the vesting rules is the option Standard Bank has chosen in preference to FirstRand’s Covid instrument route.)

It seems Just Share and any other concerned stakeholder will just have to take the bank’s word.

The ‘systemic institution’ aspect

Group chair Roger Jardine added to Von Zeuner’s systemic warning, explaining to shareholders that the board is aware that the issue of inequality is “a burning platform” in our society but that it is also “mindful that FirstRand is a systemic institution.” And, as though trying to console shareholders, he added: “We looked around the market and by no stretch of the imagination are our executives remunerated way ahead of our peers.”

Jardine explained that the board wanted FirstRand to be standing strong post-Covid.

“We think the measures we’ve taken will go a long way to ensuring that.”

If Jardine and fellow director Von Zeuner had been trying to comfort shareholders, they failed spectacularly.

The vote against the remuneration implementation report was an unprecedented 56.7%, a sharp hike from the 19.5% that opposed the report at the 2019 AGM.

“Very clearly shareholders aren’t pleased with the Covid instrument as constructed,” concluded Jardine.

Bigger issue

But perhaps the bigger issue raised during the 2020 AGM was how vulnerable South Africa’s financial system is to being held hostage by a relative handful of executives.

The danger is not just that these executives might head out the door in droves but that even if they don’t go, they’ll be so distracted by the knock to their remuneration that they won’t be able to do their jobs properly.

“It is extremely important that we retain our talent and get them to focus – without being concerned about rewards – on the task at hand,” explained Von Zeuner.

Simple solution …

There is no doubt – thanks to rapidly-changing technology, increasingly detailed regulatory oversight, and complicated and ever-changing accounting standards – that banking in the 21^st Century is complex.

But this complexity hasn’t just arrived on FirstRand’s doorstep; it’s part of an ongoing process.

Chief investment officer at Aeon Investment Management Asief Mohammed, who attended the AGM and described FirstRand’s response as tone deaf, said the group should be constantly building a large talent pool.

With 50 000 employees, there are surely systems in place designed to identify and train enough people to ensure there are at least a handful of potential candidates available to replace every disgruntled executive demanding more money?

If not, then perhaps the executives and directors in charge of nominations and risk need to be overhauled.

Executive replacement strategy

From Von Zeuner’s description it appears that the entire financial system’s executive placement strategy is based on poaching.

This of course is the easiest and most attractive option for the incumbent executives. It requires less effort from them and, by guaranteeing a continued skills shortage, can be used to underpin steadily increasing levels of remuneration.

But it leaves the Reserve Bank, shareholders and the banking public horribly exposed.

Read: Redirect the focus of exec remuneration at banks and maybe save SA

As for Von Zeuner’s comment that it will be interesting to see how other banks respond to FirstRand’s ‘Covid instrument’, in the copycat world of executive pay, that response is entirely predictable.

Standard Bank and Liberty have already moved to protect the remuneration of their executives from real world events. And thanks to FirstRand they can justify their largesse by referring to pressure from competitors.

Read: One for the people, and 10s of millions for the executives (Absa)

For Von Zeuner and his remuneration committee colleagues it is a self-fulfilling defence that enables an ever-upward ratcheting of executive pay and guarantees growing inequality.