Lessons from Davos
Who would have thought that Davos would take over from the dormant Occupy movement on the issue on ‘inequality’? Or that five years after the crisis the financial sector would still be top of the WEF Global Risks register?
Equally noteworthy, the CFA Institute recently carried an unusually direct blog about the crisis. Investors assert that they have learned the lessons but the reality is different.
Sadly, investor complacency and denial is not new. Nassim Taleb called for divestment from the riskiest banks in 2011, while John Fullerton and I proposed assertive engagement in 2012. But little has changed.
Investors have, so far, failed on two critical fronts. Remedial action is still useful. Hence I am still trying to ‘speak truth to power’.
First, investors should have pushed – and should still be pushing – for appropriate regulation, such as bank capital ratios as advocated by many, including Anat Admati. Instead, they have been either silent, or part of the problem (lobbying against the Financial Transaction Tax). One notable exception: some investors lobbied the EU to make auditor rotation mandatory – interestingly, most investors were either silent and a few even spoke against this.
Second, and even more of a failure because it is such a recognised part of fiduciary duty, investors should have corrected pay deals that incentivise risky behaviour. Instead they have set up end beneficiaries-cum-taxpayers to pick up the tab when blow-ups happen.
Investors know what to do. Use risk-adjusted return on capital instead of return on equity (ROE), total shareholder return (TSR) or earnings per share. Put customer loyalty and reputational risk in the metrics. Use performance periods (eg, five-year rolling) and design long-term investment plans (LTIPs) in line with the Institute of International Finance and Financial Stability Board post-GFC guidelines. And to focus as much on malus schemes as bonus schemes, so as to ensure bankers eat their own cooking,
Yet the two big proxy advisers – ISS and Glass Lewis – are reportedly recommending in favour of sector pay deals at Bank of America, Citigroup, JPMorgan Chase and Wells Fargo which use metrics like ROE and TSR, and whose LTIP designs are three years or less.
Why do fund managers, who generally do the voting, tolerate such weak analysis? If they just override this harmful advice, the proxy agencies would learn to raise their game. Of course, there are exceptions – British Columbia Investment Management Corporation voted against approximately 60% of Canadian pay resolutions in 2013 and NEI Investments a whopping 89%. But muscular engagers are rare.
So why do the representatives of the beneficial owners – the trustees and the investment consultants – not demand higher standards? The conflicts of interests are so strong, and the attention to prevention of the next crisis is so weak, that self-censorship is the systemic norm.
Yet there is good news from some banks, which are changing with earnestness and others with humour, such as the bank chairman (and former finance minister) Gerrit Zalm, who dressed up as a brothel madam to explain what bankers could learn from prostitutes. Some governments are acting: the new UK Banking Standards Review has a chairman who is unlikely to roll over, and there are similar hopes for the new chairman of the Financial Reporting Council.
The EU proposal on proprietary trading is heading in the right direction, albeit without a timetable. Even the trade body for the UK fund managers, the IMA, is showing welcome resolve by backing the new Investor Forum.
The big question is whether ‘positive deviant’ innovators and leaders within the investment system might show a higher level of ambition and professionalism than their employers want.
Raj Thamotheram is an independent strategic adviser, co-founder of PreventableSurprises.com and president of the Network for Sustainable Financial Markets