Those RBS bonuses: why is there even a row?
As is well known, the directors of RBS threatened to resign if Alistair Darling blocks the bonuses they want to pay their traders; apparently they’ve had legal advice that this would breach their fiduciary duties – though the row has already cooled, with the directors caving in. I must say, I found the legal advice hard to understand, if it really was as claimed: how can you breach a fiduciary duty by complying with a compulsory requirement imposed by government? It seems to me like saying you breach fiduciary duties by complying with the law on, say, pregnancy and maternity leave – which surely costs shareholders – or with regulatory orders and requirements of the FSA. Maybe some city lawyer types can explain.
vapourtrails/CreativeCommons
RBS has been supported by government through the bank recapitalisation scheme, in relation to which Alistair Darling said this last year:
If the Government is to provide capital, the issue will carry terms and conditions that appropriately reflect the financial commitment made by the taxpayer, including in relation to dividend policy, remuneration, lending policy and wider public policy issues.
Obviously one of these conditions was his consent, or UK Financial Investments’ consent, to any bonus packages. So if the RBS board thinks submitting to Treasury clearance of its bonus package is inconsistent with their duties, surely they should never have taken part in the bank recapitalisation scheme in the first place. By doing so, on their own view, mustn’t they have breached their fiduciary duties already? It’s a bit late to bring this up now.
I think the better view must be that the board was acting perfectly in accordance with its duties when it agreed to the very necessary government backing last year – and the conditions on which that support was offered. Neither that decision, nor complying with those conditions, is a breach of duty any more than agreeing to a normal commercial loan – or subsequently repaying it. Repayment is I believe normally a condition of obtaining a loan, but in itself is hardly favourable to shareholders.
The question raised by all this, though, is why the government hasn’t already taken legal power to control bank bonuses – that could remove even the possibility of any such row. Parliament is now considering a proposal in the Financial Services Bill requiring the FSA to impose remuneration policies on banks, and empowering the government to order the FSA to audit those policies against the principle of effective risk management, and international “implementation standards”.
Not the strongest regime, I would have thought; this appears no more than is required to meet the G20 agreement earlier this year. And why only now? The government clearly needs these reserve powers, or preferably stronger ones, in order to prevent even the possibility of rows like this one.
And the politics of all this are even harder to understand. In a sense the row may help Labour, as long as Alistair Darling is seen to win it. But bankers are the least popular section of society (or at least right up there with MPs), voters are angry at the thought that they may still – in spite of the complete collapse of City markets mythology – be funding fast cars and cocaine for socially useless traders, and Conservative spokesmen are threatening to outflank the government with their promises about reining in bank bonuses.
Labour has had a massive opportunity all year to grasp the political initiative and put the politics of envy to the service of real political credibility – and has missed it. Much firmer action sooner might have changed the public mood and cast David Cameron as defender of the banks. Jokes now about Eton are a very poor substitute.
Categories: All WW, Comment, Labour, Legal, News - Current Affairs
Great post Carl.
“The question raised by all this, though, is why the government hasn’t already taken legal power to control bank bonuses”
I suppose part of the answer might be that they feel any really strong system of bonuses would simply be circumvented – e.g. holidays on expenses or lunch vouchers at a restaurant or something instead – which would then be more difficult to tax.
In the particular case of RBS, it is a failed bank and if its employees leave, that’s their decision – after all, had RBS collapsed they would have left anyway. That £1.6 billion could far better be spent starting to pay down some of the bank’s debts and getting its books back in balance. After all, that’s what a “normal” company being kept alive by the injection of cash from its principal creditor (should such a bizarre situation ever arise) would do – why should RBS be any different?
What I can’t understand is why the government doesn’t simply insist that minimum 50% of all bonuses must be paid into the company pension scheme – which would surely make employees take a little more care to operate in the long-term future of the bank. Moreover, that would be dead easy to enforce and would bolster our sagging pension system.
.-= Huw Clayton´s last blog ..Ruined City =-.
The government does not have the power to tell the directors what to do. if it wants to do so it has to pass a law.
if they don’t pay the bankers the bonus more of them will leave and the bank will be less able to genrate profits to pay back the government
The last bit is spot on. Good article generally.
.-= Sunny H´s last blog ..Mail implies Christians persecuted. Were they? =-.
[...] even the board of RBS, propped up by billions of our tax pounds and owned by the government, was threatening only last week to resign if Alistair Darling blocked its bonus plans. Many people here boil with anger at the idea [...]
I’m finance professional and I recently had a chance to catch-up with some colleagues who work at RBS in New York and at the palatial new RBS headquarters in Stamford, Connecticut. Despite the outrage and rhetoric over the bonus culture in the UK, if British taxpayer knew what was going on with RBS pay in the States they would be apoplectic. With taxpayers pumping 45.5 billion pounds of assistance into RBS, I think they should be paying a little attention to the US bonus structure.
I spoke to some colleagues in the “middle office” who monitor profits and losses as well as risk. None of these people are at the top of the corporate ladder and none are in line for large bonuses, so perhaps there is some bitterness or envy when they spoke to me, but I also sensed some justifiable incredulity and outrage when they relayed what was going on. Hearing from them impelled me to write about some of these issues in the hope of contributing to a saner and fairer pay structure and to help prevent British taxpayers from being subject to further pillage. I feel the points made below are accurate or very close to accurate given the available information. However, I cannot vouch for 100% accuracy since I am not on the inside and I had no way to investigate myself. More transparency from RBS North America can prove or disprove any of the claims made below. It is not fair if RBS bankers in the UK have restricted pay while British taxpayers subsidize a continuing pay extravaganza for North American employees.
First Issue:
I was told about last year’s bonuses. Cash bonuses were restricted except for those with contracts (more on that below). However, many employees were given very generous amounts of non-cash compensation in the form of RBS promissory notes (Employee Notes), that vest over three years (1/3 vesting on each anniversary of grant, more or less). Many, many employees were given total bonuses over $1 million. The employees were told that since the British government had essentially nationalized RBS, the Employee Notes they received as bonuses were “money good” and as safe as UK government backed paper. The employees need only bide their time to get paid. The amount of these Employee Notes is in the high hundreds of millions. But at the time of grant last year the Employee Notes did not have an interest rate or maturity date set. My sources tell me that employees were told that the interest rate would be set sufficiently high and the maturity date sufficiently short so that as soon as some Employee Notes vest employees will be able to sell them for 100% of face and an RBS trading desk would make a market in the Employee Notes to help ensure they trade for 100% of face. This allows the employees to monetize the Employee Notes. What’s wrong with this? If I was a taxpayer I would want the Employee Notes to contain a term that provided that in NO case could the Notes mature BEFORE the British taxpayers investment in RBS is repaid in full. It is the taxpayer support that allowed RBS to survive and kept high paying jobs for these employees, so why should their bonuses in the form of Employee Notes be a repayment obligation of RBS that ranks ahead of the taxpayer investment? Of course this means the maturity date would not be known for certain and the uncertainty might cause the Employee Notes to trade in the secondary market at a discount but this is only fair to the taxpayer. Secondly, what is the interest rate on these Employee Notes? It should be only what a standard money market account receives. Why should RBS have to pay high interest on these Employee Notes to further fatten banker bonuses? Any interest paid on these Employee Notes hinders RBS’s ability to preserve capital and ultimately pay the taxpayer back. Of course, a low interest rate would also make the Employee Notes trade at a discount in the secondary market but once again it is only fair to the taxpayer. So, if I was a taxpayer I would ask some questions regarding the Employee Notes for US bankers:
- What is the aggregate amount of Employee Notes issued and how many employees received some?
- What is the maturity?
- What is the interest rate?
- Is it absolutely clear that these Notes cannot be redeemed before the taxpayer gets all of its RBS investment returned?
– Provide a schedule of the number of employees who received more that $500,000 in combined Employee Notes and cash last year and the number of employees estimated to receive at least that this year (the number might surprise you). Then do a subset of those making $1 million. No names, just the total number.
– Is it clear that in no cases will RBS buy any Employee Notes in the secondary market as this would be a “round about” way of paying cash bonuses when RBS should be preserving capital.
– Has there been any other non-cash bonuses or compensation paid other than the Employee Notes?
- Has there been or will there be any alteration of the original vesting schedule for the Employee Notes?
Second issue(s):
Last year RBS made an emphatic PR point that the bonuses would have “claw-back” features so that an employee would have his Employee Notes reduced or eliminated if (1) his group, (2) his larger group, or (3) RBS in general, had poor results. This was to encourage prudence over the longer term and have everyone be vested in the success of the Bank. The 2009 RBS results are not pretty as evidenced by the need for an additional 25.5 billion pounds of bailout cash from Johnny taxpayer in early November 2009. RBS has now accepted 45.5 billion pounds of government assistance. So one might think that last years Employee Notes are certainly subject to some claw back, right? In the States, no one thinks so. As long as an individual’s group has done OK (meaning they have not lost money) the expectation is that there will be no claw-back.. Senior management has not disabused anyone of this. So despite ponying up an additional 25.5 billion pounds none of last year’s Employee Notes (which as of now rank ahead of the taxpayers’ forced investment!) in the States are being reduced. A taxpayer should ask:
- How much of last year’s US Employee Notes are being clawed back for poor performance (both local and at the RBS overall level) and will the aggregate amount of this year’s Employee Notes and other non-cash compensation be less than or greater than last year’s amount?
- Can RBS provide examples of employees who worked in profitable areas but are subject to some claw-back since the Bank as a whole did poorly and required more government assistance (I’m told it will be hard to find such a person).
A related issue is vesting of the Employee Notes. Typically “deferred compensation” on Wall Street vests over three years. If you receive $1.2 million in deferred bonus on March 15, 2008, the vesting schedule should be 1/3 on each anniversary, or $400,000 on each of March 15 2009, 2010 and 2011. The employee must be working at the Bank on each date for his pay to vest. Some managers are hinting that vesting of Employee Notes will somehow be accelerated to make them more attractive to employees. Of course if this is true it contradicts the motivation for having long term vesting to begin with. I would ask:
– Has there been, or will there be, any alteration of the original vesting of the 2008 Employee Notes and what will the vesting schedule be for future Employee Notes and other non-cash compensation?
- Is it clear that there is no other non-cash compensation other than Employee Notes?
Last year the bonuses were given in March as is customary for RBS and many other
banks. Some managers have told employees bonus awards might be moved up to January to make them less susceptible to political challenge. Recall that Merrill Lynch rushed to pay large bonuses in 2008 right before its consummated the merger with Bank of America; that way the money was gone and Bank of America could do nothing once it took over. Taxpayers should demand that bonus awards are made in mid-March only as per standard RBS procedures.
In addition, since employees do not like waiting for Employee Notes to vest RBS, like some other banks, made a concerted effort to raise the salaries of many employees. Many front office personnel received salary hikes of 50%, 75% or even 100% of their base salary so they are now making a non-bonus salary of $200,00, $300,00 or $400,000. RBS told the public that this was a good thing since it made more sense to pay a higher “fairer” salary to competent professionals and concurrently RBS could reduce year-end bonuses and hopefully the risk taking the bonuses encouraged. But the employees getting salary hikes are also told by management that it will not detract from their bonus amount. It is just a way to get employees paid more cash now. I doubt if one employee who received a salary hike expects a diminished bonus. Taxpayers should ask about the States:
- How many employees received an increase in salary since October 2008 and what is the total amount of the salary hikes?
- How can RBS demonstrate as to specific employees that the higher salaries mean that the bonuses are lower? Otherwise it seems like the salary increase coming at a time when taxpayers are forced to sustain the Bank are in addition, not in lieu of, bonuses, and the “bonus culture” thrives.
Third Issue
The financial crisis in the US started in the summer of 2007. Since that time RBS North America has consistently hired large groups of professionals under contract. When a banker has a contract large pay becomes mandatory not discretionary, so why was this done? Contracts must be honored even if performance is poor. In some cases contracts give a percentage of a group’s profits to the employee, guaranteed, which encourages risk taking. Taxpayers should ask about the States:
- How many employees were given contracts after July of 2007? How many were given contracts after the initial taxpayer investment in October 2008? I understand that even after the initial taxpayer bailout in October 2008 professionals were hired for million dollar plus contracts in some cases for multiple years. RBS had no business hiring people on contract post-crisis as it locks the Bank into having to pay certain bonuses and takes away flexibility from management on pay schemes. What’s more, since RBS moved the North American headquarters north of Manhattan to Stamford, Connecticut there are many professionals who live nearby and who prefer a short commute rather than the slog into Manhattan everyday. That fact, coupled with all the talented bankers who were laid off from other banks, means there was no reason to hire anyone on contract.
- How many employees have contacts where they get a percentage of profits for their group?
- How many of all of these contacts require total cash and non-cash compensation to be, or potentially to be, in excess of $500,000? In excess of $1 million, etc.
Fourth Issue
In the United States certain areas of RBS are involved in secondary sales and trading of various instruments, such as bond, loans, mortgages, equities, credit default swaps, notes issues by Collateralized Debt Obligation funds, etc. Some of these areas seem to have done quite well and the traders, salesmen, analysts, bankers, etc. working in these groups are expecting outsized bonuses. An acquaintance works in an area that monitors profits tells me this:
Most of the secondary sales and trading areas operate as stealth hedge funds. They employ large amounts of RBS capital (generously provided by British taxpayers) and hold positions for long periods of time hoping for capital appreciation (or deprecation if they have a risky short position) What this means is that RBS in the United States is in a fairly large way a hedge fund in various areas like bonds, loans, credit derivates, CLO, CDO, mortgages, currencies and other types of investments. RBS continues to have all the risk attendant to such a model. Contrast this “hedge fund” model with the conservative trading desk model one would expect RBS to employ. In a conservative model these “trading desks” should just match buyers and sellers and make a profit as broker. For example, a bond trading desk might find a seller of a $5 million bond at 90% and then find a buyer at 91%. The spread equates to a 1% profit for RBS on the $5 million bond, which is $50,000. If this is done in volume RBS makes a nice profit with little risk or capital employed. On a conservative model, if the trading desk winds up buying a bond without quickly selling it the desk might have ownership risk for a very short period but it strives to quickly sell that bond before the bond’s price has a chance to move significantly and hurt the Bank. But RBS does not follow the conservative model. Many RBS trading desks take the taxpayer capital and make speculative bets.
This year has been good for certain desks, so they are profitable. But should outsized bonuses be paid? Who authorized all this risk taking? This risk taking with other people’s money is in part what caused massive losses in 2007 and 2008. RBS only judges the “desks” on absolute profit. There is no discounting for the amount and type of risk taken. Capital is allocated to the trading desks and each desk is only charged a very low interest rate as a deduction from profits. There is incentive to make risky bets and performance is not measured against any benchmark.
For example, let’s take a “high yield” bond trading group that used $100 million in capital on average. The group acts like a hedge fund and takes positions in speculative bonds. If this group makes $50M million of profit, the group and all the bosses will be enormously pleased. This year all the traders and other key employees in the group will want 7 figure bonuses and RBS will pay it in some shape because the threat is that if large bonuses are not paid RBS cannot compete with its peers and will lose this “rainmaking” group that generated so much profit. But RBS does not break down the nature of the profit and how it was generated. What RBS should do is: Ask if this trading desk lost money last year. If it was a high yield bond desk it probably did. If the desk was running a book of $100 million let’s say it lost $30 million in 2008. Since the desk is acting like a hedge fund then a “highwater mark” should apply. A ‘high-water mark” is common for hedge funds and it means that investors require that losses in prior years must be recouped before any profit, and reward, is attached to earnings in the present year. So in my example the bond trading desk that made $50 million has a $30 million prior loss to make up, making this year’s profit $20 million. But RBS does not do this.
RBS does not apply any measure of risk to discount the earnings. For example, a desk of 5 people that invests in volatile commodities and uses $10 million of capital to make $10 million should be paid differently than a desk that uses $1 billion of capital with 10 people to buy a 1% treasury bond to earn an identical $10 million. Basically, there is no standard to quantify the risk and the capital used. I’m told it is difficult for a manager to even get the average amount of capital being used by each trading desk for a given period.
Back to our bond trading desk example: If the desk used $100 million of capital on average to make $50 million, and RBS does not deduct prior loses the group employees are mighty proud. But should they be? The average YTD return as of the end of November for High Yield bonds in the US is 52%. So the group has a 50% return and did not even beat its benchmark. However, for purposes of determining bonuses, no benchmark comparison is made. Moreover, it is common that some of the senior employees get paid a fixed percent of the profits regardless of the costs and risks incurred in generating the profit. So they will have an enormous payday without even beating a benchmark. If RBS pays bonuses of about one-third of the $50 million profit, RBS is left with $33.3 million. Then deductions should be made for rent, overhead, benefits, infrastructure, support, outside legal fees, etc. What did RBS really get for risking $100 million in taxpayer capital? If anything, RBS should have invested $100 million simply in a high yield bond fund and then it would have cleared over $52 milling and could have avoided paying all the base salaries, bonuses, support, infrastructure, etc. By investing in a standard high yield index fund RBS would not even have needed all these traders and bankers, etc.
Despite all the talk of bonus reform it is still truly a strange world here in the US. British taxpayers should demand to know:
- How much capital is used by each desk?
- What is the cost of the capital to the desk?
- How does RBS determine the “riskiness” of the employment of capital and how does higher risk affect the bonus determination?
- How are benchmarks used in determining if a desk is profitable?
- How are bonuses determined – fixed percent of profits or some other means?
- Generally, how does RBS determine if a trading group is just a pretense for a hedge fund? We know Goldman Sachs utilizes the hedge fund model but RBS is no Goldman Sachs. If British taxpayers want their money invested in hedge funds they can do so on their own.
Giving money to stealth hedge funds operating under the RBS banner is risky and a poor use of RBS taxpayer capital that could be utilized to make loans to investment grade corporations to help create jobs or the capital could be loaned individuals trying to finance a home purchase.
A final point is that the newly opened Stamford office is palatial and has many impressive and luxurious amenities (you should see the espresso bar with all the flat screens; the bankers’ gym is pretty sweet). Although all this was planned during the bull market and most of the managers who gave the green light are gone, the new offices are still a nice piece of taxpayer funded luxury.