The arrest of BTG Pactual’s CEO André Esteves at the end of 2015 (on still-unproven charges of obstruction of justice in Brazil’s seemingly never-ending corruption enquiry ‘Lava Jato’) sparked a run on the bank that very nearly led to its collapse.
Esteves was not just the public face of the bank, he was its founder, the dominant partner and its controlling shareholder. As such, key-man risk was baked into the bank’s governance model from the very start. So when police seized him at his house in Rio de Janeiro, they kickstarted a severe reputational stress test that BTG came dangerously close to failing.
However, while it passed, the bank’s wider governance model gave it the rigidity to survive the flight of assets caused by Esteves’ incarceration. And, as originator of this model, Esteves can paradoxically take a large amount of the personal credit for offsetting the risks that the centralization of his leadership had created.
In the 2012 IPO, the shares of the bank’s partners were not placed directly into the listed vehicle but rather into a holding company that was 100% owned by the partners. If partners want to leave the bank – or cash out a little – they cannot sell their shares on the open market. Instead they have to sell their shares back to the partnership’s holding company at book value, with those shares reassigned to the remaining partners (also at book value).
Tying employees’ equity holdings up in this way – and requiring employees to invest their wealth in funds managed by the firm – clearly worked against any impulse to desert a sinking ship.
BTG Pactual marketed this innovative share-scheme design heavily in the IPO because it believed that it created an innovative and powerful incentive structure for investors – and contrasted it with IPOs by US investment banks like Goldman Sachs and Morgan Stanley, which made a lot of senior bankers very rich by enabling them to sell their positions at the listed price.
And, come the stress test, BTG’s model proved solid. There was no exodus of key talent. Usually in similar situations, a bank’s competitors circle and tempt away or, at least, distract the talent required to pull the bank through the crisis.
Huw Jenkins, who has seen a catastrophe first hand at UBS, is under no doubt that the partnership model gave BTG an edge in surviving the mess: “If I look at the speed at which a classic joint stock bank reacted [to a crisis] versus a partnership – where all the senior traders have all their capital tied up in the shares of the company – then it is very different. The speed of response was one of the couple of real plusses [that came out of the BTG crisis].”
Stronger alignment also seemed to help. With the bank in an existential crisis and scrambling for liquidity, there were no reported examples of bankers trying to protect individual P&L. The bank achieved its goal: survival.
There is one potential flaw in the governance structure: Esteves had to relinquish control voluntarily. The passing of his voting rights to the seven partners who owned the next largest block of shares in the bank only came into force if he was ‘no longer an employee of the firm’.
This condition was designed to provide for a smooth transfer of power should he die or become medically incapacitated – it had not envisaged him being sent to prison. But his personal economic alignment (he remains a large shareholder) means that it would have been a strange decision if he had not passed control to those still free to fight for the bank’s survival.
BTG Pactual provides an interesting case study. Regulators continue to grapple with complicated formulas to strengthen banks’ capital levels and tweak risk-weighted asset requirements. They have spawned new contingent convertible instruments that have changed the dispersion of risk when banks become illiquid but arguably have not done much to make these banks more stable during real-life stress tests.
Perhaps a simpler solution lies in trying to replicate the durability of partnerships – tying senior management’s long-term economic interests once again to the viability of the organization that is rewarding them so handsomely – and in doing so better aligning their interests with those of shareholders.
As Esteves said in an interview with Euromoney in 2012, bankers in the US and Europe seem to expect the level of rewards reaped by entrepreneurs without accepting any of the personal liability if those banks fail.
BTG Pactual shows this old-fashioned partnership model can be better replicated through innovative executive compensation structures. And it is high time that they were.