The resistance to mandatory bonus caps for bankers' bonuses was as inevitable as the public clamour to strip these “fat cats” down to size. In the end – after much politicking worldwide – the bankers won the first round. Mandatory caps have been rejected in favour of a system whereby cash bonuses are limited and deferred, and rewards are paid in shares, though with the possibility of clawing them back if bank profits fall.
The key G20 policy is that 40-60 percent of variable pay should be deferred for at least three years. The changes are expected to be implemented in some countries, such as the UK, by the end of the year. France, Switzerland and the Netherlands are adopting pay standards that in some respects are stricter than the G20 recommendations.
Already, many banks have decided to re-examine and change their pay and reward structures in accordance with the G20's principles. Barclays says that it is reviewing the amount it pays in basic salaries and that it is complying with G20 guidelines on guarantees, giving the impression that it is not paying guarantees lasting more than one year. US banks such as Morgan Stanley and JP Morgan, on the other hand, mindful of how entrenched massive executive pay is on that side of the Atlantic, appear to be still keeping pay high, but are favouring “clawback” clauses whereby pay rewards can be reclaimed – but only if managers and executives have acted “improperly”.
At the end of October Swiss bank UBS said that it plans to reform its pay structure by hiking fixed salaries and matching bonuses to sustainable performance, although it will not implement the changes until key units return to profit. The Swiss bank had already overhauled its compensation system at the end of 2008 after the Swiss government rescued it from the subprime crisis with a cash injection. But an internal memo released to UBS staff on October 5 showed the bank now plans to go further to meet regulatory demands in Switzerland and internationally.
“At UBS, the ratio of variable to fixed compensation was in some cases particularly high,” the memo said.” Fixed salaries at UBS should, in the future, be high enough that the variable portion can be adjusted from year to year, while still ensuring that the total compensation is in line with market standards.”
Swiss competitor Credit Suisse Group has also announced a review of its compensation structure. UBS said bonuses would in future be based on the profitability of each division after deducting capital costs. Other indicators, such as revenue quality and the market position of the division, will also be taken into account. “We can only fully implement this system, however, when our most important businesses return to profitability,” UBS said. “For compensation decisions for the transition year 2009, our general approach is to offer market-competitive compensation in all divisions.
The G20's stance has prompted some governments to codify in law or through regulation that bankers' bonus arrangements must be made more transparent and open to question. At the beginning of November, French finance Minister Christine Lagarde announced new rules to introduce tougher regulation of bankers' pay, with a view to pushing the issue to the centre of the G20 agenda in Scotland and stealing a march on their hosts. Lagarde said the rules for French banks, which include a rule stipulating that banks publish some details of employee bonuses annually, will apply both at home and abroad. Another set of wider principles, which establishes more general rules about transparency and the reinforcement of internal audits on pay, will apply to all banks operating in the country. “This will allow us to have a strong say in demanding other G20 members do the same thing,” Lagarde told a press conference. “We need a level playing field.”
Wide application
France has indicated that it is concerned that the implementation of rules aimed at limiting compensation in the financial sector is not happening fast enough, and that some countries may want to stick to general guidelines rather than enforce more precise rules – a situation that the US is in favour of. The French rules include two sets of regulations. A government decree will apply to all banks operating on French soil, and sets the wider guidelines. “We want the principles to be applied in the widest possible manner,” Lagarde said. The decree provides for more transparency in the yearly publication of banker remuneration, a split between the fixed and the variable part of remuneration, as well as a ban on guaranteed multiyear bonuses, and the principle that the total amount of compensation should not hamper the reinforcement of shareholder equity at banks.
Detailed dispositions, including the obligation to spread at least 50 percent of bonuses over four years (a percentage that is increased to 60 percent for the highest bonuses) and that at least half of the variable part of remuneration should be attributed in shares, are part of regulations set by the French Banking Federation. The rules are extra-territorial and will apply to French banks wherever they operate.
However, not everyone is convinced that the G20's campaign will be effective. In fact, some believe that it will be counter-productive and will not succeed in either capping executive pay, or make the decisions on why such pay awards are devised any more transparent than they presently are. According to some analysts and accountants, bank profits will become distorted and far harder to scrutinise and compare as a result of the G20 changes to banker remuneration.
Analysts at Credit Suisse have published a note highlighting the “potential accounting confusion” arising from moves to defer about half of bankers' bonuses following the September decision by the G20 countries to order a global shift in pay structures. They warn that the way the new bonus packages are structured could lead to disparities between banks and the way they account for staff compensation, under IFRS2, the international accounting standard governing the issue. Daniel Davies, the analyst who compiled the Credit Suisse report on the issue, said: “Several investors have commented to us that this is a confusing accounting policy that does not follow market practice.”
His analysis suggests that Deutsche Bank would show one of the most marked uplifts in profits – USD845m, or 14 percent – this year, while at BNP, there would be an USD811m, or nine percent, boost. The most extreme gain – of 29 percent, or nearly EUR1bn – would be evident at Crédit Agricole, Credit Suisse said, because the French bank is believed to defer none of its bonuses and would move to a 50 percent deferral ratio.
However, such findings have been dismissed by other institutions. For example, the International Accounting Standards Board said that there was little scope for confusion, arguing that only if there was doubt over whether an employee would get a bonus in future should the accounting treatment be deferred.
There are more immediate worries, however. As countries are hanging their rules on remuneration and reward schemes to reflect public anger at home, there is a danger that such approaches will conflict with those taken by other countries which means that the reforms will not be cohesive. For example, US financial groups with operations in London are increasingly concerned that UK regulators' tough stance on pay could create a two-tier system in which UK bankers' bonuses are smaller and spread over a longer period than those of US colleagues.
Wall Street executives say the line taken by the FSA contrasts with the more flexible approach of the Federal Reserve and could lead to uneven pay scales for bankers in similar jobs on opposite sides of the Atlantic. “We have legitimate concerns on how we can pay our people fairly,” said a senior banker at a big US bank. “The FSA appears to be more heavy-handed than the Fed so which guidelines should we be following?”
Dodging a car crash
The Fed and the FSA have issued compensation guidelines in an effort to clamp down on lucrative pay structures widely blamed as one of the causes of the financial crisis. While the Fed proposals steered clear of a benchmark – instead asking the top 28 banks in the US to show their pay schemes did not encourage excessive risk-taking – the FSA code requires banks to comply with specific principles by January, or face enforcement action.
The UK has also already forced the UK's top five lenders – HSBC, Barclays, Standard Chartered, Lloyds Banking Group and Royal Bank of Scotland – and 11 foreign banks (Deutsche, JPMorgan Chase, Goldman, Citigroup, Bank of America, Morgan Stanley, Société Générale, BNP Paribas, Nomura, UBS and Credit Suisse) to sign up to pay reforms agreed at the G20 meeting in Pittsburgh in September. Key elements of those include deferring 40-60 percent of bonuses over three years, potentially reducing the total level of cash awards paid out for 2009, and outlawing so-called “multi-year” guaranteed bonuses.
“The FSA is trying to legislate through the back door,” said a senior London-based banker. “Unless they find common ground with the US, it will cause problems for most banks.” However, people close to the FSA say it will press on with compensation reform even in the absence of international consensus.
But there have also been very strong hints that not all banks are on board with the G20's plans. At the same time as some banks announced publicly that they were overhauling their bonus and remuneration schemes in an effort to implement the G20's code of best practice, Lord Griffiths, the vice-chairman of investment bank Goldman Sachs, put his head over the parapet by claiming the public should tolerate bumper City bonuses for the good of the UK economy. Griffiths, a former special adviser to Margaret Thatcher, said he was not “ashamed” of the generous reward policy at Goldman, which just days before his comments had inflamed the bonus debate by revealing it was on track to hand out a record USD22bn to staff at the end of the year.
Speaking at a debate on regulation and ethics in financial services in London in October, Griffiths said the public should “tolerate the inequality as a way to achieve greater prosperity for all”. “I believe that we should be thinking about the medium term common good, not the short term common good,” he added. “We should not be ashamed of offering compensation in an internationally competitive market which ensures that businesses stay here and employ British people.”
But there is already a tremendous amount of scepticism as to whether bankers will actually acquiesce and surrender to public expectations about executive pay any way. Bankers reckon there are a number of wheezes to get around the G20 bonus rules, which require pay to be deferred over three years with a greater proportion paid in shares than in the past.
One such method to disguise the true level of remuneration is to lift basic pay. For example, Bob Diamond, president of Barclays Capital, has a salary of GBP250,000 a year – small in the context of his bonuses that can reach GBP20m. Yet bolstering basic pay deals could help cushion bonus cuts – a route that has not been lost on UBS, for example.
Another method is to “lend” bankers their bonuses. Last year, RBS was forced to pay bonuses in subordinated debt. It granted loans, albeit at market rates, to bankers whose bonuses were no longer in cash and is expected to do so again next year. If that option does not appeal, banks can sell their shares – even the G20 bonus principles suggest paying in shares. RBS, now majority-owned by the UK government, is banned from paying cash bonuses to anyone earning more than GBP39,000 and is likely to pay bonuses in shares for the 2009 financial year, which bankers can then sell immediately. A more politically sensitive approach might be to just decline to sign up to the agreement. While the major UK-based banks have assured the government they will adhere to G20 principles.
The way forward?
Many of the world's leading banks have already announced – or hinted at – changes to their remuneration and bonus policies. Here are just a few examples.
Barclays Capital
Barclays says that it is reviewing the amount it pays in basic salaries and that it is complying with G20 guidelines on guarantees, giving the impression that it is not paying guarantees lasting more than one year.
RBS
Most staff will receive 50 percent of their 2009 bonus payment in paper immediately convertible into cash in June 2010. A further 25 percent will be available in June 2011, with the remainder available in June 2012. Senior managers will receive 33 percent of their bonus each year, spread over three years. Executive directors will receive nothing until 2012. Clawback clauses are also in operation, but while salary has not increased, remuneration experts suggest that there has been a hike in the company's flexible benefits package to compensate.
Morgan Stanley
Morgan Stanley has a clawback mechanism which is active for three years after compensation has been paid, and which is triggered by “conduct detrimental to the company or one of its businesses”. In May, the banking group reportedly increased base salaries for managing directors to USD400k, up from USD250k, and announced that 25-30 percent of total compnsation will come from base salary in future, up from 15-20 percent historically.
JPMorgan
The bank has said that it is going to operate a bonus clawback policy, but one which will only become active in the event of dishonest and improper behaviour.
Credit Suisse
Bonuses below CHF125k will be paid entirely in unrestricted cash. Above this, a variable proportion (determined by a secret table) will be deferred. Of the deferred element, 50 percent will be paid in Scaled Incentive Share Units (SISU) linked to the bank's share price and return on equity (RoE); the other 50 percent will be paid in Adjustable Performance Plan Awards (APPA), based on the bank's RoE. The bonus system also includes a “clawback” clause: for example, APPAs are adjusted downwards if an employee's business area is loss making.
UBS
The Swiss bank has said that “the larger the bonus, the bigger the deferred equity compensation” and some of the bank's managing directors and senior vice presidents are rumoured to have received 100 percent stock bonuses last year.
BNP Paribas and SocGen
Under new French bonus rules at least 50 percent of all bonuses must be deferred, though that figure will rise to 60 percent for higher amounts. In August, BNP agreed to halve its bonus pool to EUR500m for the first half, although this applies only to the cash component of its payouts. Bonus deferrals at BNP Paribas will occur on a sliding scale: below EUR150k, everything will be paid in cash; between EUR150-350k, 25 percent will be deferred; between EUR350-500k 35 percent will be deferred; and above EUR500k 50 percent will be deferred.
