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.

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A true One Nation party would support Social Investment Funds

Alexander Pannett 1.30 pm

The re-election of Obama was less about support of his policies than about a rejection of extremist Republicanism. Both American and British voters remain unconvinced that any of the political parties can create a fairer and more prosperous society.

Despite all the announcements of Hope and One Nation politics, there has not been a real policy drive to suggest practical solutions for reversing the growing gap between rich and poor in much of the Western world. Much of the laudatory policies of the Coalition, such as raising the lower income tax threshold, do not do enough to mitigate against the disastrous effects of the Great Recession upon the more disadvantaged in society. More can and must be done to create a fairer economy that places greater emphasis on achieving both social and financial value. Policies that will create a true One Nation society.

One major innovation that could bring real social and financial dividends, is to allow some of the trillions that flood the financial sector to be invested in social finance. Allowing investors to allocate resources towards social investment vehicles that make both social and financial returns could be a revolutionary new form of social finance.

One of the major barriers to success for social enterprises is access to funding , especially funding that understands their business models. Social investment funds would be able to tap financial markets to provide such funding and it would be managed by specialists in social finance. They would be able to invest in equity or debt securities of social enterprises in order to make a financial return but also to stimulate the funding of social value. Social investment funds could also leverage their positions, as commercially-minded funds do, to magnify the amount of money that could be invested in social activities. Currently, approximately £60-100 billion of assets held by charitable trusts and foundations in the UK are not being deployed by charities to leverage more private investment into the social economy.

Unfortunately, there are various obstacles to the creation of social investment funds:

1.                       there is no existing UK legal structure that allows for the creation of a social investment fund. Directors of investment funds have a duty to maximize financial returns for investors rather than also make a social return;

2.                       current charities law prevents charities from providing private benefit to individuals or businesses;

3.                       the costs of establishing existing fund structures also preclude the establishment of social investment funds whose assets under management would be significantly lower than commercially driven investment funds; and

4.                       current UK financial services law would require social investment funds to abide by expensive and onerous red tape if they wish to market to retail investors.

Under the current UK regulatory environment, the risk of making donations is encouraged and the less risky activity of making social investments is penalised. This needs to change if we are to create a new industry of social finance and allow the third sector to tap the financial markets for funding.

The government should amend current financial services law to allow for the recognition of a social investment fund structure. This new type of investment vehicle would be allowed an investment mandate that generated both social and financial returns and which could leverage its position by having access to financial markets. The current financial promotion rules should also be amended to allow social investment funds to market to retail investors. Once financial services law has been changed to recognise social investment funds, a bespoke fund structure can be created for the social finance industry that will lower fund formation costs.

If a social investment fund is created, it would be a huge boost to social finance and would stimulate the emergence of new social asset classes, such as social impact bonds. It would also allow investment in public sector spin-outs and mutuals and would support the localism agenda, especially community right to buy and community right to challenge. Social enterprises would have access to much-needed finance and it would improve the UK’s development as a global hub for philanthropy and social investment.

Developing a social investment fund industry is an obvious and easy policy for any party that is serious about One Nation politics. It is these pragmatic and progressive policies that British voters will be looking for in 2015. Empty rhetoric will not be enough. 

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