Investment banking pay could be about to become a lot more punitive. While bonus buyouts and guarantees are long gone, there’s currently debate over the possibility of 10-year deferrals and restricting bonuses to less than 50% of total compensation.
This year, however, compensation structures are already complex enough. Investment banks are at pains to point out their restraint over bonus payments for 2011. For example, UBS has said that 17% of people in its investment bank received no bonus at all this year while 85% of RBS staff received less than £10k.
Remuneration reports from banks are more common than ever this year, but a lack of consistent disclosure among the large institutions and – perhaps deliberate – obfuscation of the types of programmes they run, arguably makes it more difficult than ever to determine which firms are the most (or least) generous when it comes to pay.
In an era of cash caps, more punitive deferral schedules and provisions for clawing back or forfeiting awards, do you really know which the most attractive bank to work for is? If you’re thinking of switching jobs, how much of your bonus will you lose, and can you be sure that the compensation structure at your new employer is better than your current deal?
Direct comparisons are difficult, but – based on a combination of company filings and press reports – we’ve attempted to determine which of the major banks is currently the least punitive around pay, and where your compensation is most likely to be hammered.
Deferrals for regulated employees are not equal everywhere
For now, the small pool of ‘code staff’ or regulated employees in the investment banks – on which the most severe regulatory pay restrictions are being applied – may not seem relevant to the majority of people.
However, there are signs that their numbers are growing, and could continue to do so in the future. For example, after classifying all of its investment banking managing directors as regulated employees last year, the number of these staff at Deutsche Bank rose from 168 in 2010 to 1,363 in 2011. UBS has 448 ‘key risk-takers’, but subjects all managing directors to the same compensation measures.
Proposals from the European Banking Authority are likely to tighten up the definition of regulated employees, meaning that a lot more traders could fall into this category.
Deferral rates are high – the FSA’s remuneration code says that at least 40% of total compensation for code staff must be deferred, rising to 60% when remuneration is more than £500k. Of this, at least 50% needs to be paid in shares. There is a loophole, however; the ‘de minimus’ clause says that if bonuses are less than 33% of total compensation and overall pay is below £500k, the deferral rates do not apply.
Bonuses make up the lion’s share of compensation – between 70-77%, in the banks we analysed below. Even here, though, there’s some disparity over bonus deferral rates.
"Some banks are following the code staff remuneration requirements to the letter, while others are going above and beyond basic compliance," says Mark Ife, partner in the remuneration practice at law firm Herbert Smith.
CHARTS: Details of compensation for regulated employees in 2011 (click for big):
US investment banks only reveal pay for their UK code staff and unveiled compensation for 2010 in January 2012.
These figures, however, suggest that they're more generous than their European peers. J.P. Morgan paid its 82 code staff an average of $4.3m in 2010, 72% of which was in a combination of retained stock, deferred cash and deferred equity bonuses. Staff in its investment bank received around 80% of this money. Goldman Sachs, meanwhile, paid its 95 key UK employees an average of $6.2m each.
Why cash caps are largely meaningless
Regulators and governments alike are keen that investment banks limit the proportion of bonuses paid out in immediately ready cash. This isn’t a requirement, but is considered ‘best practice’, hence a number of firms announcing cash caps this year. However, there's a seemingly huge discrepancy between the various organisations.
Royal Bank of Scotland, at the behest of the UK government, has limited cash bonuses to £2k ($3.2k) for the second year running. At the other end of the scale, the likes of J.P. Morgan, Goldman Sachs and Citigroup are reportedly not capping cash payments, while the Swiss banks – Credit Suisse and UBS – are limiting cash bonuses to US$/CHF2m.
However, cash caps are not as punitive as they first seem. Jon Terry, a partner in the reward and compensation practice at PricewaterhouseCoopers, says: "Technically, banks are capping the cash element of bonuses, but very often awarding stock that vests more or less immediately, so is essentially cash by another name anyway. This is particularly prevalent in US investment banks. Generally speaking, any bank that has received state support is under greater political pressure to limit cash payments."
CHART: Cash caps on variable compensation (click for big):
Despite the tiny cash bonus at RBS, for example, it pays the majority of its 2011 bonuses in deferred bonds, which technically vest over a three-year period. However, staff who received a bonus of up to £25k ($40k) will receive 100% of this bond in June 2012, those earning variable pay up to £100k ($159.3k) get 80% of their award then too and 40% of deferred bonds will vest this year for those with a bonus of over £500k ($797k).
Similarly, Deutsche Bank has capped cash payments at €100k ($133.4k), but also allows staff to receive up to €100k in stock that will vest in August. Barclays' investment bank also limited cash bonuses to £65k, but will vest £601m of 2011 deferred bonuses (or around 50%) before the end of 2012.
At Bank of America Merrill Lynch, cash awards are capped at $150k for people earning more than $1m. However, as the charts below show, 30% of total bonus payments for those earning $1m or more will be in either cash or 'unrestricted equity' – shares that vested in February 2012.
Why deferrals could come back to bite
Investment banks are deferring an increasing proportion of bonus payments, usually in the form or restricted equity and/or restricted cash that typically vests in equal tranches over three years. There are exceptions – RBS’s restricted stock vests over two years from 2012-2014, for example, while Morgan Stanley’s deferred cash vests in two tranches in December 2012 and the final month of 2013.
On the face of it, the proportion of bonuses being deferred is growing to dizzy heights within some organisations. A massive 92% of all bonus awards are deferred at RBS, this figure is 75% within Barclays' investment bank and 59% at Deutsche Bank.
HSBC's investment bank appears the least punitive, with just 27% of bonuses being deferred over three years. Staff are required to defer a portion of their bonus when it exceeds £50k ($80k).
Predictably, among the various banks, there's a lack of consistency in terms of when deferrals kick-in and the proportion of bonuses being knocked into forthcoming years.
CHARTS: Proportion of bonuses deferred and Credit Suisse deferral rates (click for big):
Arguably, Deutsche Bank has been the most restrictive here; anyone earning a bonus of more than €50k ($67k) is required to defer between 70-100% of their award. The deferred element of the bonus is split 50-50 between restricted cash and equity that vests in equal tranches over three years.
At RBS, 73% of deferred bonuses are paid in the form of bonds, which – as we explain above – isn't as bad as the overall deferral rate suggests. Even for those earning a bonus of £500k ($797k), 40% of the bond award - or £200k ($319k) – will be paid in June 2012, with the remainder paid in equal tranches over the next three years. The remaining 18% of deferred compensation is paid in shares that vest over two years between 2012-14.
CHART: Structure of deferred awards in 2011 (click for big):
Both Credit Suisse and UBS start deferring bonuses when total compensation exceeds CHF/US$250k. As the chart above shows, Credit Suisse's deferral rates are relatively low up until the CHF/US$1m threshold, but deferrals start at 60% at UBS.
By contrast, US investment banks are generally still paying the majority of bonuses in upfront cash. J.P Morgan, for instance, is reported to have paid an average of 65-70% of 2011 bonuses in cash, with those earning less than $1m averaging 75-80% in cash.
CHART: Case study, Bank of America Merrill Lynch bonus structure (click for big):
Morgan Stanley has increased the average deferral rate to 75%, from 60% last year and 40% in 2009. Anyone earning up to $250k will receive all of their bonus in cash, however, and deferrals are capped at 25% for junior staff. At BAML, deferrals only exceed 40% of bonus payments when the award is more than $1m.
In theory, deferring bonuses both wins brownie points with regulators for supposedly reducing incentives for excessive, short-term risk-taking and ties in staff – especially since few investment banks are willing to buy out a potential employee’s deferred compensation in the current depressed recruitment environment.
However, in order to remain competitive when it comes to pay, those banks deferring a greater proportion of bonuses are looking at other ways to reward staff. In 2010, this manifested itself in bigger base salaries and, in the future, deferred compensation is likely make up a greater proportion of fixed costs.
There’s not a level playing field here, though – your employment prospects could be on shakier ground within the banks deferring a greater proportion of compensation.
CHART: Investment banking compensation split 2012 estimate (click for big):
Analysis by JP Morgan's research team suggests that between 70-90% of compensation costs at 'tier II' banks – largely European firms – will be fixed next year. At 'tier I' banks – mainly US institutions – this figure will be 50-60% it says.
Instead of reducing the bonus pool, tier II banks will have to look to cut costs in other ways and this means that: "most of the investment banking restructuring going forward may have to come from senior staff headcount reductions".
The changing structure of clawback provisions
Just because your bonus has been awarded doesn’t mean it’s guaranteed to pay out. Not only can deferred awards be forfeited, but the FSA also dictates that banks need to have provisions in place to ‘clawback’ any bonuses that may have already hit your bank account.
The FSA says that banks must have processes in place that allow them reduce deferred remuneration if there's any evidence of employee misbehaviour or error, if the bank or business unit suffers a "material financial meltdown" or there's a failure in risk management.
In practice, the majority of banks require continuing employment for any deferred awards to vest – if employees resign or are laid off for misconduct, then they lose any unvested awards. Awards are generally not lost if someone retires, although Deutsche Bank says deferred bonuses could be lost if a former employee offers "similar competitive services to other financial services companies after retirement".
Increasingly, if a particular division – rather than the whole company – posts a loss deferred compensation can be forfeited.
Credit Suisse's clawback provisions are relatively light – a division has to post a loss of CHF4bn before more than 50% of unvested awards are lost (see Table Two). Deutsche Bank, meanwhile, says that 100% of unvested awards can be removed in the event of a company-wide loss.
A number of employees in UBS's investment bank lost 50% of unvested awards this year after the rogue trading incident involving Kweku Adebol. This was the most punitive forfeiture; for regulated employees, managing directors and those earning more than US$/CHF2m, between 10-50% of deferred bonuses due to vest in a particular year can be lost if a division falls into the red.
UBS's move is indicative of what looks likely to become an increasing trend – penalising executives and managers for the actions of the individuals they oversee. Earlier this year, Lloyds Banking Group announced that it was cancelling bonuses payments deferred from 2010 for its former chief executive, Eric Daniels, and 12 other executives for their part in the misselling of payment protection insurance, which cost the company £3.2bn ($5.1bn).
Meanwhile, Morgan Stanley and Goldman Sachs have specified that managers could face clawback if their employees take excessive risk or exercise other misconduct.
"We’re likely to see any remuneration forfeiture not just dependent on an individual's performance or behaviour, but based on the group as a whole, or a particular division," says Terry. "So far, banks are keeping their powder dry on the matter, however, and keeping any forfeiture policies as flexible as possible."
The most and least punitive banks
As we mention above, making accurate comparisons between investment banks' compensation structures remains challenging, even with greater disclosure. However, based on our analysis, we'd suggest that these are the most and least punitive investment banks when it comes to pay.
As we mention earlier, RBS’s tiny cash cap and huge deferral rate are not what they seem. The favourable vesting schedule of its deferred bonds means that, even with a bonus above £500k, rank-and-file staff could still pocket up to £200k in 2012, which doesn’t compare unfavourably with its peers. However, its average compensation is the lowest of all the major investment banks, and the bonus pool has declined by 58% this year - one of the biggest drops. Its regulated employees are also the lowest paid, as the charts above show.
Some compensation figures are not comparable among the major banks. For more information on pay within particular firms, click on the links below. Please note, some figures related to Barclays' regulated employees were incorrect and have now been amended.
If you’re also interested in more details about unusual compensation arrangements, click on the second link below.
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