Friday, 21 September 2018

​Grovel and Vomit: The Wrong Bonus

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  • Peters 475px June 2014

Bonuses for traders have gone from the sublime to the ridiculous – but there is a better way.

THE FINES RECENTLY imposed on Deutsche Bank by the SEC and the FCA were an eye-watering US$2.5bn but that didn’t really impress me (how quickly we become used to what was once unthinkable). What did, though, was the news that one of the traders in the centre of the controversy was a person named in official papers as “Trader Three” but who has since been revealed to be one Christian Bittar – yet another French derivatives trader who will become a byword for banking excess.

Monsieur Bittar was allegedly paid aggregate bonuses of US$136m between 2008 and 2011. Not bad for a kid in his mid 30s, eh?

On the other side of the coin, I was told this past week of a credit trader at a London-based bank whose credit book reported in 2014 a P&L of about US$20m for which – I am told by someone I trust in a position to know – he was graciously awarded a bonus of less than US$50,000.

That is considerably less than the £43,000 average weekly wage of a British Premiership footballer – including those who get relegated. But it would appear that this is not of itself an extraordinary case. The mumble on the street is that it is becoming more common.

MOST OF THE population of the City, let alone the rest of the country, would surely still be happy to be paid that, not least because it probably comes with a £200k-plus base salary and a few minor fringe benefits. But how many of those deliver US$20m – less what a whole hierarchy of risk managers and compliance officers take home – to their shareholders?

Talk of going from the sublime to the ridiculous.

Paying anybody bonuses of US$136m is not only foolish but also begs for systems to be abused. But does a bonus of US$50,000 on a P&L of US$20m make any more sense?

There surely has to be some link between gross revenue and pay-out and I see nothing wrong with a number in the 3%–4% space, especially on a cash product book. (Derivatives make things much more difficult as time-bombs can be – and have been – placed in structures, primed to go off long after their creator has retired due to excess wealth.)

THE HEADLINE OF this piece refers, obviously, to director Nick Park and his two plasticine heroes, Wallace and Gromit. Wallace is always trying to invent something that makes life easier but that invariably ends up making it more complicated and getting him into trouble. It seems to me that regulation, that old bugbear, has taken the system of compensation from one extreme to the other. I don’t know what Christian Bittar’s pay-out ratio was but no matter how low it might have been, it has to be better than the total comp of 1% or 1.5% that would be left for our currently working credit trader.

Of course much of the returns made by traders comes from the leverage they employ – and, it seems to me, their bonus should take that into account.

So why don’t we treat any profit made on leverage as nothing more than being beta and then reward nothing other than unleveraged alpha?

Thus, if the average leverage on a book were, say, four times, and the P&L were US$10m, then the profit attributable to the trader’s skill would be US$2.5m. That would be the amount upon which the pay-out would be calculated. Four per cent on that would give a bonus of US$100,000, which to me seems fair and reasonable.

This should not be paid out in full but only half should go to the trader. Of the rest, half, that is US$25,000, should be attributed to the divisional pot and the other half to the general, firm-wide bonus pool.

Thus, the risk-taker directly receives a hard pay-out of half of attributable profit and hence there should be no cap on this figure. The rest goes into more general pools out of which sales, syndicate and origination will also be paid but the trader participates in both of these pools too, albeit in a discretionary way.

Although syndicate make big numbers, most of this is, in the current structure, risk free and therefore no hard pay-out is required. Risk-free trades brought in by sales should be entirely attributed to the salesperson or salespeople involved and not the trading book on which it is captured. As there is no leverage, the revenue can be attributed in full, adjusted by the pay-out ratio.

Much could and should be done on sorting compensation

ABOVE ALL, IF fully linked to a clear and visible algorithm, the pay-out ceases to be a bonus and becomes a profit-share. The authorities should not be able to question this and mandatory bonus caps would not apply. In other words, bonuses would no longer be discretionary and all the ugliness of “grovel and vomit” at bonus time that has beset the industry for years might diminish, if not disappear.

Much could and should be done on sorting compensation and based on what I am currently hearing, the work cannot begin too soon.

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