Oct 09

Why bonuses power the government

Plus HFSB’s Borges on modifying the EU directive

Some people see conspiracy, others see cock-up. The best tale from the Conservative Party conference was that Gordon Brown’s eye problem – two injuries in the retina of his right eye, while his left has no vision – was a carefully orchestrated first move. This was to be followed by his stepping down for ill health, his substitution by a more electable party member and victory by the Labour Party in a spring general election. 

A delicious tale. As absurd as the posturing by the parties about a windfall tax on the banks. It feeds popular anger about (some unjustifiable) bonuses, but would be deeply counterproductive. Not only are two of the largest banks, Lloyds and RBS, government controlled, but all banks need to restore their balance sheets and produce profits to help move the economy out of recession.


The same dilemma – political bluster vs reality – informs the debate on bonuses and high City pay. Politicians like London Mayor Boris Johnson may well call bankers “cockroaches,” but taxes are a crucial funding mechanism for government and the contribution from financial sector employee earnings is far more important for tax revenues than corporation tax, as HSBC pointed out in a note to clients this week.

“We know that the City accounts for 25% of total corporation tax receipts,
so in the 07-08 tax year it paid £11.6bn. More important is financial sector pay which accounts for 9% of total wages and salaries in the UK,” said economist Karen Ward, highlighting the fact that without even taking into account the higher rate of tax paid by many City workers, they will have paid at the very least £22.3bn in income tax and national insurance contributions.

The message from politicians is that the wealthy are not welcome. Not only is there the 50% tax rate, which the Conservatives have declined to say they will repeal once in power, but there is also the fear of what other taxes and conditions they may impose on non-doms, who are already failing to flock to the UK as they did in prior years.

“Nearly all non-doms are considering departure, down to the very practicalities,” says Andrew Rodger, executive director of Stonehage, a three-decade-old family office. The reason there has not been a major exodus so far comes down to the need for longer term tax planning and issues like children and schools.


Could the Madoff investment scam have happened in Europe? Antonio Borges, chairman of the Hedge Fund Standards Board (www.hsfb.org), the London-based lobby group and standard setter for the industry, categorically denies it.

Borges, a former dean of INSEAD, argues that European hedge funds operate in a different environment. They are registered with regulators, while the HSFB has put in place principles and standards that involve transparency, disclosure, and separating the manager from the administrator. He finds that the UK’s Financial Services Authority, the regulator for much of the industry, has a superior  model of financial regulation, better than that found in other countries. But he admits to being surprised to hear the FSA express doubts with respect to the social usefulness of the financial industry, a reference to FSA chairman Lord Turner’s infamous words about the City.

This week, amidst insider trading charges at hedge fund Galleon Group, the US House of Representatives financial services committee is due to mark up a bill forcing hedge funds to register with the SEC. There had been attempts over the last nine years, all of which were unsuccessful due in no small measure to skilful lobbying by the Managed Funds Association, the US industry body. Borges predicts, however, that actual registration will take some time due to the convoluted and slow political process in the US.

Borges is hopeful about changes to the Alternative Investment Fund Managers directive, a draft piece of European Union legislation that the industry is up in arms about. The Directive will take around nine months to reach its final form. Meetings and hearings are still taking place. Even assuming the Council’s version is complete by December, the European Parliament’s won’t be until March at the earliest. Reconciling the two versions will take until the summer.

By then, the political climate will be less crisp. Borges notes that attempts to blame hedge funds for the crisis have backfired. None of the multiple studies on its origins have laid the finger of blame at the door of the hedge funds. "We hope, as the crisis fades away, people will be more lucid and the urge to find scapegoats will disappear," he says, speaking at the HFSB offices on Fleet Street, a few doors down from Goldman Sachs, where he was vice chairman for eight years.

Borges, Chairman of the European Corporate Governance Institute, is scathing about some of the latest suggestions that the tax system should reward shareholders for being longer term investors and that institutional investors should sit on company boards. Proponents argue that the financial
crisis was a failure of corporate governance at shareholder level – they did not act as owners of the banks – and that institutional investors need to become more involved.

Borges insists the right to sell the shares of a non-performing company is crucial and that too much unique communication with it ties the hands of the shareholder via insider knowledge. The former central banker says pension funds can’t possibly turn all their monies into activist funds.

But what he calls "specialists" ie hedge funds, are what markets require. "Most people consider specialists are speculators and should be crucified. But without them, markets are erratic and inefficient,” he concludes.

Not entirely unlike politicians.


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