Will the bankers’ bonus clawback work?

It’s quite right that the rewards that employees receive over and above basic remuneration should be linked to the success of their companies – and it’s clear that over shorter term periods it’s often hard to discern whether what is apparently good news is really what it seems to be. Thus results can be mis-focused or simply tell part of the story, as with the sale of Payment Protection Insurance (PPI) contracts that generated short-term benefits for the banks but as we know ended up with huge bills for compensation.
There’s also the interesting problem that risk-taking doesn’t always show up immediately, and the global finance community are clearly still building risks. For example in the US, as a result of the easy issuance conditions in the corporate bond markets, there is a glut of potential auto loan financing available and the terms of this credit seem to be remarkably easy. Thus car loans are now available for up to six years despite the reality that new cars are virtually guaranteed to depreciate in value rather than appreciate and six years is a long time to lend against a car. In a similar vein it’s interesting that the average duration of a US corporate bond at issue today is around 13 years but the average duration of an employee or director share option is between 30 and 60 months, with a maximum of around 10 years.
As a connected point, according to enlight research, while the average tenure of a US non-executive board member has increased towards is effective legal maximum of 9 years, the turnover of executive directors and in particular CEOs has increased significantly with the result that their average tenure is likely to be less than 5 years. These are important factors because at present, the US corporate sector may be issuing as much as $1500bn of long term bonds, and according to the latest flow of funds reports, the proceeds are going to finance share option schemes, dividends, stock buy-backs and M&A. However, it is clear that the people that are taking the decisions on these ever expanding and share price boosting distributions to equity holders (including themselves) are extremely unlikely to be in place when the debt that they issue now matures. In fact many will be explicitly prohibited from being in place. Counter-cultural it may be, but short board terms and tenure may be a contributory factor behind the under-investment and preference for financial engineering presently favoured by many companies.
With specific focus on the UK, although past bonuses can be clawed back even if spent, this will not apply retrospectively – with the rules only coming into effect from 2015 and not being applied to past problems. This is consistent with lawyers’ views on contracts and obligations but is a pity in that we can reasonably expect that there will be more problems emerging and no recourse to the bonuses paid despite the expectation that such bonuses should not have been awarded.
We can also note that the rule will only apply if there “is evidence of employee misbehaviour or material error”. This means that if a banker acts in good faith, there won’t be a claw back even if the decisions taken turn out to be poor.
More generally, the banks do now appear to “get the point” of what the government demands (not the case previously under Diamond/Cable spats) and we may suspect that the new rules will not involve too many future examples. We can all agree that the general effect of curbing reckless behaviour is sound and should be a useful step in curbing banker excess.
There is a risk that banks now become overly risk averse and lose international competiveness. But these risks should be manageable – and the clawback rules do close down one of the extraordinary eyesores that has contributed to the erosion of trust in banking and finance generally. So a step in the right direction, but perhaps a little timid and we should expect more measures in due course.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla