The promotion of Bob Diamond, one of the world’s highest-paid investment bankers, to the post of chief executive of Barclays has thrust the issue of remuneration back into the spotlight after a period in which many financial institutions tried to show restraint over pay.
Bonuses awarded to star performers such as Mr Diamond, who transformed Barclays Capital from a subsidiary of the UK lender into a leading global investment bank – for which he was paid in the region of £100m ($156m) – have been the subject of fierce criticism from governments as the global economy struggles in the wake of the financial crisis.
Matthew Oakeshott, Liberal Democrat Treasury spokesman, called the move to promote Mr Diamond an “extraordinary decision” and accused Barclays of “putting up two fingers” to the government and the governor of the Bank of England.
Critics say the banks are widely out of touch with the broader economic environment as they continue to pay bumper salaries and bonuses even though the wider economy is struggling and a number of their peers have accepted government bail-outs.
However, under pressure from regulators as well as the government, banks are being forced to change their ways.
“The structure of pay has fundamentally changed as a direct result of the lessons learned through the financial crisis,” says Stephen Cahill, a partner in the remuneration team at Deloitte, the consultancy. “We are now seeing increased use of deferral, payment in shares, and ‘claw-back’ provisions.”
Forcing banks to spread bonuses over a number of years is aimed at giving them more control over payments and encouraging a consistent performance from staff over a longer time frame.
Before the financial crisis, top bankers were often rewarded handsomely for their contribution over one particular year. Were their performance – or that of the institution – to deteriorate soon after, that money was lost. Deferring bonuses ultimately means institutions can claw back the reward if long-term goals are not met.
The other big change is a reduction in the proportion of bonuses that can be paid in cash. Regulators hope that forcing banks to award more shares and less in upfront cash payments will align the interests of staff more closely with those of investors.
But while the world’s 20 leading nations have agreed to sign up to these rules in principle, there is a marked difference in how they are being implemented around the globe. The Financial Services Authority, the UK regulator, has sought to set the global standard on responsible practices. It recently became the first regulator to comply formally with stricter rules on bonuses.
The FSA has demanded that banks and other financial institutions, including hedge funds and investment managers, defer 40-60 per cent of bonuses for at least three years. The higher deferral rate applies to larger bonuses – those worth £500,000 or more. The regulator is also insisting that at least 50 per cent of an executive’s total package must be paid in shares or share-linked instruments.
Elsewhere, in the US, Asia and much of Europe, the proposals are being treated more lightly – as guidelines rather than concrete rules. Other regulators have stopped short of making specific commitments.
Some experts fear this imbalance could have a negative effect on the UK’s stature as a financial centre.
“The nature of the competitive finance industry means there could be a first-mover disadvantage,” says Benjamin Williamson, senior economist at the Centre for Economics and Business Research. “Wall Street is terrified of business moving to London, and London is terrified of it moving to Asia.”
The British Bankers’ Association, too, has emphasised the importance of implementing changes on a global basis.
Aside from the regulatory changes, banks have also taken steps to rein in bonuses themselves. Many senior executives in the UK, Europe and the US waived their entitlement to bonuses this year, and banks have also scaled back the proportion of profits they pay out to staff.
Mr Williamson points out that it is in the interests of both the banks and the regulators to pay a smaller proportion of bonuses in cash. “Banks lost a lot of money through their own workers not having aligned incentives with the operations of the bank,” he says.
While experts believe the changes in the structure of bank pay are here for good, bumper bonuses are already starting to creep back in.
Mr Williamson points out that payments awarded on the back of single deals – a large corporate takeover, for example – may not automatically be caught by the new rules.
Also, Mr Cahill at Deloitte says it will take more than just a restructuring of pay to avert another financial meltdown. “The financial crisis was caused by failures in governance and regulatory oversight, product complexity and an inadequate understanding of systemic risk,” he says. “Remuneration may have contributed to the situation but it certainly did not cause the financial crisis.”