Wednesday, January 12, 2011

Proprietary trading and banker's pay updates

After the post-mortems to the passage of the Dodd-Frank financial reform bill, I was under the impression that the Volcker Rule, which purports to ban deposit-taking institutions from engaging in proprietary trading, had been weakened to the point where its prohibition was merely notional for the foreseeable future. For one thing, Scott Brown managed to get the ban on FDIC-insured banks investing in hedge and PE funds scratched at the last minute. I thought that implementation of the surviving provisions had been placed on a long slow track. And indeed, regulations regarding how proprietary trading will be defined and how the ban will be enforced are not due for nine more months and remain very much a matter of contention.

So I was surprised by this in yesterday's WSJ:
Morgan Stanley reached an agreement with proprietary-trading chief Peter Muller that will allow his team of traders to form a new firm at the end of 2012, people familiar with the matter said.

The widely anticipated deal is the latest exit by high-profile traders from traditional Wall Street firms because of the Volcker rule, approved as part of last year's Dodd-Frank financial-overhaul law...[snip]

In response to the regulatory squeeze, Goldman Sachs Group Inc. has essentially shut down one of its large proprietary-trading operations, called Goldman Sachs' Principal Strategies, with many of the traders who worked there going to new funds or joining rival investment firms. One group of about nine Goldman traders, led by Bob Howard, was hired by private-equity firm KKR & Co. in October.

The remaining proprietary-trading desks at banks like Bank of America Corp., Citigroup Inc. and J.P. Morgan Chase & Co. likely will be shut down or spun out to comply with the new rules, which take effect over the next several years.
Similarly, news reports at bonus time last year indicated that banks were back to their merry ways when it came to compensating their traders and investment bankers.  Pay restrictions slapped on TARP recipients were famously not operative for 2008 pay packages, and most banks were out from under by 2010, and the issue was not addressed in Dodd-Frank. So I was surprised, too, by this:

Credit Suisse Group AG will alter how it pays banker bonuses for 2010, taking into account shareholder criticism and increasing government involvement in year-end rewards.

The portion of cash bonuses from the Zurich-based bank that aren't paid immediately will be paid out over four years—one quarter annually—and be linked to Credit Suisse's return on equity from this year to 2014.

The pay announcement comes as Wall Street traders and investment bankers are bracing to hear what their

2010 bonuses will be later this month. Experts say many will see lower bonuses than in past years or ones that comes with strings attached like the new Credit Suisse plan, as banks continue to work to appease regulators critical of big bonuses paid by firms that accepted taxpayer aid during the financial crisis.[snip]

Regulators in the European Union and in the U.S. are preparing to crack down on pay. The EU is curbing upfront bonuses and guaranteed pay, while U.S. regulators are also considering requiring large Wall Street firms to defer part of bankers' pay.

One of the most closely followed changes at Credit Suisse will be the introduction of pay tied to future return on equity rather than past performance. For senior employees, about half of all deferred pay will come in this form, which has been encouraged by regulators.
The skewed heads-we-win-tails-you-lose incentive norm for bankers was fingered early (by, e.g., Raghuram Rajan and Martin Wolf),as one of the key factors inducing banks to take on undue risk.  Tying compensation to long-term performance, should it become an industry norm, could constitute a crucial form of risk management.

Not to cast any hasty or ill-informed judgments on the behemoth that is Dodd-Frank and still-pending or contemplated regulatory initiatives, national and international.  But this partial and fleeting evidence that banks are changing their behavior, as much in anticipation of new rules and norms (and shareholder demands) as in compulsory compliance, seems at least marginally encouraging.

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