In a recent Economist,
finance columnist “Buttonwood” asks why regulators are keen to apply bonus caps
to the fund management (FM) industry (http://econ.st/XHVFhu). Positing that this is due to an analogy with
the banking sector, Buttonwood argues that such caps should not apply to FM
because it does not pose systemic risks. However, the idea that the explanation for
bonus caps on fund managers might lie in a fear of systemic risk is an obvious
straw man – as Buttonwood himself concedes, funds are not leveraged, and so are
not connected to the financial system in the way banks are. It is
absurd to suggest that financial regulators might fail to spot this simple and
fundamental difference. (The same
observation also renders entirely irrelevant Buttonwood’s other observation on banker
pay, viz., that pay might best be controlled not through bonus caps but by increasing
bank capital: since funds are not leveraged like banks the idea they could
limit pay by “holding more capital” is, of course, nonsense.)
Buttonwood goes on to suggest that, as in banking, regulated
bonuses will lead to higher salaries rather than a decline in overall
compensation, “making it harder for firms to control costs in a downturn”. But doesn’t every business have to face this
problem? And don’t most businesses face
it simply by setting salaries appropriately, and without feeling pressure to
pay their staff immense bonuses? This
argument can only make sense if you start from the presumption that very
substantial compensation for fund managers (and bankers) is desirable and
appropriate, even where the revenues they produce are not sustainable enough to
ensure it can be paid for.
Buttonwood’s second suggested rationale for bonus caps is
simply that “European politicians think fund managers are overpaid”. If so, he suggests, domestic governments
could simply “raise taxes on high earners”.
A flaw in this reasoning so obvious as to be scarcely worth mentioning
is that, even in London, not all high earners are fund managers (or bankers),
making this approach both crude and unfair.
Equally obviously, it would
require the sort of coordination in tax policy that is impossible to imagine, meaning
that there would of course be nothing to stop those who become subject to such
taxes moving to another, more welcoming jurisdiction.
However, on this occasion Buttonwood is alive to the
weakness of his own argument, and has “a better answer”, namely, the
application of market principles. He
suggests that “[n]o one is forced to give money to an active fund manager . . .
[i]nvestors are at liberty to pick a passive fund . . . at much lower
cost”. However, he then undermines his
own argument by pointing out, correctly, that “the evidence suggests that the
average investor would be better off taking the cheaper option”. This being so, why do investors continue to
choose, “at liberty”, a more expensive
but inferior option? Shouldn’t the
market operate to correct this anomaly?
Buttonwood is right to complain about the scandalous but
longstanding practice, which the UK has at least attempted to address, of
active managers quietly paying incentive fees to advisers and brokers. While it is unclear how resisting the
introduction of bonus caps would make any difference in this respect, there is
an important point. Generally, market
principles fail to apply to the FM industry because it lacks true transparency
and accountability. It may, strictly
speaking, be true to say investors are “at liberty” to pick one fund over
another, but (for example) how many people really know where their pension
savings are invested? If they don’t know
but want to find out, how easy is it for them to do so? If they find out, and decide they want to
change fund manager, how often are they able to do so, and what expenses are
involved? If they want to make an
assessment of their fund manager’s competence, how many people possess the
skills required to do so? And how
incentivised are they even to look into it, when the choice is often between
managers who follow very similar investment strategies (often little more or
less than tracking some index), and who anyway present information in unclear
and not easily comparable ways?
It is for all these reasons (among others) that the business
of managing people’s savings requires appropriate regulation and oversight of a
kind that has historically been lacking.
(Speaking of oversight, while pondering the relevance of the banking
sector to that of the FM industry, Buttonwood might more usefully have asked
where the fund managers were when the banks of which they were shareholders were
building up such immense leverage and risk, and why none of those fund managers
have been taken to task for that failure.)
The
EU has been extremely clear, and the FM industry (through bodies including the
CFA Institute, EuroFinuse, Efama and AILO) has equally clearly acknowledged,
that the primary objective of the EU’s bonus cap (and other) proposals is in
fact neither avoidance of systemic risk nor punishment of overpaid managers,
but rather the protection of retail investors.
This having been made so clear, it is odd that Buttonwood should spend
so much time and effort debating these two spurious “reasons”. It is odder still that Buttonwood focuses
solely on bonus caps when the proposed legislation (which includes not only UCITS
V but also UCITS VI, MiFID II and PRIPs) addresses a wide range of important issues
which he ignores entirely – including measures on (inter alia) disclosure, conduct of business and professionalism
requirements, portfolio & risk management techniques, liquidity and the powers
of national regulators.
None of this should be taken to imply that bonus caps in FM
would actually protect retail investors, nor that bonus caps are a good idea
for any other reason. But it does show
that Buttonwood’s implication that regulators’ sole motivation is an unthinking desire to “give finance a
kicking” should perhaps not be taken at face value.
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