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Monday, 23 October 2017

The traders’ or the politicians’ option?

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SwissInvest strategist Anthony Peters learns lessons on bonuses from his dear old dad

Anthony Peters, SwissInvest Strategist

IT IS MARCH 1 and tonight spouses and lovers – not together of course – will be treated to lovely dinners out as the 2012 bonus cheques clear.

It might not have been a bumper year on the bonus front, but it won’t be all that bad for most. And compared with what might be coming, the 2012 cheque might look very good indeed – assuming, that is, that the politicians and bureaucrats of the European Union get their way and cap discretionary bonuses at 100% of base salary (or, with shareholder approval, 200%).

It was Voltaire who wrote “I do not agree with what you have to say, but I’ll defend to the death your right to say it”. I feel the same about bonuses. I hated the rampant bonus culture, but legislation is the worst possible way of dealing with it.

My old Dad passed two particular pearls of wisdom on to me which seem quite relevant here. The first was that money doesn’t smell, but that too much money stinks. The other was (though he was thinking in the context of religion) that ethics should never be codified, because when they are, all energy goes into interpreting the meaning of the words rather than trying to pursue a correct and overarching moral outcome.

At the core of the bonus issue – at least as far as the authorities are concerned – is what used to be called the “trader’s option”, which means that if you get the bet right you get paid out, but if you get it wrong the worst that can happen is you get fired.

I hated the rampant bonus culture, but legislation is the worst possible way of dealing with it

Seeing as the downside risk has a painless floor but the upside is near-infinite, there is nothing that stands in the way of the bet other than trading limits, the breach of which is cause for instant dismissal. The whole issue of the asymmetric risk of traders is of enough interest to have been picked up by Scientific American, no less, through a guest blog.

In it, the writer Chris Amade writes appositely: “Here is a guaranteed way to get paid well if you work on Wall Street. Find a best friend at a competing bank or hedge fund and take opposite sides of the same large bet. In one year’s time one of you will have a huge profit and get paid well. The other person will have lost and perhaps be fired. The sum of both your profits will be zero, but the sum of what you get paid will be positive. Split the pay.”

HOWEVER, BY CODIFYING the bonus cap, the politicians, despite their best intentions, will create a fixed target for the “bankers” to push back against.

The fact is that, as soon as the cap is introduced, bankers and lawyers will be burning the midnight oil in order to find ways of circumventing the rules. We might go back to consultancy contracts in which the trader doesn’t work for the bank and invoices the employer – who is no longer an employer – for an amount according to an agreed formula. I recall that in the 1980s many trading staff contracted by way of Cayman Island companies in order to be paid offshore.

I’m not advocating a revival of such practices, but you can rest assured that the collective brainpower available in the banks will ultimately outsmart the collective brainpower of Brussels. It might take them a while but they will get there in the end. Let’s face it: if there is money involved and you need innovative solutions, look no further than the City or Wall Street.

IF, ON THE other hand, you’re looking for misguided attempts at controlling the world, look no further than Brussels. It might have been forgotten that Italy massively failed to meet the Maastricht criteria which were preconditions for joining the single currency in 1999.

Then, in an attack of unfathomable “logic”, it was decided that if Italy was left on the outside, it could progressively devalue its currency, thus creating a persistent competitive advantage against which the likes of France, itself now tied to Germany, could not compete. Hence Italy had to be welcomed into the currency union, despite having highly visibly fluffed the membership test.

Perhaps those in charge would also like to consider capping footballers’ pay at €150,000 per season – more than enough, I’m sure – under the pretext of helping to protect their hard-pressed constituents by keeping ticket prices and satellite TV fees down.

I wonder what they would garner by way of thanks if the teams from Madrid, Milan and Munich began losing to those from Beijing, Shanghai and Seoul simply because the most talented players had decided to move to breathe the free but polluted air of booming Asia.

The banks blew it; that’s for sure. They were bailed out by taxpayers who were not offered an option; that’s an indisputable fact. As long as there were endless highly paid non-executive directorships available to retiring politicians, no questions were asked. Now that these have gone, it is easy to wax vindictive. Other than popular headlines, bonus caps will achieve nothing. Think of my old dad and his fear of codification.

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