Investment Banking Pay Structures: What are shareholders paying for?

It is a well known fact that Investment Bankers, traders and salesmen are some of the most highly paid professionals on God's green earth. Even the near collapse of the global financial and economic system has not succeeded in burying multi year guaranteed contracts or multimillion dollar paychecks.

One question that I seem not to have answer to is: why are investment bankers and traders so highly paid? Yes the hours are crap and job security should be described more in the lack of it. But do investment bankers work harder than Resident Doctors, I really don't think so. Is the job security any worse than that of military or police officers, whose careers - and indeed lives - can be easily terminated by a posting to a war zone or a chance encounter with a trigger happy bandit. So we cannot justify the outsized pay by citing job insecurity or hazard, so what drives investment banker pay?

Another often cited rationale for astronomical pay is that traders often make so much money for the company that they are guaranteed a cut of the profits - sometimes as much as 50% - as compensation. However, a bigger question that needs to be answered is who made the money in the 1st place, the trader or the Bank?. Will the same trader have been able to make as much money if he had been working for a lesser name, without access to teams of research analysts, structurers, systems people and access to real time trading flows?. Will Andrew Hall - the Citi energy trader to whom a $100 Million paycheck is due - have made so much money if he had been working for some nameless XYZ securities firm?. I seriously doubt it!. A lot of his success can be attributed to the stellar cast that Citi has been able to amass to support his efforts. He has access to the best systems, the best analysts, a far-reaching and global informal information gathering network and a whole lot of other things. So if a lot of an investment bank's success is attributable to teams of people working in concert, why are individuals then as richly rewarded as they currently are in Wall Street and the City of London?.

Let me clear, I believe that the capital markets play a very central role in ensuring the proper functioning of the world's economy. Without capital markets and the work being done by the often maligned bankers and traders, we would all still be economic cavemen. Without bankers and traders, excess capital will accumulate in one region of the world or country while other opportunity-rich regions remain starved of capital. That being said, the skills/knowledge required to be a successful investment banker/trader are neither exceptional nor scarce. Though some bankers/traders invented options, swaps and other mind bending derivatives, the truth is that the bulk of investment bankers - including many that earn million dollar bonuses - just originate and process deals. The mental aptitude required for investment banking is not on the same page as that required to be a world class poet, a Nobel prize winning physicist, brain surgeon or a Fields medal winning mathematician. Investment banking does not require or demand "out of this world" skills and as the British City Minister said "Derivatives traders and others are not footballers and should not be paid as if they are". Well said!

Although I don't support explicit pay caps for bankers, because I believe it is an example of an externality that can impair markets and unduly stifle innovation. However, the current global downturn should not be allowed to go to waste, shareholders and chief executives have a chance to force through tough pay reform measures while the financial jobs market is still soft and this has to start from the bulge bracket investment banks. Bulge bracket investment banks - such as Goldman Sachs, Morgan Stanley etc - should actually pay out the least bonuses rather than be industry leaders in terms of compensation packages. They need to develop compensation models and systems that strip out the portion of their firms' revenues and profits that are franchise/reputation driven and those that are employee initiative driven. The truth is that if Goldman Sachs pitches for 10 capital raising mandates, it would get at least 2 or 3 due to its market reputation and global coverage, even if the banker(s) making the pitch(es) is(are) near completely clueless!. It is therefore not very smart to reward a banker for free-riding on the bank's reputation in this manner.

I think bankers' compensation are business decisions that are best handled by shareholders and not by governments. However, shareholders need to be aware that the current compensation models need not be cast in stone and like any discerning buyer they must demand to know exactly what value/"alpha" they are getting from the bonuses they are paying the bankers and traders that work for them.

Much Ado about Islamic Banking

A lot of hot air has been blowing over the recent pronouncements of the CBN regarding Islamic Banking in Nigeria. With many commentators and analysts - who should know better - mentioning it as evidence of a sinister religious and/or northern agenda at play in the ongoing banking sector reforms. Although it is commonly said that there is no smoke without fire, I am convinced trhat that there is no fire in the smoky discussions - or much better: allegations, surrounding the CBN Governor's pronouncemnets on Islamic Banking.

First of all, the CBN is not trying to "introduce" islamic banking into Nigeria, as this form of banking has already been introduced and tested in Nigeria decades ago. Habib Bank (now part of Bank PHB) was licensed to carry out Islamic Banking activities- among other things - in Nigeria in 1981. Furthermore, Jaiz Bank International Plc has already obtained the greenlight - conditional upon meeting the minimum capital requirements - from the CBN to operate non-interest banking in Nigeria since 2004. That the go-ahead was obtained in 2004, under the stewardship of Joseph Sanusi - a Southern Christian - should allay the fears of cynics who view slamic Banking through the biased lenses of tribal and religious sentiments.

Secondly, an important characteristic of democracy is the opportunity it gives various segments of a pluralistic society - such as ours - to express themselves. A large number of Nigerians are muslim and many of them are desiropus of financial products, systems and institutions that are compliant with the dictates of their religion. To deny them of this opportunity - because some people are uncomfortable with the sound of the name - is not only undemocratic it is condescending and near paternalistic. Islamic Banking is one of the fastest growing fields of modern finance, with conservative estimates of assets in the field now exceeding US$ 500 Billion. Shariah-compliant financial products now cut across Investment Banking (i.e. Sukuk Bonds), non-interest bearing deposits and asset management products. Matter of fact, a Shariah compliant equity fund has been offered in Nigeria since 2008 and is even listed on the Nigerian Stock Exchange.

Lastly, one thing is clear: the decision to offer (or not offer) Islamic Banking is a business decision. For an Islamic Bank to kick off - or even raise private capital - a legitimate business need must exist for it and this legitimacy cannot be legislated into existence by lawmakers or the regulators. If there is no consumer base for Islamic Banking in Nigeria to justify its practice, then it will fail. That is the simple law of the business jungle!. Islamic Banking has been growing the world over, because it has found a ready customer base and it is serving legitimate business needs. Even non-Islamic issuers - such as the very German state of Saxony-Anhault - have found Sukuk Bonds to be an attractive and cost-effective financing tool.

I think the tribal and religious sentiments being whipped up in the wake of the Nigerian Banking sector is despicable and indicative of a worrying trend towards abondoning logical arguments in favour of sensationalism. I agree that this trend is not specific to Nigeria, even American critcics of Barack Obama's reform agenda have accused him of wanting to "Kill Grandma!". A discussion outside of the facts of the case is wrong and the people who should know better but keep on whipping these dark sentiments are doing the entire nation a disservice.

This argument should not be about a "northern agenda" or an "islamic agenda" or an attempt to "snatch the banking system from southerners". What is material to this discussion is whether or not certain executives at the helm of our financial institutions have acted in contravention of established laws or regulation and by so doing earned their day in court. It should be about whether or not certain executives at the helm of our financial system have acted in ways that put the Nation's financial at serious risk. I don't have answers to these questions and I think the accused people should be assumed innocent until proven guilty. However, I am certian that painting the CBN governor's action in a sinister and sectarian manner does everybody a lot of harm. Let's have an enlightened discussion please!

Corporate Debt Markets in Nigeria: Emergence of Green Shoots?

True to their typical bandwagon form, Nigerian Corporates (particularly the Banks) have been falling over one another to announce one multi-billion naira bond issuance programme or the other over the last few weeks. These programmes are designed to cover potential multiple bond issuances across various maturities and structures over the next 2 years (which is the typical life of a Shelf filing in Nigeria). Some of the deals announced include: GTBank Plc - N200 Billion (US$ 1.4 Billion), First Bank Plc - N500 Billion (US$ 3.5 Billion) and UBA Plc - N500 Billion (US$ 3.5 Billion). Many more of such deal announcements are expected in the coming weeks.

Though I am very skeptical of the chances of success of these Jumbo Bond programmes and slightly disgusted at the "follow follow" nature of their potential issuers, I am generally pleased with their implications for the financial markets and economy. Corporate Debt has been, and remains, an underinvested asset class in Nigeria with the last publicly issued corporate bond being Access Bank's Convertible Bond issued in 2006. Since its redemption, the number of corporate bonds in issue in Nigeria amounts to a grand total of" ZERO!.

Despite the flurry of announcements, the building blocks of a decent corporate bond market are largely non-existent in Nigeria. There is no network of corporate bond dealers willing to make markets, settlement platforms for bond trading are largely non-existent while skilled and experienced hands in bond structuring are few and far between. Furthermore, the Stamp Duty and other related charges on primary debt issues make bond issuances a very expensive proposition for would be issuers.

Despite this, the story is not all gloomy. The considerable success of the Federal Government of Nigeria (FGN) Bond market and its network of Primary Dealers/Market Makers (PDMMs) may be leveraged on in corporate bonds. FGN Bonds are so liquid and highly traded that annual volume of trades last year exceeded that of the Nigerian Stock Exchange (NSE) handsomely. The banks and Discount Houses serving as PDMMs can scale up their activities to include making markets in corporate bonds. The active trading of these bonds has also created - for the first time in Nigeria - a risk free yield curve (extending to 20 years) from which corporate bond issues of various maturities can be priced.

The demand side also gives much to cheer about. The advent of Pension Fund Administrators (PFA) has resulted in serious latent and unmet demand for corporate bonds. All PFAs are currently grossly underweight in this asset class as they are permitted to invest up to 30% of their assets in corporate bond instruments. Many of them are likey to be enthusiastic buyers in the near future as they seek to build up their corporate bond portfolios from a near zero basis. The supply side of the equation is also going to get deeper as the effects of the banking sector sector crisis and subsequent cleanup cause banking loan portfolios and appetites to shrink across board and lead to seriously compromised financial intermediation capabilities. Many highly rated corporates may decide to approach the debt markets directly for financing rather than be at the mercy of banks that are probably in a weaker financial position than they are.

On the regulatory side, the stars also seem to have aligned very nicely in favour of corporate bond market development. The CBN Governor has - from his first press briefing - always reiterated his support for a virile corporate debt market to reduce pressure on the banking sector. The current Finance Minister: Mansur Muhtar served as a Director General of the Debt Management Office (DMO) and it was under him that many innovative measures - such as the PDMM framework - were introduced into the FGN Bond Market. Debt Market proponents are very likely to get a receptive hearing from him. In addition to these people, the recently nominated Director General of the Securities and Exchange Commission (SEC), Arunma Oteh, was a past treasurer of the African Development Bank (ADB) and has spent most of her career working in Supranational and Sovereign Debt Capital Markets and funding. I dare say that Nigeria has never had a trio of people so conversant with, and supportive of, Debt Capital Markets as we currently do, this chance must not be wasted but seized upon to bring lasting development to the Corporate Debt marketplace.