The changing face of deferred bonuses

Shareholders are divided on them, regulators are encouraging their use and, ultimately, they’re not a bad deal for the bankers receiving them. The use of coco bonds in the deferred element of bonus payments is likely to accelerate.

The Association of British Insurers has issued an “amber-top” warning over Barclays’ use of contingent convertible (coco) bonds to raise capital and pay its bankers, suggesting that they could dilute shareholder value. This is not the first time fears have been raised about the instruments, which both concern and lure investors with promises high yields.

Cocos are different from regular convertible bonds and other hybrid instruments, because they convert to equity after a specified event, such as a bank’s core one capital falling below a particular level.

Barclays and Credit Suisse have used them as part of their deferred bonus awards, while Belgian bank KBC raised $1bn by issuing cocos in January with a generous yield of 8%.

While shareholders are still wary about their use, the new European Union bonus rules, which were approved yesterday and call for bonuses to be capped at 2.5 times salary, encourage the use of alternatives to share options in deferred remuneration packages, said Jon Terry, partner in the reward practice of PwC.Expect greater use of cocos and other bond instruments.

“Regulators are actively encouraging banks to use these instruments in bonus payments, which is causing some tensions between the banks and shareholders,” he said. “The commercial coupon is generous compared to other debt instruments and share awards in the recent past and it adds diversification to pay packets that is being encouraged by both regulators and shareholders.”

If Barclays maintains a capital ratio of 10% then its coco coupon rate of 7% is sustained, which is a relatively good deal for the bankers receiving them as part of deferred remuneration plans over more turbulent share options. UBS, meanwhile, said in February that it would pay staff a total of CHF2.5bn (£1.76bn) in “bail-in bonds” that could be written off against bad debts if its capital buffers fall below 10%.

For the past two years, Royal Bank of Scotland has been paying a proportion of bonuses in deferred bonds, but these vest relatively quickly. For those earning a bonus of up to £100k, 80% is eligible to vest in June.