Leaked document shows government has been secretly protecting bankers’ bonuses

[Magda Hassan]

Bonus Balls

Posted January 24, 2011
A leaked document, published exclusively on monbiot.com, shows that the government has been secretly protecting bankers' bonuses.

By George Monbiot. Published in the Guardian 25th January 2011.
It's bonus season, the time of year when bankers show us what they really believe. As soon as they get their money, they spend much of it on land and houses. They know that these are safer investments than the assets in which they trade. If they trash the economy again, they at least will survive.
This year the frenzy will be almost as bad as ever. But it could have been worse. Here is the story, revealed by a leaked document, of how our government covertly tried and failed - to kill tougher European rules on bankers' bonuses, and how the Chancellor of the Exchequer appears to have misled parliament.
Before I explain what the government did, let me remind you of a few of the statements the Conservatives made about bonuses while in opposition. In February 2009, David Cameron announced that "where the taxpayer owns a large stake in a bank, we are saying that no employee should be paid a bonus of over £2,000″(1). Stephen Hester, chief executive of RBS, 84% owned by the taxpayer, is now said to be lining up a bonus of around £2.5m(2).
In October 2009, George Osborne announced that he was calling on the Treasury to stop retail banks "paying out profits in significant cash bonuses. Full stop."(3) Bob Diamond, chief executive of Barclays, is due to make around £8m this year, half of which is likely to be cash(4).
In April 2010, a Tory policy paper observed: "news that bank bonuses this year are expected to total £7 billion shows that Gordon Brown's claim to have ended the era of the big bonus was ridiculous."(5) Bank bonuses in 2011 are expected to total £7 billion(6).
A fortnight ago, a Downing Street spokesman admitted that the government would, after all, make no attempt to limit the size of bonuses(7). This much we knew. But what the leaked document shows is that even as the government claimed to be seeking strong international rules to curb the bonus frenzy, it was secretly lobbying to prevent them from being passed. The document is, or should be, big news, but so far it has been covered in just one place: Tribune magazine, where the freelance reporter Ben Fox broke the story(8).
As David Cameron pointed out before he took office, the UK's bonus culture "encouraged short-term risk-taking instead of rewarding the long-term interests of shareholders and the public."(9) This risk-taking helped cause the financial crash. The EU wanted to prevent it from happening again, by reducing the incentive to chase short-term gains. It hoped to update the Capital Requirements Directive, to ensure that bankers could take only a small part of their bonus as an immediate cash payment(10). The rest of the bonus would be a mixture of cash and shares, held over for up to five years. If, during that time, the bank did worse than expected, some of the promised money would be clawed back(11).
This would force bankers to think about the future as well as the present. The European draft proposed that no more than 30% of smaller bonuses and no more than 20% of larger ones could be paid upfront in cash(12). The British government had other ideas.
The leaked document, which was passed to a socialist-group MEP, lays out the UK Treasury's negotiating position(13). It reveals that "throughout the negotiation and implementation of the Directive, we have supported an interpretation that limits upfront cash to 40% of a total bonus". The European parliament's proposal for a 20% limit would, the UK claimed, "have a significant impact on the European financial services sector's international competitiveness." The Treasury, the document shows, also contested the plan to impose a minimum period for deferring the rest of the bonus payment. "Some may argue," the leaked document conceded, "that we are supporting a position that is less onerous on bank pay than other European legislators."(14)
Under the heading "Line to take", the document proposed that the government should claim that it has "led the way in implementing G20 principles and doesn't believe that the EU should go further than what was agreed by the G20." It argued that "the only consistent option" is to drop the "minimum retention conditions."(15) I'm publishing the leaked document in full on my website.
In December the UK proposals were defeated, and the tougher rules on bankers' bonuses were adopted by the European Parliament(16). But here's the kicker. On January 11th 2011, the Chancellor of the Exchequer, George Osborne, made the following statement to the House of Commons. "… on 1 January this year we introduced the most stringent code of practice of any financial centre in the world. For the first time, there will be a strict limit on the amount of bonus payable in up-front cash. Also for the first time, there will be a requirement that 50% of bonuses be paid in shares or other non-cash instruments, which bank employees will not be allowed to sell on for an appropriate period."(17)
In other words, Osborne is claiming credit for the very policies his government tried to squash. He is also wrong to claim that the UK's is the most stringent code of practice. It is in fact the minimum possible implementation of the EU directive (for example, under the UK interpretation, bonuses aren't classified as "large" until they reach £500,000). The rules are mandatory, and they came into force in all member states on January 1st. It seems to me that Osborne misled parliament.
As for the claim in the leaked document that the tougher rules would damage the sector's competitiveness, such restraints will do the opposite, as Cameron and Osborne both acknowledged while in opposition(18,19,20,21). They defend the banks against their bosses' greed.
The Treasury made the following statement when I asked if it had tried to water down the directive. "This accusation is wrong. The updated Code is tougher than last year's … for the biggest risk-taking employees, the amount they can take up-front in cash has been halved from 40% to 20%."(22) Yes, but what it failed to add is that this happened despite its best efforts. The deception continues.
The Prime Minister and the Chancellor of the Exchequer have been playing a double game. They claimed they wanted to tame the banks. In reality, they were protecting them. They never meant to address the economic polarisation of this country, or to check the incentives which caused the last crash. Their intention was always to pamper the rich and to make the poor pay for their follies. As the leaked document shows, the Conservatives are ready to risk the whole economy to help the filthy rich get richer.
http://www.monbiot.com
References:
1. http://www.telegraph.co.uk/finance/newsb...nuses.html
2. http://www.guardian.co.uk/business/2011/...-coalition
3. George Osborne, 26th October 2009. Speech: The British economy needs confidence and credit. http://www.conservatives.com/News/Speech...redit.aspx
4. Cash (see below) will now make up a maximum of 50% of a bonus. Those who can get cash are likely to take it. http://www.guardian.co.uk/business/2011/...ob-diamond
5. Conservative Party, April 2010. Change for the Better in Financial Services.
6. http://www.guardian.co.uk/politics/2011/...onuses-tax
7. http://www.guardian.co.uk/politics/2011/...-ministers
8. http://www.tribunemagazine.co.uk/2011/01...onus-laws/
9. David Cameron, 15th December 2008. Speech: A day of reckoning. http://www.conservatives.com/News/Speech...oning.aspx
10. http://europa.eu/rapid/pressReleasesActi...anguage=en
11. Committee of European Banking Supervisors, 10th December 2010. Guidelines on Remuneration
Policies and Practices.
http://www.eba.europa.eu/cebs/media/Publ...elines.pdf
12. http://www.europarl.europa.eu/en/pressro...sh-bonuses
13. UK Treasury, no date given. CRD3 Briefing: CEBS Guidance on Remuneration Provisions in the Capital Requirements Directive. The full text is at: http://www.monbiot.com/archives/2011/01/24/how-the-treasury-deceived-us/.
14. As above.
15. As above.
16. Committee of European Banking Supervisors, 10th December 2010, as above.
17. http://www.publications.parliament.uk/pa...1161000004
18. David Cameron, 15th December 2008, as above: "Many bonuses were also calculated using return on equity rather than return on overall assets. This created a massive incentive to borrow - by financing with debt rather than equity bankers could increase their returns on a small equity base and therefore increase their bonus."
19. George Osborne, 26th October 2009, as above. "But instead of using these profits to lend more and get credit flowing again, the banks are threatening to pay out billions in cash bonuses instead. If this happens it will make the credit crunch worse."
20. See also: The Conservative Party, July 2009. From Crisis To Confidence - Plan For Sound Banking:
"It has been clear for some time that irresponsible remuneration practices contributed to the financial crisis by encouraging individuals to pursue high risk, short-term profits."
21. And: The Conservative Party, September 2008. Reconstruction - Plan for a strong economy: "It is clear that employees who are incentivised with massive bonuses to focus on short-term gain are likely to take more risks than those whose pay is linked to the company's longterm success through share options."
22. HM Treasury, 24th January 2011. By email. Here's the full text of their statement: "Here's our line on the claim that we tried to water down the capital requirements directive: This accusation is wrong. The updated Code is tougher than last year's. Around 250 firms are now subject to the toughest rules, compared to 25 previously. What's more, for the biggest risk-taking employees, the amount they can take up-front in cash has been halved from 40% to 20%."


This is the text of the leaked document referred to in Bonus Balls.

Posted on monbiot.com, 24th January 2011
CRD3 Briefing
CEBS Guidance on Remuneration Provisions in the Capital Requirements Directive
Summary
There are two issues at play in the various press reports covering the CEBS guidance on the CRD3 remuneration provisions: (i) the current interpretation of the upfront cash limit provisions and the tax implications of retention conditions; and (ii) the exaggeration of provisions that relate to state assisted banks and fixed/variable pay ratios.
Upfront Cash and Retention Conditions
The provisions in CRD3 imply a cap on the maximum proportion of a bonus that can be paid in cash upfront.
These provisions are open to interpretation and throughout the negotiation and implementation of the Directive, we have supported an interpretation that limits upfront cash to 40% of a total bonus. This interpretation is consistent with the G20 agreed FSB Standards.
The European Parliament has taken a different view and interpret the provisions as imposing a 20% cap. This will go beyond the globally agreed position and will have a significant impact on the European financial services sector's international competitiveness.
In addition, the EP are looking to impose minimum retention conditions on non-cash components. These carry critical tax implications that are internally inconsistent under both the EP's and our view on upfront cash.
With respect to the EP's view, an employee will face a tax liability at the point their remuneration is awarded. If an employee is awarded 40% of their bonus upfront, only half of which is paid in cash, their tax liability will consume this entire cash position and any further NICS charges will likely mean his total liabilities cannot be paid out of current income.
With respect to our interpretation, 60% on an employee's bonus will be deferred, 10% in cash and 50% in shares. At the point a deferred tranche is released (vests) it will incur a tax liability. However, when a tranche of deferred shares vests, they will be subject to further retention criteria and cannot be sold to pay this liability.
The Committee of European Banking Supervisors (CEBS) has been tasked with providing non-binding guidance on the proper implementation of the provisions. Despite significant support from other Member States for our position, CEBS have issued a consultation document supporting the EP's position.
As such, despite the fact the EP's interpretation threatens the sector's international competitiveness and in is inconsistent from a tax perspective, the lack of support from CEBS means some may argue that we are supporting a position that is less onerous on bank pay than other European legislators.
State Assisted Banks and Fixed/Variable Pay Ratios
In addition, various press reports have suggested the Directive and the CEBS guidance will impose variable/fixed pay ratios on firms and will block the payment of variable pay to Directors at banks that are in receipt of state aid. These reports are inaccurate and exaggerate the provisions of the Directive.
To be clear on state assisted banks, the directive says variable remuneration should only be paid to directors to the extent it is justified and that the remuneration policy should reflect the banks' priorities to rebuild capital and provide for the recovery of taxpayer assistance. The CEBS guidance makes it clear that member states' competent authorities have flexibility in imposing conditions on director's pay at these banks and does not require a moratorium on their bonuses. For obvious reasons this would impair the competitiveness of these banks and have a significant impact on the recoverability of taxpayer support.
In addition, the guidance says quite clearly "it may be necessary to pay variable remuneration to new directors, who are hired to rescue the institution. As it will be difficult to hire new adequate management capacity for an institution, it may be justified to award or pay variable remuneration to new directors". (CEBS Guidance, p.28)
On Fixed and variable pay ratios, the directive says "fixed and variable components of total pay are appropriately balanced […] Institutions should set the appropriate ratios…" (Annex V, Section 11, point 23). The CEBS guidance repeats this view that it is the responsibility of the institution and not the regulator, to set this ratio.
Lines to Take
The Committee of European Banking Supervisors (CEBS) has issued a consultation document on non-binding guidelines implementing EU legislation on remuneration and bonuses.
The consultation will run for one month before CEBS gives a final view.
The UK believes it is important that in Europe we implement our remuneration policy in line with the principles already agreed globally by the G20.
We need global action to tackle bonuses. The G20 principles have international agreement, which is why we believe they provide most effective basis for action.
The UK has led the way in implementing G20 principles and doesn't believe that the EU should go further than what was agreed by the G20.
Background
Two provisions in the Directive combine to impose an upfront cash limit on variable remuneration packages:
The deferral condition states that at least 60% of a bonus must be deferred over an appropriate period; and
The Cash/Equity condition states that at least 50% of a bonus must be paid in non-cash instruments and held over an appropriate retention period.
We interpret the cash/equity condition as applying to the whole variable remuneration package. As such conditions can be satisfied by deferring 50% non-cash and 10% cash, leaving 40% cash available upfront.
The EP interpret the cash/equity condition as applying equally to both the deferred and non-deferred components. As such, of the 40% not deferred, half must be paid in securities and retained, leaving only 20% of the total bonus available in cash upfront.
In addition, the EP support minimum retention criteria on all non-cash pay components. This is inconsistent from a tax perspective and will result in unfunded tax liabilities no matter which interpretation on upfront cash is taken.
The FSA have already issued a consultation document outlining their proposal to implement these provisions on the basis of our interpretation.
Throughout the negotiation of the Directive we have indicated to the FSA that we support the line they have taken in the development of CEBS guidance and the view reflected in their consultation.
Worked Example of EP's Position
20% upfront cash limit and retention conditions on all non-cash components.
An employee receives a £1m bonus. 60% is deferred and 40% is non-deferred.
Of the 40% non-deferred, half (20%) is paid in cash and half in non-cash securities that must be held over a minimum retention period.
However, as a higher rate taxpayer, the employee will have to pay 50% income tax on the entire non-deferred component in the year it is awarded. This means the half paid in cash is automatically consumed by the tax liability and the employee receives zero cash upfront. Any further charges like NICS will be unfunded.
This is a significant departure from the internationally agreed position in the FSB Standards.
Worked Example of Our Position with Minimum Retentions
The same employee receives the same £1m bonus. 60% is deferred and 40% is paid upfront in cash.
On the deferred component, 50% (£500,000) is paid in shares and the remaining £100,000 is cash.
When the deferred component vests it incurs a 50% tax liability (£300,000). However, only £100,00 is available in cash to satisfy this. The vested shares are still subject to minimum retention conditions and cannot be sold. As such this results in an unfunded tax liability.
Our Position without Minimum Retentions
The only consistent option is as above without minimum retention conditions.
If an organisation has discretion over the appropriate minimum retention criteria, they can structure their remuneration packages such that they comply with our upfront cash cap, are consistent with globally agreed standards and do not imply any unfunded tax liabilities.
This is the position we have supported throughout the directive negotiations.