In an interesting bit of reporting disparity, news of planned EU legislation on bank pay is a top story on the front page of the Financial Times, yet is buried in the Wall Street Journal and didn’t make the cut at the New York Times. Admittedly, that is no doubt in part due to that any EU pay restrictions will affect London based bankers. But it is the US FT edition that is presenting this story prominently, and with good reason. To have rules like that imposed over such a large number of important markets to US firms is going to pose quite a conundrum. No one with an operating brain cell (or who is any good) will take a posting in regions that subscribe to the EU pay model if he can have more liberal pay elsewhere. That in turn means the US firms might need to adopt similar measures.
The high concept of the legislation is that it will substantially defer the payment of bonuses. As the Financial Times explains:
Under legislation expected to pass the European parliament next week, between 40 and 60 per cent of bonuses would have to be deferred for three to five years and half the upfront bonus would have to be paid in shares or in other securities linked to the bank’s performance.
As a result, the cash portion would be limited to between 20 per cent and 30 per cent, far tighter the limits currently used by most members of the 27-nation bloc…
National regulators will have some discretion in applying the rules to their own countries but the overall percentages appear to be fixed. Regulators would be able to impose financial or non-financial penalties on groups with risky remuneration policies.
The legislation would also force banks to link bonuses more closely to salaries – with the aim of reducing the importance of such payments in the financial sector.
Any banks bailed out by taxpayers must rebuild their capital first and repay those funds before focusing on employee pay.
On Wednesday, lawmakers and EU officials welcomed the agreement and said it should help to reduce the “bonus culture” in the banking sector.
“This EU-wide law will . . . end incentives for excessive risk-taking,” said Arlene McCarthy, the MEP steering the legislation through the European parliament.
The Wall Street Journal provided additional detail:
The new rules would also ensure high pension payments are generated as contingent capital, with their final value linked to the strength of the bank. The measures aim to avoid the kind of bloated severance packages for disgraced departing executives that have caused an outcry in Europe.
Banks would also be required to hold a minimum amount of capital to ensure they are covering risk from their trading book and complex securitized investments, such as mortgage-backed securities, to avoid a repeat of risk-related losses like those seen during the financial meltdown. The capital requirements would take effect in 2012.
One has to assume that a big goal is to make sure most of the cash a performed earned is still at the firm in case his results are later found to be, ahem, exaggerated.
Needless to say, the industry sabre-rattling started almost immediately. Back to the Financial Times:
Senior bankers contacted were reluctant to comment but said they believed the instruments would be difficult to design and warned that tough pay rules could drive business to Asia and the US, which have shunned strict limits on bonuses.
Angela Knight, of the British Bankers’ Association, said politicians should realise most banks have already changed their pay practices and keep in mind that “this is an international and mobile business”,
Yves here. The EU has gotten similar threats on other financial services initiatives and has not been deterred. As we noted:
In March, the EU announced plans to restrict the operations of private equity funds. This is far from surprising, since US and UK firms have exhibited a nasty propensity to lever up firms, pull out a lot in the way of special dividends, and too often overdo the cash extraction and leave a bankrupt hulk in their wake. The irony is that while that is peculiarly seen as a legitimate way to do business here, most EU member states are not at all happy with it. The EU has been working on a proposal to restrict investors in the EU from putting funds in private equity and hedge fund firms outside the EU, and also limit the ability of foreign investors to buy European companies.
The amusing aspect of this initiative, as we noted in an earlier post, is the private equity industry immediately started threatening that the proposal would “seriously disturb” many of the world’s biggest PE funds. So? That would seem to be a feature, not a bug.
Yves here. The contretemps got even more entertaining:
The EU seems unintimidated by various threats the hedge fund and private equity fund industry have tried to make to forestall efforts to restrict the activities of those firms….
The idea that any government dare tell the moneybags what to do is a bit of a stunner to the industry, which has gotten used to having its way in the US and UK. But despite the loud noises from the industry, there has been no change in the stance of the Europeans.
Indeed, it gets even better. An EU parliamentarian who is the rapporteur on the proposed reforms, in effect said that what was at stake was 3000 hedge fund jobs…
From the Guardian (hat tip reader Swedish Lex):
Jean-Paul Gauzès, the European parliament rapporteur on a proposed directive on alternative investment, said: “If the directive wipes out two or three thousand speculators, I am not going to be sad.”
US based readers might assume that non-EU firms could slip the leash, but that may be easier threatened than done. The EU is requiring private equity firms and hedge funds to be licensed locally and adhere to local regulation Securities firms already require local licenses, so anyone operating within the country would presumably be captured in this net. It isn’t clear how the EU would deal with bankers flown in for particular deals, or whether firms will try clever dodges (locating trading desks, say, in Moscow). But the EU operates under a principles-based regime, which also gives it considerable latitude to attack practices designed to circumvent rules.
This will most decidedly continue to be amusing.
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More details:
http://www.europarl.europa.eu/news/expert/infopress_page/042-77286-181-06-27-907-20100630IPR77285-30-06-2010-2010-false/default_en.htm
Re: “linked to the bank’s performance”
I’d take that regulation PR with a grain of salt, because last year the Dow was up like about 90% and then of course back down 90% — but “perhaps” this is why banks will end up playing the hedge fund game of selling themselves short more often, and “linking bank performance” to hedging.
Then, the other issue of accounting fraud remains lingering in the air, a smell related to FASB re-writing all the accounting metrics for mark-to-fantasy — a game of fraud that helped line many banker pockets last year (and this year)!
IMHO, performance will continue to be linked to FASB/SIFMA and ABA lobbying games and then supercharged by crooked lawmaker that are never held accountable for anything.
FASB Eases Fair-Value Rules Amid Lawmaker Pressure
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=agfrKseJ94jc
“FASB’s vote was “long overdue,” Representative Spencer Bachus, the ranking Republican on the House Financial Services Committee, said in a statement today. “Financial institutions and community banks have been adversely affected by the rigid application of these rules during this financial crisis, causing further instability in the banking system.”
“I think we’ll see significant write-ups as a result of this,” boosting bank earnings, said Brian Wesbury, chief economist at First Trust Advisors LP in Lisle, Illinois. “It will put the banks back to where they would have been if the rule hadn’t been in place.”
The biggest remaining question is “whether auditors will agree with the judgment of the bank management,” Wesbury said in an interview.”
==> Auditors …. phfft … this is a global game of hide and seek and it doesn’t matter if the EU is trying to look tuff or if Obama is talking about “Fat Cats” — it’s all just meaningless PR ….
The quote about eliminating two or three thousand speculators is very pertinent to this debate. Much of the hue and cry from banking concerns the loss of profits associated with purely speculative activities.
I do not deny the use of derivatives and speculation in the capitalist process; indeed, it is why I am retired before fifty. But, is there any truly productive output from a hedge fund, inside or outside a bank, other than more money for billionaires? Taking massive positions on third derivatives of illiquid underlyings is not going to build factories and finance schools.
Say what you will about Morgan, Rockefeller, and Carnegie, but these men, as corrupt and despotic as they were, at least built and left behind real institutions. What does a hedge fund manager leave behind? A smoking ruin whether he wins or loses.
The evidence that hedging or speculation plays any beneficent role at all in the economy is non-existent.
So, 2000-3000 jobs affected by this in Europe.
How many would be effected by a similar tax in America?
And why do those few thousand, who do nothing for the economy, not be taxed into oblivion?
What, are their votes, as well as their pay, , worth thousands of time more than regular people?
Particularly as it seems their pay oflate come straight from the Federal Reserve….or should I say other people’s tax payments?
I very much agree with the thrust of what you say!
Re: The utility “of derivatives and speculation”…
I again agree that they are essential elements in certain contexts and decision processes. (Though I see no social utility in the use of naked derivatives and a number of other cleverly engineered flavors designed by idiot savants.)
But it’s a matter of the “weight” of various elements of that process.
We seem to agree that the ‘first’ element so to speak should be that something useful to the ‘whole’ comes out… a network of railroads, steel mills, the Internet, etc.
Derivatives we’d agree (I think?) are a hedging or ‘insuring’ mechanism appropriate for securing a stable price for a needed commodity over time… like a railroad securing a fuel price over time.
And speculators are needed both for that hedging mechanism as well as some other pricing necessities.
But the problem is in the ‘weight’ of these different elements… literally the amount of money each sector is sucking up to perform its function.
Each of these elements are components of a vital ‘decision technology’.
I’d suggest that both the derivative and speculative elements should be a very small tail on a very big dog.
This is no longer the case.
The tail is wagging the dog.
In fact the tail has become cancerous like in some surreal science fiction movie and is eating the dog.
The dog is just about dead.
Social veterinarians are needed. Where’s the market for that?
a minute to late [a $…]?
similar legislation is undergoing discussions here in IL.
Do I have this right?
When confronted by the police after beating up a “customer”, the loan shark threatens to move to another neighborhood. And this is bad because?
Oh wait, the police are getting a cut of profits. Now I get it.
HA! Too funny. Took me a few seconds to “get it”.
They had more sense back in the 1930s and knew that if they let the bankers get bigger they would overwhelm the government -so, they, Roosevelt, et al said enough, threw some of them in jail and got on with the business of the people.
Obama, on the other hand, last night ‘hailed the vote [in the House last night] “a victory for every American who has been affected by the recklessness and irresponsibility that led to the loss of millions of jobs and trillions in wealth.’
Since Wall Street has refused to participate in meaningful reform, indeed, has put obstacles in the way, taken over the Treasury Department and effectively silenced players from around the world while conducting business as usual with taxpayer money and backing, this REFORM is a bad JOKE.
But there’s Nancy and Barney smiling a victory smile on the Huffington Post. Can’t blame them. at the same time can’t wait
With a paralyzed silenced Justice Department; there is no reform.
Zerohedge has a great map this morning of how this thing is constructed so even your teen-aged kids can understand it this is GOOD, from a comment at Zerohedge, “Explaining Derivatives, And Goldman’s Dominance Thereof, In Four Simple Charts”
by Miramanee
on Wed, 06/30/2010 – 17:50
#445335
I have an even easier way to explain this crap to the know-nothings on Capitol Hill:
(Long)
Actually, only one bankster got thrown in jail and that was because he had stolen from some of that same crowd. See the writeups of the Pecora Commission. Almost all of those guys skated.
I think you’ve missed the point with your “No one with an operating brain cell (or who is any good) will take a posting in regions that subscribe to the EU pay model if he can have more liberal pay elsewhere.”
Assuming the banker will leave if they’re not paid a globally competitive total package, this legislation will mean they’ll get almost all of it as salary. Guaranteed, in real time. I fully expect long queues of salivating banksters to form outside every border post as soon as this kicks in…
Robin,
First, you seem to miss the key point, that under a principles-based system, regulators can respond to efforts to vitiate the intent of legislation. The intent is to have cash comp in the current year be no more than 20-30% of total comp. Trying to increase the % paid in salary greatly won’t wash. Now the UK may decide to not enforce, given their large financial services industry, that’s a possibility, but they were mundo unhappy re how the firms behaved with the bonus tax (and that was written more narrowly). And I am not a constitutional expert, the UK may NOT have all that much ability to undermine or not comply with EU initiatives.
So where, exactly, will these people go? Traders might be able to operate in other locations, but any client facing staff needs to be local, and if they are selling securities, or providing or selling hedge funds or PE funds, they need to be licensed locally. So maybe M&A people can fly in to, but EU denizens generally have not taken well to foreigners trying to do deals in their market. M&A is a terribly personal business, most clients need to trust their banker. You might fly in some supporting members of the team, but that does not work well for the dealmakers.
Second, the EU had indicated it is happy to have the firms leave. If you want to sell financial products to customers in their markets, you need local licenses. Period. So the big firms will need to play ball if they want to be a global firm and not lose share in the EU.
Sorry to play the pedant, but their intention is for immediate cash BONUSES to be no more than 20-30% of total comp. If someone typically makes a total comp of 100k on a 20k salary this legislation intends to force a package of [20k salary] + [immediate bonus of 16k cash & 16k shares] + [48k deferred over 3-5 years]. Alternatively the company could say “don’t worry mate, we’ll bump your salary to 90k, so you don’t need to worry too much about the 6k we’ll have to defer”.
Since the legislation says nothing against jacking up salaries this would be fine. In fact this even follows the spirit as well: since everyone seems to thing it’s bonuses as a type of payment that the problem, the fact that the bonus ratio will have fallen from 400% to 10% should apparently be a good thing. Of course now the individual can take all the risk they like or sit on their hands and the shareholder is guaranteed a 90k bill, rather than the previous 20k.
Very good point, Robin. There needs to be some further regulation to limit total compensation no matter what form it’s in. Punitively progressive income taxes are dirty words but they seemed to have worked quite well from 1950-1980. But that would probably be too easy, wouldn’t it? We need codes and regulations that are so sophisticated that only the wealthiest of weasels find a way to circumvent them.
Michael Dooley makes a couple of great points in a paper for the BIS (www.bis.org/publ/bppdf/bispap51g.pdf):
1) Regulation is futile: even before the ink’s dry the profit motive will be driving people to find ways around it, the world changes, etc.
2) Active supervision is key: you have to manage the situation on the fly. If a product produces consistent outsized profits it’s probably bad news so should be illegal until someone can prove that it’s good news. If you wait to understand it before acting you relive the CDS/CDO bubble. Essentially since the rewards are front loaded and the risks are back loaded the burden of proof should be on the potential perp rather than the potential victim.
Unfortunately that means you need un-captured authorities. Shame, that.
They worked very well because we were paying for WWII.
While tax avoidance was a serious preocupation, our rule of thumb was pay the taxes and move on. So, I earned rather large amounts that evaporated on March 15th, gotta loves those Ides.
But then yes, tax the hell out of very high earnings. Tax Carried Interest for what it is ordinary income. Tax it!
Will the taxes stop the fraud? Nope, only prosecution and draconian punishments will. That’s where the point of action is. Look at some the curious little scams that we have seen of late. A CDO that by its very nature is a failure waiting to happen. A CDS that is lacking a sponsorship that has the ability to perform even before the ink is dry on the contract.
We don’t want to be regulated. Why? Well, if regulated, it might become self evident that the CDO is a scam as its cousin the CDS. Does it not occur to anyone that executing a contract that you have no prayer of being able to honor is a fraud on its face?
Let them pay what ever they want, Let them fail and find a way to extend joint and several liabilty beyond the veil of a corpoarate charter.
Proscribing certain levels of compensation is the wrong kind of intervention. Prosecuting fraud is the incentive that will curtail the fraud that has occurred.
Robin,
You and I know that the guys who make $100K are not producers. That’s less than what new MBAs make.
No regulator will object to the comp of support or junior staff being rejiggered. But I also doubt you will see the EU cast a blind eye if guys who got $200K in salary and $3 million in bonus are suddenly getting a $1.5 million salary. I would anticipate intervention, although there might be a lag.
FYI- This “Robin” is not me “Robin” who has rarely commented but reads here every day…just sayin’…
Bashing bonuses is an easy political win & I’m not sure even the EU would go as far as to dictate salary levels in private corporations, but it would certainly be entertaining to watch!
How about tying the bank janitors’ salary to the executives salary and no allowing the ratio to go over 20?
We had about enough from the moronic geniuses who run the financial system.
You point is actually extremely pertinent.
From “Compensation and the Social Network”
http://culturalengineer.blogspot.com/2009/10/compensation-social-network.html
Should disparities in wealth be limited?
(Whether through taxes, limits on salaries and bonuses, a negative income tax, changes in corporate governance or any other method)
Is there some point at which disparities can actually debilitate incentive, damage innovation… and promote corruption?
Aristotle believed a middle class was vital to a healthy democracy and that the disparity between the wealth of the lowest and highest citizens should be no more than 4 times (of course his idea of who was a citizen was rather limited).
During the Eisenhower administration the gap between the CEO and average wage earner was an order of magnitude greater… about 40 times.
And now that gap has gone up another order of magnitude… over 400 times.
Hypothesis:
That the individual’s drive for wealth and status takes place within the individual’s social network and NOT the social organism as a whole. That some disparities in wealth and status are natural, necessary and acceptable BUT the viability of any social organism* will degrade where that disparity exceeds a threshold level and/or is not recognized as connected to performance valuable to the organism as a whole.
Further, in scaled social organisms (societies larger than a hypothetical Dunbar’s Number, essentially non-existent since we were hunter/gatherers), there is a tendency towards isolation of social networks which will inevitably degrade the social organism (related to limits of biological altruism) without mechanisms to counteract those tendencies.
—–
And an hypothesis derived from the first predicated on the globalization of communication:
from “On the Birth of the Global Social Organism”
http://culturalengineer.blogspot.com/2009/05/on-birth-of-global-social-organism.html
Only when the gap in wealth and status approaches that level which would be considered fair within a Dunbar’s number-sized social network in daily contact… only then can we consider the possibility of a healthy, scaled social organism*.
*A self-recognized and internally governed economic/political grouping organized for basic survival decisions and actions.
Moreover, it may be that the rapid expansion of ICT and the nature of the Ultimatum Game makes this first assertion no longer just a nice ideal but a survival necessity.
—-
I may be an independent and unemployed political anthropologist. and I could even be wrong! It is a rather long-term view. But some fresh perspectives from outside the Beltway, Wall Street and/or the Ivy League could be of use for developing perspectives we sorely need.
… and guys like AIG’s Cassano get $1 million a month for their amazing contributions to the general welfare!!! Is there anything wrong with this picture?
With so much money at stake, surely the result of such a rule would just be the bankers letting their offices pile high with dirt and garbage. Which would be satisfying and fitting in its own way. (and give a new meaning to the phrase “filthy rich”)
The notion that any of these firms relocating to a more bonus friendly environment is somehow a viable threat is laughable. The firms move, so what? What of value is lost?
3,000 jobs, for example, is less than a drop in the bucket.
My view is that these firms no longer contribute much value, if any, to the real economy. We can do without them; we managed it for a very long time.
Expat says:
July 1, 2010 at 3:44 am
“I do not deny the use of derivatives and speculation in the capitalist process; indeed, it is why I am retired before fifty.”
Warning readers: Keep all sharp, pointy objects away from Expats swollen head.
Don’t discriminate against the fat and blunt, Simon :D
The bankers’/hedge funds’ threats to move to Asia has led to huge salaries for new bank staff in Singapore, e.g sales staff earning S$25k/month after a few years and 8 month bonuses.
The compensation rules there will not change to match the EU’s because finance is the only game left in town, after manufacturing has declined and moved to China and elsewhere.
Also, that’s the benefit of relying on the US/EU to be the ultimate back-stops- the burden of taking care of a major bank’s collapse is on the US/EU governments, not the Asian ones (except maybe Japan), while the benefits of a booming financial sector are absorbed by Asian countries.. “all of the gain and very little of the pain”…
Simple workaround. Create a new financial product called a “Bonus Default Obligation” or BDO, which pays out in the event that deferred bonuses are not eventually paid to the recipient (e.g., if there is another financial crisis and the government takes steps to prevent it).
Sell a lot of these at a really cheap premium, enough that the required payout if the bonus is not awarded is at least an order of magnitude higher than the bonus itself. Repeat for all your senior executives, and those of your competitors for good measure.
Voila – pay bonuses at less than promised amounts by even a little and you trigger a cascade of defaults leading to the collapse of civilization as we know it.
Isn’t financial innovation a wonderful thing?
(I am joking, but http://www.risk.net/risk-magazine/news/1590861/citi-plans-crisis-derivatives wasn’t all that different in concept).