Last week, UBS AG published a far-reaching set of changes to the way investment-bank staff will be paid. It will scrap bonuses for the chairman, and bring in a system that will distribute rewards over several years. When your deal does well, you get a bonus. When it does badly, you get a “malus.”
It’s a good start, and by far the most honest attempt by any bank to grapple with bonuses. The trouble is that it does not go far enough. Investment banks will have to find more radical ways to align risks and rewards for their people. And they will need to get a lot smarter about motivating employees when the prospect of easy bonuses no longer chains them to their desks.
It is no great surprise that Zurich-based UBS is leading the way. It has been one of the hardest hits of all the main European banks in the credit crunch. It couldn’t afford to blithely carry on as if the past year had been no more than a minor stumble for a business that was otherwise in great shape. The bank has had more than US$44 billion of credit losses and writedowns since the start of last year, the most of any bank in Europe.
To its credit, UBS has been painfully candid about its mistakes. Unlike many of the hedge funds, it hasn’t been blaming “market volatility” or “unprecedented turmoil” for losing a ton of money. It has recognized that it took far too many risky bets on the market.
In April, UBS published a review that nailed the bonus culture as one of the main culprits for its losses.
‘Heads I win’
“Bonuses were measured against gross revenue after personnel costs, with no formal account taken of the quality or sustainability of those earnings,” the report said. Since then, we have found out just how “sustainable” those earnings were.
The new pay regime is an attempt to fix such failings. It will be studied by all the major banks, and rightly so.
UBS has identified “heads-Iwin-tails-you-lose” incentive programs as one of the main problems. Do a deal that makes money this year, and you get a big bonus. If it loses money next year, you keep the bonus, and the bank and its shareholders suffer the losses. The game was structured to favor taking wild bets on the market, since that was the quickest way to make a fortune.
The “malus” puts a bit more of the “you lose” into the equation. Rewards will still be paid, but you get only some of the money in the year it was earned. The rest will be placed in an escrow account on your behalf. Whether it ever gets distributed depends on the future performance of the bank. If it makes losses, a “malus” will be awarded – a chunk of the money will be deducted from your account.
Reason for caution
“This should bring about a cultural shift in the company,” the bank said last week. “Those who are rewarded will be those who deliver good results over several years without assuming unnecessarily high risk.”
It should certainly level up the score. Once you have a few hundred thousand euros in your account, you will think twice about betting the bank’s money on oil shooting above $100 a barrel again by the new year. The threat of the “malus” will force traders to think harder about their positions.
There are several shortcomings with the new system.
First, it will take time to become effective. The “malus” doesn’t have any meaning until you have built up a decent-sized bonus pot. Until then, the incentive will still be to take aggressive risks. UBS will be creating a generation gap: The younger staff will still take big, chancy bets. The older employees will be protecting their earnings.
Good times
Next, staff will accept it in an economic decline, but will they do the same in good times? No one is going to quit a bank when there is zero chance of finding a new job. But when the bull market is finally back, how are you going to recruit new people? And how will you stop them taking their bonuses and walking before the “malus” takes effect?
Lastly, the emphasis is still on the individual. Traders will be working to fill their own bonus account rather than working for the good of the whole bank. The system will make employees more cautious, that much is certain. It is hard to see how it will make the bank work as a more cohesive unit.
The reality may be that investment banks need to go back to the partnership structure that many abandoned during the boom of the last two decades. Partners had a long-term commitment to the firm; they built up wealth over a long career; and they depended on the bank’s survival over generations for their own wealth.
By Matthew Lynn*
* Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own. |
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