City bonuses face fair value reckoning

Bonuses paid to City bankers could be overhauled amid concerns that complex
fair value accounting should be stripped from incentive schemes.

Investors are scrutinising the use of mark to market valuations in company
figures amid fears that bankers cashed in on fair value upswings in asset

The moves could even see less weight being given to audited accounts in bonus

The move would be the latest development in response to the ongoing credit
crisis and would see investors call on banks to find ways of incentivising
individuals that did not rely heavily on a fair value calculation at some point
in the bonus reckoning.

One influential investor recently drew attention to the fair value component
of IAS 39, and its effects on the pricing of financial instruments at a City

He said that it allowed for the ‘booking of unauthenticated, unrealised
instrument gains as profit and affecting incentives, with banks then paying
bonuses on the back
of these’.

Investors conceded that the fair value issue was ‘not an easy one’ to
resolve. Rather than eradicate fair value altogether, they have raised the
prospect of rebalancing remuneration equations so they don’t become over-reliant
on the accounting.

They pointed to other factors such as return on equity, return on assets or a
cost to income ratio as ways of ‘counterbalancing inflated balance sheets’.

But any change to the bonus system is likely to come with a host of caveats.

It is understood that questions on remuneration and bonuses are currently
being discussed in one-to-one meetings between investors and executives, but so
far there is no evidence of a formal demand for change being made.

Some of the concerns follow Credit Suisse’s admission that there had been
some ‘intentional misconduct’ by a small number of traders in relation to the
pricing of asset-backed securities in its investment banking division.

In the US a report by bankruptcy officials into the collapse of the huge
sub-prime mortgage company New Century revealed that the bonuses paid in 2005 to
the company’s three founders were 300% more than they should have been after a
series of ‘accounting failures’ in the business.

There are also concerns that some bonuses could be paid out against what are
essentially impaired assets.

Meanwhile IAS 39 and fair value are under review by the International
Accounting Standards Board, which is consulting with a view to making changes in
the future.

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