Banks Plan Pay Code to Head Off Backlash

The Financial Times reports that the investment banking industry is considering implementing guidelines regarding compensation to ward off further criticism.

However, in reality, legislators and regulators are highly unlikely to impose any kind of standards. The worst the industry faces is being hauled before Congress and called bad names for ten minutes.

The absence of a real threat of external discipline means any moves are window dressing. And it’s easy to impost grand sounding pay schemes in an industry recession when bonus expectations are modest. Even so, the FT suggests it may be hard to reach agreement on measures that are in the shareholders’ best interest, such as having trader pay based on longer term performance. And that’s because on Wall Street, even more so that elsewhere, the inmates run the asylum.

Perhaps the only place you might see meaningful change is in CEO packages, particularly severance. But that won’t come out of these discussions, but from further media and regulatory pushback.

From the Financial Times:

Leading investment bankers are proposing new guidelines on pay and bonuses in the financial sector as they seek to head off a growing political backlash against what were seen as excessive rewards for bankers whose risk-taking helped cause the credit crunch.

In particular, the Institute of International Finance, a global association of banks, is seeking to create a code of best practice, which would discourage banks from giving incentives to traders to take excessively risky bets while failing to censure them if these turn sour.

The idea, which will be privately discussed at an IIF meeting in Rio today, marks the first time that the sector has attemp ted to create any voluntary code.

The discussions about compensation principles – which are at an early stage – are part of a much wider set of reform initiatives being prepared by the IIF.

“We [at the IIF] are discussing this issue [of compensation] right now,” said Josef Ackermann, head of Deutsche Bank, who also chairs the IIF. Charles Dallara, head of the IIF and a former US regulator, said: “Executives need to take a very hard look at compensation structures.”

Ideas being floated include bonuses being deferred until the full impact of bankers’ strategy is clear to prevent them benefiting from short-term high-risk bets that subsequently turn sour.

Another variant would see those who lost money for their businesses having to earn it back before they secured new bonuses. However, the concept is likely to prove highly controversial, particularly among investment bankers in London and New York. “It does not sound workable,” said a senior Wall Street executive, who argued that it was highly unlikely Wall Street banks would agree to any kind of uniform compensation rules for fear of giving up a competitive advantage.

The issue of banking pay is becoming particularly controversial because salaries in the financial industry have exploded this decade relative to other sectors of the economy. However, some sectors with the biggest pay-outs in recent years – such as complex credit – are in the storm of the current credit turmoil. Meanwhile, the banks are still paying high bonuses to many employees, in spite of a swath of writedowns.

This is triggering growing criticism of compensation structures among policymakers and some investors. “At present, compensation incentives are asymmetric . . . This encourages employees to take excessive risks,” says Philipp Hildebrand, vice-chairman of the Swiss National Bank.

But many senior bankers say it is hard for individual banks to change their pay structures, since they are in a competitive market place. “Compensation is [bankers’] incentive for taking risks – that’s really what risk management has to change,” said Mr Ackermann.

“The big problem with compensation is how do you create a culture where people suffer jointly and win jointly? Unfortunately, competitors do not allow that.”

Nevertheless, some bankers hope an IIF code could pave the way towards a broader industry shift and they warn that the sector risks a serious clampdown if it does not take proactive steps.

The IIF was expected to produce a wide-ranging set of proposals for banking reform this week. However, the compensation issue threatens to delay that.

A London-based board member of one major global firm said: “The issue should have nothing to do with the public unless they are shareholders, and the low valuations that investment banks now trade on show how shareholders have voted on the issue.”