Bonuses: They giveth; they taketh away

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Banks could learn something from prop trading houses when it comes to withholding bonuses.

The chief exec of one prop trading house tells us their compensation system works thus... No one earns a salary: everything is bonus. Bonuses are deferred and paid in a lump sum, but to ensure that no one starves, something's also advanced at the end of each month - typically 65% of that month's profits.

The remaining 35% is then totted up at the end of the year, withheld for a further six months and paid providing the account is still positive. However, if the account has fallen into "negative territory", that 35% is kept by the company.

Unappealing as this may sound, the managing director of another London trading house says banks' prop traders, fearful of seeing their efforts wiped out by the CDO desk, are queuing up to join: "It's much more transparent here - everyone knows where they are on a day to day basis," says Danny Kessler, MD of Met Traders.

Banks could do with taking a leaf out of prop traders' books.

Last week, Bloomberg pointed out that bonus pools are up 8.3% despite banks having one of their worst years on record, and the Financial Times has run various articles claiming banks are out of touch with reality and financiers should be paid according to their long-term performance rather than the vagaries of a single year's rampant risk taking.

The calls for bonus justice don't appear to have gone totally unheeded. John Thain is reportedly planning to shake up Merrill's bonus system so that next year its bankers will be rewarded for the whole company's performance, then their business unit's performance, and then their own performance, in that order - which means that this year they'd have got almost nothing at all.

However, Jon Terry, a compensation specialist and partner at PwC, points out that Thain's promise isn't as revolutionary as it seems, and that bonuses aren't totally out of kilter with long-term reality anyhow: "Most banks start from the premise of keeping bonuses fixed as a percentage of profits and then allocating the pool by business line and individual. And people forget that for senior staff in particular, a high proportion of bonuses are equity, which is long term and aligned with shareholders' interests."

(Or at least it would be, were it not for the fact that Merrill and UBS have apparently felt the need to accelerate vesting to just one year instead of the standard three.)

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