Credit Suisse maintained its reputation for bonus structure creativity when times are tough with its recent move to make payments to some staff in the form of bonds linked to its own derivatives counterparty exposure. The paper will offer healthy coupons of 5% in Swiss francs or 6.5% in dollars, but without the upside offered by the original Partner Asset Facility (as it was dubbed) from 2008, which delivered a return of 70% by giving staff exposure to toxic mortgage and high-yield debt assets that had collapsed in price but later recovered value.
Some outsiders pointed out at the time that the original Partner Asset Facility was rife with potential conflicts of interest. However, shareholders did not seem to be bothered and the programme came to be seen as an efficient way for group chief executive Brady Dougan and his investment bank head, the late Paul Calello, to retain key staff at a time when there was little scope for payment of cash bonuses.
The latest wrinkle on the theme – after another bad year in the form of weak 2011 performance, both on an absolute and relative basis – should avoid some of the conflicts of interest in the original facility and even serve to improve the quality of risk management at Credit Suisse.
The shifting of risk from the firm to its employees serves an immediate purpose in offloading counterparty exposure. This is similar to the approach taken with the few securitizations of derivatives counterparty risk that have closed, involving the sale of exposure to hedge funds. There is an obvious capital benefit for banks in offloading their counterparty exposure but many potential deals have foundered over a lack of confidence among fund managers in the valuation of derivatives positions by dealers, and concern that banks could manipulate the counterparty exposure behind a trade.
The Credit Suisse facility for employees skirts this issue in one obvious way: staff members simply have to take what they are offered by the bank’s senior management. But it also gives a broad pool of experienced staff members a direct interest in monitoring the quality of the firm’s derivatives counterparties. That could encourage internal whistle-blowing when credit valuation issues arise, rather than the rueful shrug that often accompanies signs of optimistic assumptions within investment banks.
This is a far from theoretical issue, as Credit Suisse employees well know. The firm recently drew unwelcome headlines when three former employees were charged by the SEC with falsifying mortgage security valuations in 2007 to boost their bonuses. Two traders pleaded guilty to the charges at the start of February, while their old boss, former structured credit head Kareem Serageldin, remained in the UK, temporarily out of SEC reach.
Nor were the amounts at stake negligible. Credit Suisse was forced to take a $2.65 billion write-down at the start of 2008 after it uncovered the fraud. Serageldin had been awarded a $6.9 million bonus for his supposed performance, of which $1.7 million was cash, although the bank at least managed to rescind the remaining share portion of his award.
The recent move to pay a portion of bonuses for 2011 in the derivatives-based bonds should contribute to a spirit of "trust but verify" within Credit Suisse. It also allows Dougan to position Credit Suisse as a firm that is at the enlightened end of the spectrum of investment banks when it comes to aligning the interests of staff, shareholders and the taxpayers who would end up on the hook if a globally important firm were to fail.
Dougan has certainly been a pioneer since 2008 in articulating evolution in the business model of the modern investment bank and the alignment of stakeholder interests. The problems have come in delivering on this model.
Some Credit Suisse employees must look wistfully at the more old-fashioned approach of JPMorgan chief executive Jamie Dimon. His business model is to make more money than the competition and pay himself more than his peers, bringing along key subordinates for the ride.
| Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks |
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