REGULATION: Everything and nothing has changed

In the rage against ever-rising executive pay, regulators are stumbling to create rules that address remuneration practices in the financial services industry. Stefanie Eschenbacher asks what has changed since the collapse of Lehman Brothers five years ago.

“Your company is now bankrupt, our economy is in a state of crisis, but you get to keep $480 million. I have a very basic question for you: is this fair?”

Those words by Henry Waxman, an influential member of the US Congress, are probably the most memorable ones of the Lehman Brothers collapse.

Grilling its former head Richard Fuld in front of the US House of Representatives’ Committee on Oversight and Government Reform, Waxman asked a question that is still on peoples’ minds five years later.

Is this fair? (Several news outlets ran articles about the hearing with the headline We’ve been Fuld.)

Public anger over executive pay has increased in recent years and regulators are creating rules that address remuneration practices in the financial services industry.

“The issue of remuneration being aligned to risk and genuine performance will still interest legislators,” says Sharon Bowles, chair of the European Parliament’s Committee on Economic and Monetary Affairs.

Referring to the fact that members of the European Parliament rejected a cap on bonuses for Ucits fund managers in July, Bowles says looking at performance over a reasonably long cycle and other provisions will be the way forward.

“Some in the parliament may try and revisit the notion but it does not rest comfortably with the arguments made that bankers were in a special position with regard to risk.”

Still, members of the European Parliament decided that half of the variable part of a Ucits fund manager’s remuneration would be paid in the assets of their fund.

Payment of at least a further 25% of this variable remuneration would be deferred, a measure that is meant to prevent excessive risk taking and encourage fund managers to take a more long-term view.
“This is possibly not the last we have heard about bonus caps,” says Charles Muller, a partner at KPMG in Luxembourg.

The European Parliament, the European Council and the European Commission have started negotiations on Ucits V, including the bonus cap.

Muller says much depends on how fast negotiations are moving from there.

With only a few months to go until the European Parliament elections in June next year, nothing is decided.

If the final vote comes from the European Parliament after the election, the majority could change slightly in favour of the parties that voted for the ban. Back in July, the bonus cap was rejected by 345 votes to 341.

“This could reopen the whole debate,” says Muller.

Even if there is no bonus cap in the final piece of legislation, Ucits V will include rules on remuneration.

The Ucits V rules on remuneration are widely expected to be similar to those set out in the Alternative Investment Fund Managers Directive (AIFMD).

Article 13 of the AIFMD, which came into force in July, requires all alternative investment fund managers to have remuneration policies for everyone who has a material impact on the risk profile of their fund.

Muller says the ambition of the European Commission is to have rules for everybody. The question, though, is which rules.

While the European Commission proposed comparable rules to the AIFMD for Ucits V, the European Parliament wanted to go one step further and apply the same rules as it does for bankers.

“The risk-taking of alternative funds is normally greater than that of Ucits and that would justify stricter rules in the AIFMD than in Ucits, although nobody has proposed that,” Muller says.

“The provisions of the AIFMD – and I expect that would be the same in Ucits V – are that if an asset manager delegates from a European company to outside the EU, there needs to be comparable regulation in place.”

He also says that asset managers will not be able to simply “move their staff out of the European Union”.

The US has its own set of rules that address remuneration: a short section in the Wall Street Reform and Consumer Financial Protection Act, known as the Dodd-Frank law.

In a bill that runs to 2,300 pages,    just 140 words, in Section 953(b), state that public companies need to disclose the median number on worker pay, placed side by side with the chief executive’s.

Back in Europe, the rules on Ucits V do not prevent European governments to introduce their own regulation on a national level. The Netherlands have already proposed a bonus cap of 20% for all financial services professionals as part of a coalition agreement, which could also apply to employees of Dutch groups elsewhere in the world.  

Some asset managers have even imposed their own rules on compensation, Muller observes. “Those who have not done it will have to do it once the new regulation comes into place, be it on a European or on a country level,” Muller says.

Sven Giegold, member of the European Parliament, who spearheaded the push for a bonus cap in Ucits funds, argues that large bonuses negatively affect the relationship between fund managers and their investors – who often earn a fraction of the pay of the fund managers. “Somebody who has done a good job should get more money,” he says, but adds that the public does not understand the “crazy” bonus system of the financial services industry.

“I do not believe that the investment funds have been the drivers of the financial crisis; those were the banks, but there is a common culture in large parts of the financial services industry.”

Giegold says this culture contributed to the crisis and a pay structure that is more down-to-earth would help.

Bowles says she has always looked more at the fee take and the impact that it has on the investor than on the bonus culture. “The ethical aspect is whether there is proportionality. It is not only the individuals but management fees in general.”

She says there can be situations where fund management fees always take more profit out of an investment than the investor gets. Regulators, she says, are clamping down on this, initially through better transparency.

If bonus payments are regulated, it is widely expected that base salaries will rise as a result. And Bowles adds that it is impossible to regulate base salaries at a EU level.

This has been tried with footballers (Gareth Bale has been in the headlines since he became the most expensive footballer in September when he completed a £85.3 million (€102 million) move from Tottenham Hotspur to Real Madrid) and the European Court of Justice ruled it illegal, arguing it went beyond the Treaty.

Massimo Tosato, chief executive officer at Schroders Investment Management and vice president of the board at the European Fund and Asset Management Association, challenges the idea that fund manager remuneration should be regulated. He says remuneration needs to reflect the global place in which asset managers compete.

“We do support the request for greater transparency, but we need to retain the flexibility to pay for performance,” Tosato says. “Without this flexibility we would be much less able to compete with international firms that are not based in the EU.”

Tosato adds that international asset managers, including Schroders, need to compete with local peers in regions such as Asia and the Middle East, and a cap on fund manager pay would be a hinderance.

Funds Europe contacted the top ten asset managers in Europe by assets under management – BlackRock, UBS Global Asset Management, Franklin Templeton Investments, DWS Investments, Pimco, Fidelity Worldwide Investment, Union Investment, BNP Paribas Investment Partners, JP Morgan Asset Management and Schroders.

With the exception of Schroders and Frankfurt-headquartered Union Investment, none of the other asset managers would comment on regulations around remuneration. One declined, saying it is an “emotive subject”.

Andreas Zubrod, head of legal and public affairs at Union Investment, says Giegold is using examples from the US and the UK for his political agenda, suggesting that the bonus culture is a problem across the financial services industry of all 28 EU countries, the norm.

“We do not share this view. It is in the interest of investors that exceptional achievements by the fund managers are rewarded accordingly.”

It is also not in the interest of investors to raise base salaries because that would reward fund managers even if they performed poorly, says Zubrod. It would also raise asset managers’ costs.

Zubrod says the remuneration of fund managers in Germany is not comparable with the base salary and the bonus of international investment banking. “The variable part of remuneration is usually less than half of the base salary and is partly a deferred payment.”

Union Investment, he adds, has a remuneration policy that aligns the interests of the fund manager and the investor.

“There are already rules in Germany to avoid damaging effects on the investments and the investors, [on] the integrity of the market and the society,” Zubrod says. “There is no need to change the regulatory framework of a constituent private sector to solve pseudo problems.”

It remains an issue in investors’ minds, though.

Deborah Hargreaves, founding director of the High Pay Centre, says there are strong business reasons for having a fairer pay policy in general.

Having done research into pay ratios, Hargreaves found companies tend to perform worse if there is a large gap between those on the top and everyone else.

“Socially and morally, this is important,” she says, adding that there is a corporate elite at the top of the pay scale that does not feel any connection with those further down.

“Nobody in the wider society has had much of a pay rise, and pay rises given were often so low that they have not even kept up with inflation, so living standards have shrunk,” she says. “Once such big divisions are created in society, it becomes unstable.”

David De Cremer, professor in management at China Europe International Business School and a visiting professor at London Business School, has studied the bonus culture in Europe and beyond.

“Five years after the collapse of Lehman Brothers, we are still asking the same questions,” De Cremer says of the discussion of what is fair when it comes to remuneration. “People think things have changed but the fact that we are still asking these questions around bonuses actually indicates that not much has changed.”He says the financial services industry still holds on to the invisible hand, a metaphor by Adam Smith to describe the self-regulating behavior of markets.

The bonus culture, De Cremer says, is more cultivated in the US and the UK.

“It is related to what people think is a fair way of compensation. There might be a cultural aspect in the sense that some countries have a more developed social security system and their culture is much more based on the collective than on the individual,” he says. “In other countries, individuals have to take more responsibility.”

He says their approach is often that “you can achieve everything and you can lose everything”.

However, he highlights that corporate culture is much more powerful. “The corporate culture in the financial services industry is focused on an individual’s achievement and profit development, and that is where bonuses come in.”

As far as corporate culture goes, De Cremer says there is not much difference between financial services professionals in different countries.

“Those who work in a corporate culture where bonuses are accepted and normal, compare their salary to the people in the same company, who work under the same scheme,” he says.

Hargreaves shares this line.

“It is not so much about the amount of money but about how one compares with their peers,” she says.

Whether they work on Wall Street, in London or anywhere else, De Cremer says the bonus culture is so strong that people have to comply. His research, he says, shows that the bonus culture is “self-serving”.

In one-to-one interviews, he says, financial services professionals often state that money is not the only reason they do their job (also because “nobody wants to be looked upon as a greedy person”).

“They will say that the bonus is not that important to them … but if they have to hire someone else they will have to offer them a bonus [system],” De Cremer says, adding that this has become a norm.

In fact, he says research has shown that bonus systems work best in jobs where people have to perform repetitive tasks and are “not effective where people have to think outside the box”.

Most fund managers would certainly argue that they fall into the second category.

De Cremer adds: “They have tried to implement changes where people get their bonuses after three or five years, but what we hear is that the old traditions are coming back anyway and people are being signed up with bonuses on the short-term as well.”

©2013 funds europe



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