Bankers’ pay: Bonds. The bonus is in bonds.
Tucker supports Liikanen proposal; Bank chairmen split on compensation
The vexed question of banker pay was high on the agenda at the British Bankers’ Association conference in London in October. Bank of England deputy governor Paul Tucker raised the issue in characteristically ebullient manner by arguing that those in the industry should be paid in bail-inable debt to tie them more closely to the success of their firm. "Bankers should be paid not only in equity options but also in subordinated debt," he said. "There needs to be a significant financial stake not only in the profitability of the firm but in the survivability of the firm. The Liikanen report supports this."
The governor of the Bank of Finland’s October report on restructuring EU banking did mention the idea, although Erkki Liikanen did not expand on why bankers should be paid in a form senior in the capital structure to equity investors. In any case, more forceful than his mention of bail-inable debt was Liikanen’s suggestion that a regulatory approach to remuneration should be considered that could stipulate absolute levels, for example that the overall amount paid out in bonuses cannot exceed paid-out dividends.
In September, Deutsche Bank laid out new plans to retain deferred equity compensation and only pay it out after five years, leaving long enough time for capital losses to accrue from any trade that greedy bankers might have put on to secure up-front earnings.
|Bank of England deputy governor Paul Tucker|
So, far from coming across as tough on the banks, Tucker might find that he is pushing against an open door on this one. Bankers that have been paid in subordinated debt over the past few years have generally been delighted. When Credit Suisse announced in 2008 that it would pay some senior staff in legacy assets such as CMBS and high-yield bonds rather than cash there was a collective snigger among staff at rival banks. These assets had, however, increased in value by 75% at the end of last year. The bank’s share price was down 23% over the same period. Another bank that has paid staff in subordinated debt since 2009 is RBS.
The banks themselves seem to support the idea too. "If we can get investors interested in CoCos it will be very interesting," observed Barclays chairman Sir David Walker at the same meeting. "The principle is perfectly attractive." The UK bank first announced its intention to pay bonuses in contingent convertible notes at the beginning of January 2011 under then chief executive Bob Diamond. Since then, however, the market in CoCos has stalled.
Given the performance of many bank shares in recent year, and the profound uncertainty over whether banks can sustainably generate returns on equity above the cost of equity, most in the industry would prefer to be paid bonuses in almost anything other than stock.
At least Tucker is aware that there is a healthy degree of scepticism over the extent to which pay in bail-inable debt will temper bankers’ behaviour. "People have to believe that the regulators will pull the trigger," he admits. "How do you persuade people that you really will do it?" He argues that it boils down to having the right resolution regime. "There are very powerful incentives not to ask for government support. Making a success of resolution requires having the right regime in place," he says. "The European Recovery and Resolution Directive (RRD) that is now going through is very important. In many ways it is more powerful than Dodd-Frank." Tucker has limited sympathy with the argument that if bank bonds are held by a small number of large institutional investors then bailing them in could be too disruptive. "The people who were bailed out [when the UK government nationalized Lloyds and RBS] were the holders of the bank bonds – not the bank themselves. Don’t forget that," he says.
In a panel discussion that BBA chief executive Anthony Browne claimed set the world record for the number of bank chairmen on one stage, opinions were sharply divided on the issue of compensation. The discussion included Barclays’ Sir David Walker, Lloyds’ Sir Win Bischoff, Standard Chartered’s Sir John Peace, RBS’s Sir Philip Hampton and HSBC’s Douglas Flint.
Hampton did not mince his words on pay. "It was grotesque," he said. "Pay became completely out of line with pay in other sectors and completely out of line with shareholder returns." He noted that "it is falling quite sharply now. All of our metrics on pay have been heading south for the last four years."
But others maintain that the public’s continuing criticism of compensation in the industry is more a reflection of the economic environment than a justified observation that something is wrong. "Banks have not been very good at making it understood what the primary purpose of banking is," mused Bischoff, chairman of Lloyds Banking Group when asked about pay, adding that "we have to demystify banking." He dismissed concern over pay, stating that: "High incentive compensation is paid in many industries. But it has to be paid out of profits after shareholders have been paid."
Flint, group chairman at HSBC Holdings, said:. "What has happened has drawn attention to it." He conceded that pay structures were flawed. "What was absolutely wrong was that people were paid in advance of profits being realized, but we have addressed this. The division between executive and shareholder pay needs to be addressed – but shareholders weren’t concerned about the levels of executive pay when profits were rising," he pointed out.