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CommentP&M Notebook

P&M Notebook: Bonus damage?

Is the bonus cap damaging or not? If you’ve been disappointed in this comp round, or recently found yourself looking for other opportunities, you might have views.

So does the European Banking Authority, which has been a staunch proponent and defender of the cap since it was first proposed. The industry, the UK government, and any number of financial luminaries have piped up to argue that the bonus cap is a bad, risky piece of design.

Since it does nothing to the underlying economic forces which ensure senior bankers get to keep a big chunk of the business they bring in, the argument was, the bonus cap would just raise fixed pay, reducing the flexibility of banks to manage their comp bill in good times and in bad.

Now the figures are in (at least, for 2014… meaning the comp round for 2013). The EBA argues, quite rightly, that the change in fixed pay hasn’t weakened the financial system. It uses somewhat inflammatory wording, calling it “not material” — perhaps an odd phrase for a €6bn wage hike — but it’s right. €6bn, spread across Europe’s investment banks, is not a dent in capital worth worrying about.

But that doesn’t mean it should be dismissed out of hand. There are lots of methodological issues with the EBA’s data, but even apart from that, it doesn’t mean the cap isn’t destructive to capital markets businesses.

Most of Europe’s large investment banks are also large universal banks. When you’re, say, BNP Paribas, with €10bn in revenues every quarter, then a small bump in a small part of your annual expenses doesn’t matter, at group level. But it matters to the individual businesses you choose to be a part of.

Actually, the solution is for bonuses, and, eventually, pay to come down. That’s the endgame for an industry which is much less lucrative than in the past, and in an environment where banks are competing to retrench, not to expand.

The EBA will see that, but in two year’s time, when the 2015 pay round figures come through. Actually though, what has brought pay down is not the bonus cap, but terrible growth, a flat yield curve, manipulated or supressed markets, and a multiplication of regulatory complexity and capital cost.

Prudential policy, political point

GlobalCapital has been looking at other misfiring areas of regulation this week, and lighted on SME funding. Despite a regulatory subsidy which cuts regulatory capital by 25%, European banks still aren’t lending — because it’s simply too confusing to figure out what an SME is under the various different regulations, and because the European Banking Authority, rightly, loathes the capital cut.

It is pretty daft — like the bonus cap, it’s a misguided use of prudential policy to achieve a political objective, in this case, shoring up SMEs. Things that might encourage SME lending include a backdrop of growth, helicopter money, a tax cut, more labour flexibility or, really, anything that makes the environment better for SMEs.

But if lending is risky and unprofitable, it doesn’t necessarily matter whether there’s a regulatory capital cut — it’s not the binding constraint.

For the hardcore regulatory geeks, GlobalCapital managed to get hold of a leaked copy of the European Commission’s plan to harmonise MREL and TLAC. While it’s encouraging that there is a plan, it’s one of the most punishingly complicated regulatory papers we’ve looked at, and we don’t say it likely.

With Easter overlapping into this week, it hasn’t been huge for hiring and firing —– plenty of senior bankers have been off, and the week has dragged along. But there were a few nuggets.

Nicola White, global head of rates trading at Morgan Stanley, jumped ship to Citadel Securities, prompting a further flurry of articles about how Citadel is eating everyone’s lunch in interest rate swaps.

The European operation has been slower to get off the group (the US enforced clearing for interest rate swaps much earlier, an essential part of the package for a non-bank like Citadel to offer its service) but according to one informed source, is getting waves of CVs through the door every day.

Plenty of European big banks have cut out large parts of their rates operations, and plenty of traders can see the writing on the wall, and want to join Citadel while they have the chance. But the broker-dealer, and other high frequency firms such as Virtu, will never be able to soak up the manpower coming out of the investment banks.

The whole point of the high frequency traders is to be fastest, cheapest, and most certain, and let the customers come to them. Out with long lunches and telephones; in with instant, competitive quotes.

Other non-banks are making a running in specific areas. David Rothnie’s Southpaw, this week, was about Macquarie Capital, a small institution in London, but one with an interesting model for this day and age — invest and lend as principal, follow behind as advisor.

It helps to be involved in infrastructure, which has been a buzzword for most of the post-crisis period, and it helps to have the giant buying power of MIRA, the firm’s fund arm, waiting in the wings. But it shows that, for non-banks, there are a multiplicity of models of there that still work.

In other, more disruptive plans, the steady march of the blockchain took another step forward this week, with Blythe Masters’ Digital Asset Holdings teaming up with Depository Trust & Clearing Corporation to work on a solution for clearing and settling US Treasuries, agency, and agency MBS repo.

It’s only one small step along the way to the blockchain taking over the world, but it is a significant one – smoothing out the settlement in the deepest and most liquid fixed income markets seems like a good place to start, and periodically, there is some sort of panic about rising fails in Treasuries. (The FT had one last week).

But talking to one head of corporate and investmeng banking on Friday, GlobalCapital found scepticism — yes, blockchain will take over the world… but not yet. Early adopters have an advantage, but only if they adopt the right thing.

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