Rebalancing Bonuses, for Goodness Sake

Now where are the ‘animal spirits’ going to go?

Deutsche Bank just took its most daring step yet to reprogram its workforce.  It adopted a policy denying the bank’s top-performing traders plum promotions and fat bonuses if they’re deemed to be “disruptive” or non-team players.   DB knows that this reform will lead to high-level departures, but, in announcing it, Colin Fan, DB’s co-head of investment banking, said that “these are people [who] probably won’t fit into the new banking environment anyway.”

To risk losing its star traders, DB must have concluded that nothing else could transform a culture of pure profit into one of playing by the rules.  Apparently, stern messages from its co-CEOs and reinforced compliance policies proved incapable of chastening DB’s employees, especially the outstanding ones. 

EU bonus clampdown

Stocksy_txpfe1fa775GXC000_Small_17008Still, DB would never have recast its bonus scheme so radically were it not for the relentless pressure EU regulators have exerted on EU banks to curb their extravagant pay policies.   EU regulators blame pure-profit-driven bonuses for the excessive risk-taking that precipitated the global financial crisis and for creating banking environments that produced outrageous rate-rigging, front-running, sanction-busting, market manipulation and toxic products, for which the banks have been duly and repeatedly excoriated. 

Last year, the EU capped 2014 bankers’ bonuses at twice their salaries1 and, just recently, outlawed the so-called role-based allowances2 that EU banks (and US banks with EU staff) have been using to sidestep the bonus cap.    

The EU has now actually passed a criminal statute holding bankers liable for “reckless staff behavior.”

The EU has now actually passed a criminal statute holding bankers liable for “reckless staff behavior.”  Two directors of HSBC stepped down immediately.  None other than Mark Carney, Governor of the Bank of England, suggested that bankers uncomfortable with the new rules should resign.   Andrew Bailey, Deputy Governor of the BoE, proposed that the right way to prevent reckless behavior in the financial markets is to expose senior people to the risk of losing “a meaningful proportion of their remuneration.” 

Stevie Cohen’s Damascene conversion

Adding to these pressures on all members of the financial community are the emergence of whistleblowers and the success that criminal prosecutors have achieved in “flipping” mid-level financial personnel to give up their superiors.  Hedge funds and private equity firms around the world now know they had better tighten their controls over employees even if they are not so closely regulated as the universal banks.  A case in point is Stevie Cohen’s hedge fund turned family office — Point72 Asset Management — which actually preempted DB this month by earlier announcing its introduction of a 4% extra bonus for staff who demonstrate adherence to its compliance policies and contribute to their communities3.

“You cannot seriously be operating under the old culture.”

As for the bankers fleeing DB4, they may be in for a rude awakening when they show up at private funds.  The best and brightest of those funds do not tolerate executives or traders who are indifferent to regulation5.  Nobody in the alternatives industry is looking for wildcatters who could turn their firms into an SAC or Amaranth.   Those days are over.  As DB’s Colin Fan put it, “you cannot seriously be operating under the old culture.”

1 The bonus cap for any EU bank is 2x salaries with shareholder approval but only 1x salaries without it.

2 These allowances are annual payments to senior employees in fixed amounts (like salaries), but have been banned because they may be adjusted or cancelled by management which renders them more like bonuses.

3 Point72’s new bonus program is called “Rewarding What Matters” which employees can access by raising issues with compliance, suggesting policy changes and serving on charitable boards. Ironically, the word “bonus” actually derives from the Latin word for “good.”

4 Barclays is reportedly also about to announce a change in its bonus scheme along the same lines as DB’s new policy, so we may soon see high-level departures from that institution as well.

5 One very senior Bear Stearns executive I know from years past used to start our meetings with “Ok, the lawyers are here, now it’ll take 3 hours.”