Despite efforts by regulators to reform pay practices at the world’s major investment banks, they remain a credit risk, according to a new report from Moody’s Investors Service.
The report, which examines pay practices at 15 global investment banks (including Canada’s RBC, along with major global firms such as Bank of America, Barclays, BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan Chase, Morgan Stanley, Nomura, RBS, Société Générale and UBS) finds that compensation plans remain geared to short time periods, leaving bondholders exposed to associated risks.
Pay practices at the world’s leading investment banks have been reformed by a combination of regulatory pressure, and business-driven shifts that, Moody’s says, have reduced the absolute size of annual incentives, deferred a greater portion of compensation, and significantly reducing or eliminating the use of stock options in long-term incentive plans.
However, it also notes that the changes, which have more closely aligned senior executives’ interests with those of shareholders by tying compensation more closely to share price performance and giving shareholders a greater say on executive pay, could have credit negative effects.
“The compensation reforms at large banks have generally been positive, helping reduce managers’ incentive to take on excess risk,” says Christian Plath, a Moody’s vice president. “However, even with these changes, performance, vesting and deferral periods are still too short to cover credit cycles and potential tail risks.”
Moody’s says that the U.S.-based investment banks have the shortest compensation periods, generally three years; whereas, in Europe and the UK, vesting periods are generally around four to five years, and could be stretched further, Moody’s says, better aligning employee compensation with risk taking and the longer-term consequences of their actions. Still, it points out that tail risks may play out over a seven to 10 year cycle.
“The risk appetites and investment horizons of shareholders and creditors don’t always align, and they’re likely to have very different ideas of what constitutes an optimal pay structure,” Plath adds. “Given the extent of these regulatory and structural pressures, as well as the current tenor of the operating environment, banks’ pay practices will continue to evolve.”