The bonus cap on UK bankers is to be lifted as of the end of this month – per a joint statement released by the UK’s Prudential Regulatory Authority (PRA) and Financial Conduct Authority (FCA) today.
This is likely to support the UK’s DCM markets in three ways. First by attracting high-performing DCM bankers to the City, second by making it less risky for banks to hire DCM bankers in the UK, and third by changing the incentives for DCM bankers.
Attracting High-Performing DCM Bankers To The City
The removal of the bonus cap will help attract high-caliber DCM bankers to London – in origination, structuring, trading and sales.
Banker bonus caps have reduced the width of the pay distribution between top performing bankers and normal performing bankers. Removing these caps again allows the highest value creators to be paid accordingly. Some of these bankers will be from other jurisdictions (some still with and some without their own bonus caps) and some from non-bank roles in the industry.
In relation to this, the regulators’ statement points out that “a bonus cap is not routinely imposed in other leading international financial centres outside the EU”.
Less Risky For Banks To Hire DCM Bankers
An unintended consequence of the bonus cap has been that banks have had to materially increase base salaries to retain staff. As a result, banks businesses – including their DCM businesses – suffer from higher profitability volatility.
In years when markets and performance is poor, the business suffers higher losses than in a world without bonus caps because base salaries are higher. This can also force more layoffs in bad years – and then a scramble to find talent (and accompanying base salary competition) in good years.
From the regulators’ statement: “The change to the approach to implementation would also achieve the secondary PRA objective of facilitating effective competition as firms would be able to immediately apply the change which would give firms more flexibility to risk share with employees.”.
The removal of the bonus cap makes it more attractive to run a DCM business in the UK.
Changing DCM Banker Incentives Towards Results
Higher base salaries and lower bonuses has changed the payoff profile for DCM bankers. It has partially skewed their rewards away from achieving high revenue – as they no longer had the potential from a bumper bonus from a bumper year. And has increased the incentive to “play it safe” and keep their jobs and higher base salaries.
This change could see UK DCM bankers being more innovative, working harder and looking to better use capital.
A More Active Role For Risk And Regulators
Greater incentives for bankers to focus on revenue will need more active supervision by bank’s risk departments and by governmental regulators. Primarily to avoid systemic risks building – as happened with the credit bubble that led to the 2008 credit crisis, but also to ensure frameworks are in place to manage the risk from individual bankers and teams.
This is a good thing if the benefit is that we get better use of capital and greater innovation. Slamming on the brakes was a sensible immediate response to the 2008 crisis. Now travelling while keeping our eyes on the road is a good way forward.
