Claw-back bonuses Refund, Please!

Germany’s top financial regulator is tightening the rules for generous banker bonuses. Starting March, German banks will have the right to claim back bonuses from fallen executives.
Arrogant bankers. "The Big Short" drew attention to the actions of bankers in the run-up to the financial crisis, which was partly caused by bonuses.

Josef Ackermann hasn’t exactly been free of controversy over his long banking career. The former head of Deutsche Bank is perhaps most famous in Germany for a picture of him brandishing a victory sign at the start of a trial into improper meddling in a company merger. The picture became a symbol here of the worst side of capitalism.

And so it wasn’t particularly surprising when Mr. Ackermann triggered a new wave of indignation toward the end of last year. At an event in Berlin, the investment banker said he didn’t see why he should relinquish portions of his bonuses, even if his former employer, Deutsche Bank, is in dire straits these days – the result of a crisis partly of his own making.

The troubles at Deutsche Bank have already forced his successor John Cryan to crack down on bonuses at Germany's largest bank. Mr. Ackermann, who led the bank from 2002 to 2012, also said that he saw "no legal basis" for the bank to make retroactive claims on his bonuses.

That may be about to change. Germany's top financial regulator, known here as BaFin, has announced a tightening of the rules when it comes to banker bonuses – basically freeing up employers to go after their top executives when they’ve done something wrong.

Only a few years ago, compensation for bank managers was still a private matter...This view of things has changed fundamentally since the financial market crisis.

Beginning in March, German banks will be required to demand repayment of bonuses that were already granted (known as the claw-back rule), if a bank is doing worse than expected or the manager in question has seriously violated internal and external rules.

Ironically, the move could potentially turn the banking sector from the bad boys of industry into a role model for other sectors. BaFin’s decision could trigger a ripple effect: The center-left Social Democratic Party (SPD) supports similar claw-back rules in other business areas as well.

BaFin is proving particularly aggressive. In the recently-approved compensation directive, BaFin actually sharpened the claw-back rules compared to an earlier draft version. As of March, bonuses that are stretched over a five-year period can be clawed back up to seven years after being granted. The draft version had limited the claw-back period to five years.

It’s a stunning turn of events. Only a few years ago, compensation for bank managers was still a private matter. No regulator had the right to exercise influence over manager pay. Like many things in the banking sector, this view of things has changed fundamentally since the financial market crisis.

Since 2008, regulators around the world have been searching for ways to crack down on bonuses – not just to punish bankers but to discourage them from taking the kinds of risks that got the world into the 2008 financial crisis in the first place.

It became clear that the incentive structures for bonuses, for example, were designed in such a way that managers made high-risk gambles to achieve short-term success. These false incentive structures became a threat to financial stability – and to the taxpayer that had no choice but to bail out the banks.

Or, in the words of Germany's finance minister, Wolfgang Schäuble: "With the banks, we saw that fictitious profits were privatized through compensation, whereas risks and later losses were socialized."

The guidelines have already been tightened since. Bonuses can be no more than twice as large as an employee's base salary and can no longer be paid out in full. Instead, at least 40 percent of bonuses for bank employees must be stretched over three to five years. In the case of bank board members and the second-tier management level, 60 percent of bonuses must be distributed over a five-year period.

The new rules starting in March could have an immediate effect. Florian Frank, a compensation expert with Willis Towers Watson said he doesn’t see any problem with enshrining the new rules even into bankers' current contracts.

"The bank can predicate future promotions, salary increases and bonus payments on an employee's consent to the agreement," Mr. Frank said in an interview with Handelsblatt.

The SPD party, which is in a coalition government with Chancellor Angela Merkel’s Christian Democrats, sees the ability of banks to reclaim bonuses as a blueprint for other sectors. According to the Social Democrats' plans, it would be possible to "retain or demand repayment of bonuses in the case of poor performance or even irregular behavior."

This isn’t just about Deutsche Bank or the banking sector. It actually reflects the SPD's desire to learn lessons from the Volkswagen Dieselgate scandal. While the scandal has severely damaged the carmaker's reputation, VW has no power to demand the repayment of bonuses from now-disgraced executives like Martin Winterkorn, its former CEO.

Bonuses have also become a hot topic in the run-up to federal elections set for the fall. The SPD is pushing for other changes to tax rules, putting it at odds with Mr. Schäuble and Ms. Merkel's Christian Democrats.

Compensation expert Mr. Frank said he likes the idea of expanding the claw-back rules BaFin is implementing to other sectors.

"Personally, I always asked myself why this claw-back principle should only apply to banks. Companies in other industries should also reward only long-term success," Mr. Frank said.

Germany’s financial regulator is taking its foot off the gas pedal in other ways. Facing a backlash from smaller German banks that have felt strangled by regulations since the financial crisis, BaFin has made clear it’s going after the biggest – those banks that can cause serious damage for the financial system.

For example, BaFin dropped a proposal that would have forced every bank in Germany to name their risk-takers – those managers in other words that could cause the most trouble or lose the most money. Instead, the rule will continue to apply only to banks with total assets of at least €15 billion ($16.1 billion).

This leaves many of the hundreds of credit unions and savings banks spread across Germany unaffected by the rule, something banking associations welcomed.

Does all this mean the former Deutsche Bank CEO Mr. Ackermann has to worry about his retained bonuses now? Experts don’t seem to think so. Even Deutsche Bank officials are convinced that the new rules could hardly be applied retroactively.


 Frank Drost covers financial policy and regulation for Handelsblatt from Berlin. To contact the author: [email protected]