New EU bonus rules mean bankers can be paid in bonds to promote long-termism

A new European Union law which will cap bonuses from 2014 will also allow bankers to be paid in bonds. Current rules allow bonuses to be up to 50 per cent cash, with the remainder in shares that can not be immediately sold.

The new rules will allow bankers to be paid in bonds known as contingent capital (CoCos). Our banking reporter Tim Wallace explains how these instruments work:

“CoCos,” as they are commonly known, act as debt but convert into equity when a bank looks like it is getting in trouble – usually when the share price falls below a set trigger level.

This is intended to shore up the bank’s position by increasing its loss-absorbing potential, but the report warned that shareholders and coco investors face different and competing sets of incentives.

The European Banking Authority (EBA) said that "instruments should provide incentives for staff to act in the long-term interest of the institution".

If payments are made in the form of CoCos, then they must be written down if the bank's tier one capital falls below 8.5 per cent of risk-weighted assets. Lower quality CoCos would wipe out with a trigger of 10.5 per cent.

However a universal and simpler trigger of seven per cent is also being considered.

While short-termism can have downsides, so can excessive long-termism. Our editor Allister Heath:

WE keep being lectured about the effects of short-termism, sometimes rightly so. But nobody ever rails against an equally pernicious problem: long-termism, when decisions that should be taken now keep being delayed.

Many zombie firms have been kept alive for years thanks to cheap money and banks’ leniency, yet show no sign of ever healing. Capital and labour remain misallocated, dodgy debt clogs up lenders’ balance sheets, and the economy cannot readjust. Many government policies promote dithering and weaken the economy’s ability to reinvent itself.

(Full article)