A misguided cap on Bankers’ bonuses

Alexander Pannett 3.30pm

And so they are marching again. The restless European Parliament is finally getting its revenge against the unscrupulous “Anglo-Saxon” capitalists in London. It has voted to reign in bankers’ bonuses, reducing permitted amounts to the base salary of bankers.

The rules would apply to Europe-based employees of any bank, as well as to staff of European banks wherever they are located. That means a Barclays trader working in New York would be subject to the cap, as would a Goldman Sachs banker based in London.

I am sceptical of the bonus cap’s effectiveness. The reduction of bonuses will mean that remuneration will be granted in the form of higher salaries.  This adds inflexible costs to financial institutions which, in a crisis, will have to reduce head-count rather than being able to cancel bonuses in order to preserve capital levels. It will lead to the increased use of temporary contracts as banks seek to maintain flexibility.

Increased salaries, rather than bonuses, also moves the City away from performance related pay. Bankers will receive salaries despite the poor risks and mistakes they make. Failure will be rewarded. This is also unnecessary as recent claw-back regulations have been introduced which are designed to ensure remuneration is performance linked. Bankers whose trades made losses in the long-term would see their bonuses reclaimed, which incentivises bankers to consider long-term risks. Higher salaries do not ensure that bankers mitigate risks.

I also have an intrinsic revulsion at politicians who interfere with business for political or even emotive reasons. Do these politicians understand or even care about the effect that these changes will have on London’s financial services, which is a considerable European strategic asset? I suspect they do not.

Despite my above concerns, we must not ignore the considerable antipathy that the British public holds for the financial sector. It is almost satirical that RBS, which was saved with taxpayer’s money, has posted 2012 losses of more than £5 billion whilst paying out £600 million in bonuses last year. This European cap on bonuses may be mis-guided but that does not mean the City now smells of roses.

A reform of the bonus culture may indeed be needed, such as substituting locked-in equity for current bonus structures or changing the criteria for awarding bonuses so that they are more strongly linked to the overall performance of a financial institution. However, this European cap on bonuses is not helpful and will be counter-productive as it harms the international competitiveness of one of Europe’s few remaining engines of economic growth. The prime minister is right to resist.

Follow Alexander on Twitter @alpannett

Rejecting crony capitalism

Alexander Pannett 9.45am

With the City bonus season fast approaching, politicians are talking a lot about the need to tackle “crony capitalism”.

Both David Cameron and Ed Miliband have called for executive remuneration to be made fairer and more transparent.

This follows a paper by Jesse Norman, the conservative MP for Hereford & South Herefordshire, published in December that called for the conservative party to tackle the rise of crony capitalism.

Jesse wrote:

“Crony capitalism arises when economic activity escapes the constraints of law, markets and culture. It is marked by the clash of business activity and the wider public interest, and the separation of business merit from business reward. Value creation is replaced by rent seeking and certain groups become enormously wealthy without taking risk. These factors lead to long-term economic underperformance, and sometimes to social unrest.

 It has been suggested that granting shareholders a veto on remuneration packages and the amount of pay executives receive when they leave a company would produce a fairer system.

However, as Daniel Cowdrill has pointed out on these pages, shareholders in FTSE 100 companies are mostly passive rather than active investors, holding equity for short-term objectives rather than for long term value.  They are unlikely to hold back executive pay even if they are given a determining vote on pay levels.

But I disagree with Daniel that tackling executive pay, while difficult, is a minor issue and not worth the political capital. When household incomes are falling across the UK and unemployment is rising due to mistakes that originated amongst our business elites, it is unacceptable that such elites’ pay continues to rise, despite their actual underlying performance, while everyone else shares the pain of the recession.

Research from the Institute for Public Policy Research (IPPR) has highlighted that chief executives in nearly 90 per cent of the FTSE 100 companies took home an average of £5.1 million in basic pay, bonuses, share incentives and pension contributions in 2010-11. This represents a year-on-year increase of 33 per cent, while the average increase in company value was 24 per cent. Since 1999, the pay of FTSE 100 chief executives rose 13.6 per cent every year until 2010, whereas the FTSE itself rose by an annual average of just 1.7 per cent.

There is clearly a severe disconnect from reality in the boardrooms of the UK’s top companies. While encouraging shareholders to be more active may prove difficult, allowing employee representatives to become members of remuneration committees would give such committees more insight into life outside their corporate bubble and would help in setting pay that was proportionate to the real economy. 

 Greater transparency would also allow for more public pressure and scrutiny to be brought against public companies that encouraged excessive remuneration. Directors should demonstrate that their executive pay does not breach their fiduciary duties to the interests of shareholders. The law could also be changed to give greater power to both creditors and shareholders for clawing back the past pay of executives who caused companies to go insolvent or to suffer periods of particularly poor performance.

 Far from being a minor problem, crony capitalism severely undermines the economic health of the UK.  When capitalism no longer rewards autonomous risk taking, competition and real increases in productivity, it leads to economic inefficiency as companies consolidate and grow, not to improve performance but to gain elusive economies of scale that in reality are little more than an oligopolistic stranglehold over a market.

The prevalence of crony capitalism marks the wider shift in the UK economy away from real capitalism, which brought social value by serving the actual needs of consumers, to the ideology of the free market that values speculation and short term profits over longer term growth and stability.

Markets should not be the panacea of a new business religion but cultural tools that are bound by mutual dependency and tradition and should be used to address both social and economic problems for the benefit of all society.  Rich or poor.

Share this article on Twitter

While the Euro remains on life support, it’s business as usual for the City

Daniel Cowdrill 10.04am

Listening to David Cameron’s opponents during the weekend, you would think his veto signals the end of civilisation - or at least the UK’s participation in it.

One of their scare stories is that the City of London is worse-off than before the EU summit. In reality, however, it is in much the same position.

The sticking point was the financial transaction tax (FTT). This is a tax on every sale or purchase of stocks and bonds or other financial products by banks. On these pages, Craig has dismissed a FTT as an unhelpful ‘soundbite tax’, while Alex described it as ‘misguided’. Elsewhere, Sir John Major has labelled it a ‘heat-seeking missile aimed at the City of London’.

As 75 per cent of the EU’s financial services industry is located within the City of London the burden of this tax would fall disproportionately on the UK economy and the two million people who are employed in financial services in this country.

Unfortunately, France was not willing to listen to British demands. President Sarkozy’s refusal to concede led to a fiscal ‘pact’ rather than the fiscal union the markets had desired. What is set to be agreed over the coming months without the UK is unlikely to be enough to stop the deterioration of the European debt crisis, and President Sarkozy won’t be so ‘heartened’ if (or when?) France’s credit rating is downgraded.

However, beyond all this the fundamentals remain the same for the City. The UK remains part of a single market that allows the (reasonably) free movement of people, capital and services across a trading block of 500 million people. The City will continue to benefit from the single market - Mr Cameron’s veto does nothing to alter this.

To be sure, it could be argued that the new 17+ euro block will foist regulations on the City when Qualified Majority Voting (QMV) is introduced in 2014. But these are future deals that are yet to be negotiated and agreed. When the time comes there is no reason why Britain can’t win support and obstruct the worst that might come our way.

In any case, there are some people who believe that had the UK not vetoed the new treaty the French would be less determined to impose other regulations on the City. This thinking is deluded. French dirigiste tendencies have been strengthened by a financial crisis that many in France perceive as the fault of speculators in the City of London. This isn’t going to change no matter how much sovereignty we sign away.

Furthermore, access to the single market is not the only thing that attracts business to the City. In the 1980s the ‘Big Bang’ attracted financial services to London from all over the globe, not just Europe.

The UK’s competitive regulatory and tax framework continues to attract financial services to these shores. We are also near the main European continent and, of course, we speak English. Even the EU tends to deliberate great matters in English - now the global lingua franca (such irony might be lost on the French).

The City will live to fight another day. The euro, on the other hand, may not.

Britain needs a safer banking system, so we should welcome the Vickers Report

Sara Benwell 10.30am

This week has seen the publication of the long-awaited 'Vickers Report' (officially the Independent Commission on Banking), which was tasked to give an answer to what the Chancellor, George Osborne, referred to as the “British dilemma”. British banking had to be safer and more competitive.

The big headline was that the ICB recommends the introduction of ‘ring-fencing’ investment operations from retail services. It was a more flexible ring-fencing than expected, as banks would be free to place activities such as lending and trade finance on either side of the fence. The idea is that the retail arms of banks should be independent from the investment arms and any interaction should be regulated like that with a third party.

Ring-fencing is meant to ensure that retail deposits don’t fund investment banking and to “make it easier and less costly to resolve banks that get into trouble” - i.e. without requiring taxpayers to bail them out again.

In a further bid to make banks safer, they will be required to increase the amount of equity capital they hold to a minimum of 10 per cent of risk-weighted assets within the ring-fence. The report made a further recommendation that either side of the ring-fence holds at least 17 to 20 per cent of loss-absorbing capital. These measures are stronger than the international guidelines set out in Basel III, prompting concerns that they could affect Britain’s ability to compete in global financial markets.

In a bid to heighten competitiveness among British banks, the report makes two main recommendations: first, that the planned sale of 632 branches of Lloyds Banking Group would lead to the emergence of a “strong challenger bank”, which must have at least 6 per cent of the personal accounts market and a funding position “at least as strong as its peers”; second, that it must be made easier for consumers to switch banks.

These reforms should be enforceable by 2019 at the latest.

The Government welcomed Sir John Vickers’ report. In a speech in the House of Commons, George Osborne said that the report and its timescale would be welcomed in principle and now they must get down to the serious business of implementation. The Chancellor said it is “a question that should have been asked and answered a decade ago”.

The report has attracted a number of criticisms - the biggest coming from the banks themselves, who argue that such far-reaching reforms will reduce Britain’s global competitiveness.

Indeed it seems logical that some of the reforms could reduce profitability for some investment banks and it is arguably true that some of the harsher regulatory standards could lead to a reduction in Britain’s standing as an international banking centre.

Sir John Vickers addressed some of these concerns, stating that the reforms will give Britain a more secure banking framework, which will make the country more appealing. Banks would also, he claimed, remain competitive.

There are questions about the timescale, with concerns that amidst growing volatility in Europe and increasing fears of a double-dip recession, a 2019 target is a long way off. The Chancellor argued that the deadline was given by the ICB itself and that Sir John Vickers had warned such radical reforms would be impossible to implement faster. In other words, don’t blame the Government.

It seems to me that the ICB’s recommendations combine as an important step towards a better regulated banking system. While there are valid concerns about the impact on Britain as a global financial centre, it is more important now than ever that we put in place a more stable banking environment.

The 2019 deadline seems a long way off, however it seems likely - if not definite - that some reforms will be brought in earlier via the Financial Services Bill. The Government has committed to giving a full response by the end of this year and to legislate within this Parliament, so by 2015.

Hopefully we will begin to see changes starting to take shape sooner rather than later.

Follow Sara on Twitter @sarabenwell