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Changes in store for fund managers’ pay?


Executive remuneration is a hot topic in the media right now, and hedge fund managers have found themselves, unwillingly, part of the debate.

Executive remuneration is a hot topic in the media right now, and hedge fund managers have found themselves, unwillingly, part of the debate. The fact that many individuals have received a significant portion of their annual salary in a cash lump sum is being blamed as a contributory factor in the credit crisis.

The issue is particularly acute at banks that have passed into government ownership. President Barack Obama has capped executive pay at banks bailed out by the US government to USD500,000, a salary cap has been imposed in Germany, and there is pressure on publicly-backed banks in the UK – fanned by news reports on the size of bonuses due to staff and management at ‘failed’ banks.

How does this affect the typical fund manager who doesn’t work for a nationalised bank?

At a seminar last September entitled How Far Does the Industry’s Compensation Culture Threaten its Future? How Can We Fix It?, the Securities and Investment Institute noted: ‘The public believes that greed is endemic in financial services and is the root cause of the banking crisis. Regulators appear to agree. Can the industry take action to put its house in order, or is it already too late to avoid regulatory involvement in compensation structures?’

Last October the Financial Services Authority wrote to industry members that ‘inappropriate remuneration schemes may have contributed to the present market crisis’. The UK regulator cited as bad or poor practice bonuses paid wholly in cash, with no deferral in the bonus element and assessed on the results of the current financial year.

Investment firms may not cut staff remuneration simply on the basis of a letter from the FSA, but there has been a surge in interest in alternative incentive schemes such as deferred cash bonus programmes, share options, employee benefit trusts holding shares in the investment management company or partnership interests in an investment management limited partnership. Different options will suit some firms better than others.

Hedge fund firms that are short of money may be happy to fall into line with the FSA and pay bonuses in shares rather than cash. An alternative, to defer payment and base it upon performance, might also offer a cash flow benefit to the business.

In the meantime the cash can be invested. With listed fund managers, it could be used to help to maintain the share price. With unlisted management firms, the employee benefit trust could provide a market for staff to buy and sell shares annually at an independent valuation.

Deferred cash bonuses could be invested into the underlying funds for which the employees are responsible, a particularly appropriate way of structuring an incentive plan. The employer might be freed of the requirement to pay deferred cash bonuses if the staff member in question leaves the firm, perhaps reducing the pain of losing a star manager.

Another way for employers to cut benefits is through a ‘malus’ – the opposite of a bonus. A bonus awarded for good performance might be reduced or wiped out by a malus the following year in the event of poor performance. UBS is widely reported to have implemented this concept already.

Finally, with share values at their lowest level in years, it appears a great time to grant share options to employees with the prospect of prices rising over the coming months and years.

Joe Truelove is head of business development for corporate clients at Kleinwort Benson in Guernsey

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