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Ending the never-ending bonus war

Solving the bonus questions

I’m fed up with the argument about bonuses and cannot believe it still rumbles on after a year of debate and G20 meetings. With Barclays announcing record profits last week, and therefore increased bonuses, the media latched onto this angle more than the fact that Barclays, UBS, Goldman Sachs and others demonstrates reviving markets and a recovered financial sector.

Sure, bonuses are irritating … but only because we don’t get them, the guys who do are as reliable as stockpickers as monkeys, and no-one knows how to break out of this cycle of paying millions for a job that is demanding, but no more so than many.

So here’s my suggestion as to how it could be resolved.

First, set a regulatory limit on the bonus pool and the size of an individual's bonus payment.

For exmple, limit the bonus pool allocation to no more than 33% of the bank’s full year profit after tax across all bank subsidiaries, as shareholders and capital reserves must have an equal recognition.  This means that profit should be apportioned equally – one third – to each constituency.

Then limit individual bonus payments to a cap of 0.1% of full year profits after tax.

For example, Barclays net profit was £9.39 billion in 2009, up from £4.38 billion a year earlier.

£9.39 billion profits would create a maximum bonus to any one trader of £9.39 million. That may seem a lot, but it’s been a good year and is far less than some of the current payouts. Equally, if you take Barclays profits from the year before, it would have been £4.38 million. A mere pittance compared to today’s bonus culture but, if you have a level playing field, far better than today’s excesses. And this is looking at a decent bank result.

Meanwhile, take a bank like Royal Bank of Scotland (RBS).

The rules above would be extremely punitive for them. It doesn’t necessarily outlaw any bonuses within RBS, but it does challenge the bank as to how to create a bonus pool when there is no profit.

But look at the wording. It says the bonus pool ‘cannot exceed’ a third of group profits, not that it must be a third. Therefore, for RBS, they can allocate bonuses.  In fact, they have to in order to retain talent and remain competitive.

Nevertheless, you would want to ensure that a loss-making bank allocated bonuses that were in the best interests of the bank.  As a result, the stipulation should be that the bonus plan and allocations for all banks are approved by an independent panel comprising a cross-section of the shareholders of the bank. Approval of the plan must be agreed by a majority – greater than sixty-six percent – of the panel, and the panel must comprise a minimum of ten investors including at least three retail investors.

The selection and choice of panel members must be approved by the home regulator and, whatever the panel size, a minimum of one third must be retail shareholders rather than institutional.

This should ensure a bonus pool and payout that seems agreeable to all shareholders, and therefore should also keep the regulator and media quiet.

All of the above may sound reasonable (or not), but then you have the other key question which is: how would you ensure these caps are adhered to?

After all, any government who contemplated the above would just find all of their banks moving to the Cayman Islands or Switzerland to avoid such punitive arrangements.

OK, so let’s stop that one at the same time by declaring that, for a bank to operate in certain markets – especially the G20 nations – the bank must be registered in a country that has signed up to and been recognised as implementing the G20’s taxation agreement.

This taxation agreement is based upon banks regulated under the new Tobin Tax regime (oh yes, if you didn’t think it was going to happen, it will!). From today’s FT:

For years, taxes on capital flows were seen as a barbarous relic of the 70s, on a par with Demis Roussos and Baked Alaska. No friend of free markets dared support the idea of US economist James Tobin, dreamed up to curb currency volatility after Bretton Woods collapsed. That’s changing. Since Lord Turner, chairman of the UK’s Financial Services Authority, started stirring interest in taxing financial transactions last year, politicians in Germany, France and Australia have voiced tentative approval. Now Japan, through the musings of vice-finance minister Naoki Minezaki, might just be falling in line.

So, the first thing is that the bank must be head quartered and file accounts in a recognised G20 Tobin tax location.

Second, the banks’ accounts must be filed in that country and show a detailed breakdown of profits and losses using IFRS accounting, not GAAP (ouch, that might hurt).

Third, and most crucially, the bank must declare any movement of funds or debt to a location that falls outside the G20 Tobin tax coverage, such as the Cayman Islands or Costa Rica. This is to ensure that complex debt equity swaps, such as the Barclays transaction that took place last September, are registered, regulated and monitored to ensure that this is legitimate tax avoidance and not evasion.

All of the above would ensure that banks and their individuals on major bonus deals, could not just upsticks and move to a location outside the grip of the bonus rules as, if they did, they would effectively be removing themselves from the markets where they need to trade – the G20 markets.

Anyways, it may not solve or cover all the ground required – as I’m no lawyer or accountant – but at least this would be a start.

I think what’s bugging everyone right now is that this crisis began in August 2007 – almost two and a half years ago – and blew up into a full blown meltdown almost eighteen months ago in September 2008. So here we are, years after this all began, with bailed out banks, angry taxpayers, a full blown recession and all the news is of investment markets behaviours remaining unchanged.

That’s what’s bugging everyone … so come on G20, pull yer finger out, get some actions started, and put an end to this never-ending bonus debate.

p.s. the last discussion of this issue at September's G20 summit ended up with a split view between France and Germany, and the US and UK.

About Chris M Skinner

Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, the Finanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal’s Financial News. To learn more click here...

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  • Alex

    You state that the bonus pool should be limited to one third of the profits so that the profits are distributed equally between each constituency (the traders, the shareholders and the capital reserve if I understand your reasoning correctly).
    How about the losses? They are certainly carried by the share holders and the capital reserve. Will the traders pay-up as well from the bonusses they have collected over previous years? Or will they be exempted from sharing equally in the losses in this new grand scheme?

  • Chris Skinner

    Good point Alex
    Some of us would contend that the traders should be paid on a ‘clawback’ system where losses are offset against bonuses in previous years.
    I understand the European Commission is considering this, based upon the fact that half the bonus pool is now paid in shares rather than cash, with limitations on how the shares can be traded.
    Be interesting to see what happens.

  • Paul Fahey

    Why place a 0.1% cap on an individual’s share of the 33% bonus pool — if it is agreed that the 33% is equitable, why limit an individual’s upside? If he was responsible for 50% of the success is he not entitled to 50% of the return?

  • Chris Skinner

    Hey Paul
    Glad you picked that up as I hoped someone would.
    The cap on an individual’s pay within a bank is a suspicion I have that the regulators will introduce such a thing.
    The reason is to avoid risk accumulating in a bank by getting those taking the biggest risks – and therefore generating the biggest rewards – out of the banking system and into the private equity and hedge fund markets, where many such rainmakers are today.
    This means that banks will have limited ability to recognise individual talent and will be forced, instead, to spread reward.
    The rainmakers will therefore leave and move to PE and HF groups, or banks will delist and become partnerships, like Goldman Sachs used to be.
    The idea of a too big to fail bank, in public sharedholding, creating individual star rainmakers and rewarding them for a good year (or two) with no clawback … those days are over.
    Just a thought.

  • Governments need to stop treating banks as an industry and get back to thinking of them as an enabling technology that allows the productive sectors of the economy to function. Exorbitant profits should not be paid out but should be ploughed back into industry to increase exports and consequently generate wealth. I have no problem with paying bonuses, but bonuses should be a small two digit percentage of an employee’s wage – 15% to 20%. A bonus should not be 300% to 1,000% of an employee’s wage! Why should be pay so much to gamblers? I would use this year’s bonus to send them all to Gamblers Anonymous.

  • Ajay Kumar

    Individual Cap of 0.1% of revenue will basically inspire people to move to bigger banks, as bigger banks will have bigger profit so their 0.1% share would also be big, whereas smaller bank will have smaller profit and hence smaller individual bonus, note that the effort and contribution by the individual may be the same in both banks