The Labour Party's plan to end 'offensive' banking bonuses makes no sense

If and when another British election happens later this year, the Labour Party has a real chance of winning. As the Financial Times pointed out this week, Labour and the Tories will be neck and neck if an election is held after Halloween. For some in the City, a Labour government would be a welcome way of avoiding a No-Deal Brexit. However, it's becoming increasingly apparent that a Labour administration led by Jeremy Corbyn and John McDonnell wants to make big changes to the financial services industry. 

In an interview with the Financial Times today, McDonnell says, "People are offended by bonuses," and that unless banks stop paying them voluntarily Labour will "take action" and ban them altogether. 

“Nurses, teachers, shopworkers, builders, just about everyone is finding it harder to get by, while Morgan Stanley’s CEO paid himself £21.5m last year and UK banks paid out £15bn in bonuses,” said McDonnell. 

McDonnell added that the Labour Party intends to publish the names of everyone earning over £150k in the UK, and to disclose how much income tax is paid by anyone earning over £1m. He also wants to ban share options, 'golden handshakes and golden goodbyes.'

The FT says McDonnell's thinking is drawn from a report he commissioned last year from Prem Sikka, a professor at the University of Essex whose research focuses on the 'dark side of capitalism.'

Banks in the UK are already constrained (for the moment) by EU rules restricting bonuses to 200% of salaries. The chart below shows average bonuses and salaries in London (for U.S) banks and globally for (EU) banks for material risk takers at leading banks in 2017 and 2018. Material risk takers are the most senior staff in banks - bonuses this large are typically only paid to the top 15% of employees, or fewer. 

If bonuses are banned, the implication is that salaries in London will rise - as happened preemptively at Deutsche Bank in successive years after 2016. Some mid-ranking traders at Deutsche Bank are already understood to be earning salaries of £600k, with no bonuses at all. Traders on these packages at the German bank are said to like it (headhunters claim they don't work as hard.) However, as Deutsche is now discovering, this can be a difficult cost-structure to manage in an industry where revenues are erratic. 

In a world where bonuses are banned, the other alternative would be for bankers to receive 'allowances' instead. Daniel Pinto, the London-based CEO of JPMorgan's corporate and investment bank, is the poster boy for this method of payment. In 2018, Pinto received a salary of $621k, a bonus of $14.7m and a cash allowance of $7.6m. As a result, Pinto received $687k a month in cash, something that would be very welcome to bankers whose bonuses are currently locked up in the (often declining) shares of their own employers.

Under compensation rules introduced by the Bank of England in 2015, senior managers must have their bonuses deferred for seven years, risk managers must have their bonuses deferred five years, and material risk takers must have their bonuses deferred three years. These deferrals apply to 40% to 60% of bonuses awarded, and bonuses can be clawed back for seven years or more for senior staff.

For this reason, McDonnell's threatened edict seems strange. The Labour Party has said it wants to encourage employee share ownership and longer-term thinking. However, it now also wants to mandate that people in finance receive all their remuneration in instantly available cash (as salaries) without appearing to notice a contradiction.

The intention of the existing banking pay rules is to tie pay to outcomes, and to allow for the clawback of compensation years later if outcomes turn bad. By compelling banks to pay people in cash before outcomes are apparent, the Labour Party would break the link between performance and results (good or bad) which was strengthened after the financial crisis.

If Labour really wants to fetter financial services pay, it would make far more sense to mandate that more compensation should be paid in bonuses and that all that bonuses should be deferred. Then 'bankers' would be really unhappy.

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