Investors at Barclays Plc and HSBC Holdings Plc have voted decisively to eliminate UK bonus caps for investment bankers and traders. This move signals a shift towards greater cost and risk management, rather than a frenzy for excessive payouts. With US banks like Goldman Sachs Group Inc. leading the charge, the demise of these caps seems imminent, marking a pivotal moment in financial regulation. Yet, challenges remain in restructuring pay and mitigating risk effectively.
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By Paul J. Davies
Investors in Barclays Plc and HSBC Holdings Plc voted overwhelmingly to scrap UK bonus caps for investment bankers and traders at their annual general meetings this month. Shareholders haven’t been hypnotized by money-mad rainmakers, nor are they falling over themselves to throw more of their share of profits at employees. Quite the opposite: They voted to claw back greater control of costs and risks by making pay more flexible and allowing more of it to be deferred for longer.
Among US banks, Goldman Sachs Group Inc. has already told staff it will be getting rid of the bonus limit in the UK, while JPMorgan Chase & Co. is reviewing its policy, according to Bloomberg News. It’s a fair bet that peers will follow suit, consigning the cap to history before long.
With investment banking fees recovering strongly this year, predictions of higher bonuses have logically followed, generating easy headlines about windfalls for overpaid bankers. Indeed, Britain’s umbrella group for trade unions called on UK banks not to follow the lead set by Goldman Sachs while so many hard-pressed families struggle with a cost-of-living crisis.
But it’s not that simple, and scrapping the cap is the right thing to do. It will be complicated for banks to change the structure of how they pay material risk-takers and convince some of them to sign up for deep cuts to basic salaries, because for some the upshot could be a drop in total income in the years ahead.
Limiting bonuses in Europe and the UK was always a triumph of political posturing over practical impact. After the 2008 financial crisis, people wanted to see bankers punished for taking too much risk and leaving taxpayers with the bill, while everyone was looking for ways to make such a disaster less likely in future. Hitting the industry in the wallet seemed a quick way to quell public anger and end casino capitalism.
However, plenty of non-politicians, including UK regulators, foresaw the obvious unintended consequence. Restricting bonuses to 100% of base salary (or 200% with direct shareholder assent) just meant fixed pay rose significantly. In Europe, average base salaries more than doubled and, in one infamous case, the highest-ranking Citigroup Inc. executive based in London, Paco Ybarra, saw his fixed salary balloon to more than five times that of his boss, Chief Executive Officer Jane Fraser.
Remember that a key aim of going after pay in the financial sector was to discourage excessive risk-taking and forestall another major economic crisis. The actual effect was precisely the opposite: Traders were guaranteed a much bigger slice of their income no matter what happened with their bets, paid immediately and in cash.
A far better way to stop traders swinging for the fences when they’re putting a bank’s money on the line is to defer more of their rewards for longer. That way, executives, shareholders and regulators get to see the full consequence of bankers’ actions before their compensation as been awarded, taxed — and spent.
In the US, some regulators are making a third attempt since 2011 to force larger banks to defer as much as 60% of bonuses for as long as four years, a much more effective way of mitigating risk. Unfortunately, there’s little chance of this being adopted, according to Bloomberg Intelligence, because the proposal isn’t backed by the Federal Reserve or the Securities and Exchanges Commission. It’s being led by the Federal Deposit Insurance Corp., whose reputation has been severely damaged by a deepening scandal over workplace misconduct.
It wouldn’t be a surprise to see the bonus cap scrapped in Europe at some point, too. The bloc’s biggest banks will be campaigning for that because they must obey European rules on pay in every market around the world — US and UK banks, in contrast, only satisfy requirements for employees based on the continent.
Deutsche Bank AG Chief Financial Officer James von Moltke said on Bloomberg TV recently that the UK move would put the German lender at a competitive disadvantage outside Europe. The regulatory differences could make it harder for European investment banks to attract the top traders and dealmakers who expect to bring substantial revenue into their firms and get the rewards for doing so. At the same time, it could make it much easier to keep those bankers who are less senior or less certain about how much business they’ll get credit for.
But von Moltke and other European bank CFOs will be left struggling with the higher base of fixed costs compared with US and UK peers. That’s the real competitive disadvantage they’ll worry about most.
In the UK, scrapping the bonus cap is one of the few real benefits of Brexit the government can claim, although it probably wouldn’t be the most politically astute move. It at least gives banks another reason to resist the pull of moving individual bankers to Europe and so could protect Britain’s income-tax take from the sector. But it’s UK bank investors that are getting the best chance to take back control.
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