Historically traders have been paid a % of their PnL. Over the years it became apparent that some people abused this policy engaging in activity known as exercsiing their “Traders Option”… e.g take a big bet;
if it works out => great big bonus
if it doesnt => agh well no bonus this year, get fired and move on to play the game again at another bank
Its shocking but it always amazed me how many guys out there could lose a bank massive sums and then turn up at another bank the next year and be as reckless again. If you lost 2m for bank you were considered dumb. If u lost 100m u seemed to have some mystique that surrounded you and you generally turned up somewhere else in a senior role. Yes, thats how odd Wall Street became
Its all changing though…
Apparantely banks are moving towards paying traders on “risk-adjusted performance” (JPM etc). So its not necessarilly the guy with the biggest PnL who will make the biggest bonus. This will also stop people abusing a banks balance sheet. Just look at DB, apparantely they had a book with 6bln$ of bonds hedged with CDS, the goal was to exploit a small price discrepancy in massive size. Thy ended up having to dump the book at a 1bln loss as that spread got wider and wider. This is exactly how LTCM blew up, except it was in the much more liquid Tsy market. When will people learn!
Further, bonus’s look like they will be mostly paid over a 4-5 year vesting period. ie You get paid X this year, it will vest over 4 years, but if u mess up in year 2, u risk whatever has yet to vest. As such, one is conscious that one is not only risking the banks money, but ones own money as well.
All this is good for the industry. People will have to commit themselves to banks for years and will hopefully never be incentivised to “swing the bat” in any given year as they risk alot of their own unvested salary if they do.
Something tells me though, that despite all the “talk” surrounding these issues and the fact that alot of the banks have engaged in such policies for this year to appease the powers that be etc, that there is a risk that in a few years things are back to normal again! 