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Archives for June 2009

Can we afford the carriers?

Robert Peston | 09:57 UK time, Tuesday, 30 June 2009


What I think many will find odd about the 25% or £1bn increase in the cost of those colossal carriers over the past year is the government's statement that it is explicit policy to pay more.

Aircraft carrierOn the Ten O'Clock News last night, Quentin Davies - the minister for defence equipment and support - said that some of the price rise was down to inflation and to changes in technical specifications (the bane of so many defence projects over so many years).

But he said the main contributor was that the Ministry of Defence has chosen to extend both the timescale over which HMS Queen Elizabeth and HMS Prince of Wales will be built and (more important) the timescale for making payments.

This two-year extension was announced at the end of last year. And one of the main reasons for the delay was that the size of the annual payments will fall, and will therefore exhaust a smaller chunk of the MoD's annual budget.

Or to put it another way, the MoD is the equivalent of a family that takes out too big a mortgage - and negotiates to reduce the size of the regular payments knowing that the total bill over the life of the mortgage will soar.

Some will see this as a budgeting practice from the "one-born-every-minute" school of management.

Since in elongating the life of the project, the contractors have to employ workers for longer, they have to finance working capital for longer, and they have to budget for rising prices over a longer period.

It all adds up - to many hundreds of millions of pounds of incremental cost.

This so-called "resource re-profiling" extends and massively increases the liability for taxpayers.

The question, however, is whether it is right to purchase such enormous pieces of kit if the MoD can't afford to pay for them over what was originally perceived to be the most rational duration of the project.

But with tax revenues so tight and public sector debt rising so sharply, we're probably going to see a good deal more of this kind of thing throughout government - with the cash payments for all manner of big public-sector projects transferred expensively to later years.

Tomorrow's taxpayers may not end up thanking today's ministers.

Aircraft carriers' costs soar £1bn

Robert Peston | 17:53 UK time, Monday, 29 June 2009


A £1bn cost over-run is threatening the future of the publicly funded project to build Britain's biggest ever warships.

I have obtained a memorandum written by the lead contractors for the two 65,000 tonne aircraft carriers, HMS Queen Elizabeth and HMS Price of Wales, known as QE Class carriers.

Written earlier this month, the memo says:

"The MOD [Ministry of Defence] will publish its annual report and accounts in July; these will show c£1 billion of QE Class cost growth and the project will come under severe pressure through the opposition and the media".

It continues: "this is a very real fight for the programme's survival".

The original budget for the two carriers was £3.9bn. That was the price when the MoD signed the contract for the project with the Aircraft Carrier Alliance last July.

In other words, in just 12 months the cost of these enormous ships - which will be 280m long and 70m wide, or the size of almost three full-size football pitches - has risen by 25% to around £5bn.

This massive inflation in costs will be widely seen as alarming, especially at a time when there are intense pressures on the government to cut public spending.

The memo, written for the chief executives of companies participating in the project - who are collectively called the Alliance Management Board or AMB - attributes the cost increase to "a combination of direct costs, inflation and accounting adjustments".

The paper then discusses possible measures to reduce costs, including the possibility of "substantial redundancies", of the order of 400 to 500. It also says that the future of the Appledore shipyard [which is in Devon and is owned by Babcock] would be under threat.

The Aircraft Carrier Alliance is a consortium consisting of BVT Surface fleet, which is itself a joint venture between BAE and VT Group, together with Babcock, Thales and the MoD (which describes itself as a partner and a client).

In December, the MoD announced a delay of up to two years in the schedule for bringing the new carriers into service. That has caused much of the increase in costs, according to an executive at one of the companies involved in the project.

However work has continued, and the first steel for the ships is scheduled to be cut in Govan on the Clyde on 7 July.

If the worst fears of the Aircraft Carrier Alliance's board were realised and the project was scrapped, the knock-ons would be serious.

For example, some 80,000 tonnes of steel worth £65m has been ordered from Corus, the beleaguered Anglo-Dutch steelmaker.

And it could also put in jeopardy plans for BAE to acquire VT Group's stake in BVT, which employs over 7,000 and was created to be a near-monopoly in the construction of warships in the UK.

However official sources say there is little prospect of the project being dropped, because 40% of contracts relating to the carriers have already been placed and ministers are said to be impressed with the way it has been managed so far.

Update, 18:35:

Here is a statement from the MoD in response to my story:

"The MoD took the decision to delay the two future aircraft carriers in December 2008. We did this in order to reprioritise investment to meet current operational priorities and to better align the programme with the Joint Strike Fighter aircraft. We acknowledged at the time that there would be a cost increase as a result.

"We are currently re-costing the programme. The MOD accounts published next month will present an initial estimate and the formal costing will be available later in the year."

Update, 21:14:

Here is a statement by Babcock, one of the members of the Aircraft Carrier Alliance:

"The increase in cost of the Queen Elizabeth Class aircraft carriers is a direct result of the Equipment Examination review carried out by the MoD earlier this year. The review sought to balance the spend profile on major defence projects over the next few years and in the case of the new carriers it was decided to extend the length of time taken to complete the build programme. This has the effect of reducing the spend in the next four year period but will result in an increase in the overall cost of the project."

A Babcock spokesman said that this increase in cost was purely the result of an internal MoD "resource re-profiling exercise" and was not due to design or manufacturing cost escalation. The spokesman went on to stress that the Alliance industrial partners, BAE, BVT, Thales and Babcock continued to work closely with the MoD and were fully committed to achieving the lowest possible cost outturn for the project.

Royal Mail: The rescue is in the post

Robert Peston | 10:10 UK time, Monday, 29 June 2009


The full transcript of George Parker's interview with Peter Mandelson begins like this...


"Do you want to start by paying tribute to Michael Jackson, Peter? Everyone else seems to be doing that."

Peter Mandelson:

"I'm not absolutely sure who Michael Jackson is. Is he the...he's called Jacko, isn't he?"

No comment required on any of that. So let's move straight to what the first secretary told the FT's political editor about his cherished and controversial plans to sell a stake in Royal Mail to the private sector.

Peter Mandelson

Here's what Mandelson said:

"I'm being jostled by other bids for the remaining legislative days in the Commons before the summer."

What he's saying here is that his plan to legislate before the summer recess for the partial privatisation of Royal Mail is being put in jeopardy by the alleged demands for parliamentary time for other bills.

Hmmm. Many would feel that a minister with Mandelson's conspicuous authority would have been able capture a bit of parliamentary capacity were it urgent to do so.

Which is probably why he elaborates:

"[T]he main the unfavourable market conditions for an equity sale".

And he puts it more starkly a little further on:

"[W]e have not had the successful bidding process that we envisaged accompanying the passage of the legislation through Parliament".

In other words, the auction of a stake in Royal Mail has been a flop. There's been just one bidder, CVC Capital Partners, whose initial offer is seen by the government as undervaluing Royal Mail's long term prospects.

Now it's something of a mystery why Mandelson - who's savvier about markets than most ministers - was ever persuaded that it was a cracking idea to auction such a substantial asset when the availability of credit has rather dried up (not a great secret this) and when the global economy is suffering its worst recession since the 1930s.

Something of a longshot-kicked-the-bucket wager that one.

So those who oppose bringing the private sector into Royal Mail have acquired a few more months (at least) to persuade Mandelson and Gordon Brown to drop the partial privatisation in a definitive sense (which the first secretary insists he hasn't done).

None of which really matters to Royal Mail's directors, who are agnostic about whether the likes of the private-equity firm CVC should be brought in as a so-called partner.

What will have horrified them was something else uttered by the first minister:

"The government remains of the view that implementing all three main recommendations of the Hooper review is the right way to go for Royal Mail, and these are a package: reform of regulation, bale [sic] out of the pension fund deficit and...introducing the minority strategic partner. We will not do one of these without the others."

In other words, the things that Royal Mail's management really wants - regulation that takes more account of the competitive pressures its faces from e-mails and the internet, and removal from its balance sheet of its crippling pension-fund deficit - will not happen till market and parliamentary conditions allow a partial privatisation.

Grown men will be weeping in Royal Mail's boardroom, because it's now highly likely that two life-or-death uncertainties about its future will not be resolved till after the election.

Which will damage its ability to make basic business decisions.

And, in respect of the pension problem, there may have to be a last-minute scramble to avoid financial disaster.

Having launched a formal revaluation of the fund in April, Royal Mail has till the summer of 2010 to agree a formal repayment plan for a deficit that's expected to emerge at a company-crushing £10bn. The 15-month timetable is apparently a legal requirement.

So the way it looks today, the victor in next year's general election will have just a few weeks to negotiate how to protect the retirement savings of tens of thousands of Royal Mail employees and also lift a pensions liability from the business that would by now have bankrupted any private-sector company.

Call it Mandelson's gift to his successor (which could, in theory, be himself).

Why banks must be allowed to die

Robert Peston | 00:00 UK time, Friday, 26 June 2009


There's something of an Old Testament sermon at the kernel of the latest Financial Stability Report by the Bank of England.

Bank of England Financial Stability ReportWhen discussing how to reconstruct the banking system so that its periodic excesses never again propel more-or-less the whole world into recession, this is what those sobre chaps in Threadneedle Street say:

"To control risk-taking, financial institutions need to face a credible threat of closure or wind down."

Or to put it another way, the prospect of death rather focusses the mind. For most of us, it's a deterrent against taking excessive risks.

If we knew that we'd always be patched up and kept alive, no matter how much damage we wreaked on ourselves through reckless behaviour - well, we might be tempted to party just a little bit harder than is wise.

So banks too can't be expected to behave themselves unless and until they become convinced that the deal-too-far would send them to the knacker's yard, rather than landing taxpayers with an enormous bill for rescuing them.

Which implies three things:

(1) Banks must be prevented from pumping themselves up to such terrifyingly enormous dimensions as became almost commonplace. Because no government would ever willingly take the risk of allowing the precipitous demise of a bank, like Royal Bank of Scotland, the assets and liabilities of which exceed the output of the British economy by a comfortable margin. If RBS had gone bust, the UK would have been hammering on the door of the IMF for succour.

(2) No bank should be so complex that the relevant regulator can't confidently predict the impact on other financial institutions and the economy of its demise.

(3) All banks should write a contingency plan - what Mervyn King calls a "will" - that would make it easy to protect and separate the deposits of its innocent retail customers, in the event of an accident that mullered the shareholders and other creditors.

Those are the three rules for sanitising the banking system. Sounds simple enough, doesn't it?

If only it were.

The financial elite is broadly divided into three groups on all of this:

(a) there's the Treasury and the Financial Services Authority, which believe that banks can be encouraged to go on an crash diet by imposing a hefty punitive tariff - in the form of disproportionately high capital ratios - on those that remain dangerously big and complex;

(b) there's the Lib Dems, the Tories and (not quite yet) the Bank of England, which explicitly or implicitly say that banks have to be bifurcated by fiat;

(c) and then there are the grey-haired bankers, who think that chaps like me will soon tire of our tedious preoccupation with their size and structure, and they will soon again be gorging to their hearts' content.

Corus, jobs and electricity usage

Robert Peston | 15:24 UK time, Thursday, 25 June 2009


As I have been saying for some time, it may well be the case that the rate of contraction in the economy has slowed markedly.

In fact, in a technical sense it is possible that the recession is over or almost over (though we won't be statistically sure of that for some time).

But any talk of recovery will look profoundly misplaced if you are one of 2,000 workers at Corus's British steel facilities who are to lose their jobs.

Corus Steelworks in Scunthorpe

They are victims of a halving in sales of steel over the past year - with the company saying there's no significant upturn in sight.

Coming on top of the 2,500 job losses announced in January, there will be a reduction in Corus's total British headcount of just under 20%.

The company, a subsidiary of giant Tata Steel of India, will emerge with just over 20,000 staff in Britain - though that could fall another 2,000 or so if a vulnerable plant on Teesside is shut.

So Corus remains a substantial if diminished presence in the UK.

Can we be certain it has shrunk as much as it will? Well we can't.

There's been no significant pick up in steel demand for construction or for manufacturing.

And here's my depressing statistic of the week, courtesy of the National Grid.

Last November, use of electricity in the UK fell 4% - which was the first ever recorded fall in electricity consumption (since at least World War II).

That was a leading indicator of the depth of Britain's recession, especially in manufacturing, as plants and factory lines ceased operating.

There's a lot of talk at the moment of factories re-restocking and production lines starting up again, but power usage remains 4% down (even after adjusting for seasonal factors).

So the bit of the economy that's particularly important to Corus - the bit that makes stuff - shows no discernable sign of recuperation.

How much power for Bank of England?

Robert Peston | 08:50 UK time, Thursday, 25 June 2009


Here's a funny thing.

Bank of EnglandFollowing my note of yesterday on Tory plans to give the Bank of England much greater authority over banks and insurers, I've been deluged with messages from bankers and regulators saying they fear that George Osborne would be giving the Bank too little power, rather than too much (and no, these missives haven't all been signed "Mervyn").

Here are their fears.

If the Tories were to give the Bank of England regulatory and supervisory responsibility for only the biggest banks and insurers - what are known as high-impact firms, those whose failure would have the biggest impact on the economy - the rump of the FSA left behind would become the lamest of lame ducks.

The Bank of England would be seen as the seat of real power in the regulatory game. It would be the glamour employer, if regulation and supervision can ever be glamorous. So the more able regulators and supervisors - the Ronaldos of risk assessment, the Kakas of capital adequacy - would want to work there, not at the FSA.

And the negative impact on the FSA would be immediate: such is the power of the Tories' substantial opinion-poll lead when an election looms, the FSA's current ambitious programme to recruit loads of better staff would grind to a halt.

But curiously those anxious bankers and regulators are not using their fears that the FSA would become the equivalent of a non-league side as a reason to promote the status quo (although there are some who think that the so-called Tripartite system can be improved with a bit of tweaking).

They say that if the Bank of England is to regain a role in supervision and regulation, there are two superior options.

One would be a full-scale merger of almost the entire FSA with the Bank of England.

The FSA's market regulation and financial capability bits might be left out of this merger. But everything else - some 2000 staff monitoring the health and business conduct of all financial institutions - would become part of the Bank of England.

This would present a management challenge. And the Bank would become a remarkably powerful institution - probably more powerful than the Treasury.

But the new institution would be seen as coherent. And with the right decentralised structure, it could well be effective.

The alternative is the so-called Twin Peaks model - which the chairman of the FSA, Adair Turner, hinted he rather liked in his evidence to the Treasury select committee on Tuesday.

This would see the Bank of England taking charge of prudential supervision and regulation of all financial firms, whether they were big or small. The Bank would determine whether each and every bank, securities firm and insurer had enough capital and liquidity and whether they were managing themselves in a sensible prudent manner.

The FSA would remain in existence as the assessor of the products sold by financial firms and also the evaluator of the selling methods of financial firms. It would determine, to simplify, whether you and I are being ripped off when we invest in an ISA, or buy insurance, or acquire a new credit card.

There is some logic to this split. It's the system that exists in Australia and the Netherlands, where it seems to have worked adequately.

But this division between prudential regulation and conduct-of-business rules is not completely clean.

Take for example the highly topical question of how much banks should lend in a mortgage as a percentage of the value of the relevant house, the so-called loan-to-value ratio.

This is relevant to prudential supervisors, in that it's an important factor in determining whether a bank is taking too much risk when lending. And it's also relevant to conduct-of-business regulators, who are concerned about whether customers are over-stretching themselves when borrowing.

In other words, there are benefits in combining within the one house both prudential and business-conduct regulation.

But I am absolutely clear that Osborne will split them. And no one tells me that would be a disaster, though some don't like the split.

The more pertinent question is whether Osborne would transfer to the Bank prudential responsibility for the biggest firms alone or whether he will give put the bank in charge of assessing financial risks being taken by every single financial institution.

Between now and the announcement of his decision, he'll be under intense lobbying pressure from the City to go for a fully fledged Twin Peaks system.

That said, whichever way Osborne jumps, the Bank of England will become much larger and more imposing. Within the context of the UK's mountain-range of economic and financial institutions, it would be moot whether the Treasury or the Bank of England would be Everest.

Tories to give sweeping new powers to Bank

Robert Peston | 10:15 UK time, Wednesday, 24 June 2009


The Bank of England would regain primary responsibility for regulating big banks and financial institutions of importance to the health of the economy under radical plans to overhaul financial regulation being drawn up by the Tories.

I've learned that the shadow chancellor, George Osborne, will overhaul in a fundamental way the Tripartite System created by Gordon Brown in 1997, which created the Financial Services Authority as the super-regulator for all financial institutions, with the Bank of England and the Treasury retaining a role in decisions affecting the stability of markets and the economy.

George Osborne

Mr Osborne believes the distribution of responsibilities between the three institutions has been blurred and inefficient. So as part his overhaul, the Bank of England would get back much of the regulatory and supervisory functions that Gordon Brown removed from it, when he was chancellor.

However the Conservatives are unlikely to confirm any of this for several days. They will unveil the precise details of which financial institutions would fall under the sway of the Bank of England in the coming fortnight - probably after the Treasury publishes its paper on financial regulation next week.

What's unclear is whether the Bank of England would be given responsibility for the health only of big banks, or whether it will also be charged with monitoring and supervising substantial insurers too.

However, the essence of what George Osborne wants to do is similar to what the US president unveiled last week: Barack Obama said he intended to give the lead role to the US central bank, the Federal Reserve, in maintaining the soundness of all systemically important financial institutions.

It's plain that the chairman of the Financial Services Authority, Adair Turner, has an inkling of what the Tories are planning.

When giving evidence yesterday to the Treasury select committee, Lord Turner said there was an argument that the Bank of England should take back from the Financial Services Authority total responsibility for banking supervision - and he would not be fighting to the death to keep it.

He was "agnostic" about such a reform, he said.

As it happens, the Governor of the Bank of England, Mervyn King, has been demanding that that the Bank should have the formal power to boss banks around (see my note, "Why King changed his mind").

But he has implied that he wants to share this responsibility with the FSA, rather than to have the lead or primary role.

The Tories, however, are not in favour of giving Mr King only the power to meddle in what banks are doing, as and when it suits the Bank of England, while leaving the burden of the regulatory role with the FSA. That would lead to confusion and wasted effort, it believes.

Mr King may not, therefore, be completely thrilled by the Tory plans - because supervising banks has the potential to do more damage to the reputation of his venerable institution than anything else a central bank can conceivably engage itself in.

In practice, it may be seen to suit the Bank that when there's a public outcry about the unholy mess at a Northern Rock, or an HBOS or a Royal Bank of Scotland, the Bank is well clear of the line of fire, as the smelly stuff coats the FSA.

When King and his colleagues reflect on the risks associated with banking supervision, they may determine that co-operation with the FSA is superior to taking over one of its central functions.

Turner yesterday offered Mervyn King a model of co-operation that paid due deference to the majesty of the Bank of England.

A new committee for curtailing excessive lending by banks, as and when credit and asset bubbles start to form, should be chaired by the governor and have a majority of its members drawn from the Bank, said Turner.

But it would also include FSA representatives and it would be informed by analysis provided by both Bank and FSA.

As for responsibility for ensuring that the decisions of this mooted Credit Policy Committee were implemented by banks - that if banks were instructed to increase their holdings of capital relative to loans or to hold more cash - that would naturally fall to the FSA, if it were to retain its banking supervisory role.

In the City, bankers tell me that what they most want is an end to the bickering between the Bank of England, the FSA and the Treasury about who does what.

Update, 11:32: Having dug a little deeper, I have learned that - under the Tory plans - the Bank of England would have supervisory and regulatory responsibility for our biggest banks and our biggest insurers. So the likes of Royal Bank of Scotland, Barclays, HSBC, Lloyds, the Prudential, Aviva and Legal & General would all fall under its sway.

The role of the Bank of England would be to ensure that they were not taking excessive risks, that they had sufficient capital and liquidity, and so on.

As for the FSA, it would retain a relationship with these institutions, in the sense that it would still be in charge of making sure they conduct business with customers in a fair and proper way. To use the jargon, it would remain the authority in respect of "conduct-of-business" rules.

What's driving the Tories to make these changes?

Partly, it's down to feedback received by George Osborne's team from City firms, to the effect that the FSA hasn't raised its game sufficiently since it pledged to do so more than a year ago, after the Northern Rock debacle.

But the primary motivation is the widespread acknowledgement that the health of certain big banks and huge insurers, and the way they invest and lend, has profound implications for the health of the economy.

In other words, what's known as micro-prudential issues dovetail with macro-prudential issues. And if that's the case, it would make sense to put the central bank, the Bank of England, in charge of both. Or so the shadow chancellor believes.

Liverpool walks on

Robert Peston | 08:24 UK time, Tuesday, 23 June 2009


The good news for Liverpool FC supporters is that the club is not about to go bust.

George Gillett and Tom HicksI understand that Royal Bank of Scotland has told its two billionaire owners, George Gillett and Tom Hicks, that their £350m debt - which falls due for repayment on 24 July and is owed to Royal Bank and Wachovia of the US - will be refinanced.

A new lending agreement will be put on place.

The less good news is that Liverpool is a microcosm of the British economy: the club borrowed too much; and it now has to tighten its belt, pay down debt and endeavour to live within its means.

There's no reason for Liverpool supporters to feel hard done by or victimised. With household debt, corporate debt and public-sector debt at record levels in the UK (equivalent in aggregate to 400% or so of GDP), they're living a footballing version of what the next five years will be like in UK plc.

And although there may be less money available to the manager to spend on what his supporters want (am I talking here about Benitez or G Brown?), many would say that's better than the alternative of living with the constant fear of foreclosure by creditors.

Royal Bank and Wachovia will insist on significant payments from Hicks and Gillett in the subsequent six months.

The banks have sway over Hicks and Gillett, because the US duo have pledged a good chunk of their US assets as security against the Liverpool debt - and plainly they would rather not have these US assets seized by the banks.

But there's a proud history, lots of backbone and a talented squad (am I talking here about Liverpool FC or the UK?). It may have been foolish to borrow too much, but the lesson has been learned (presumably) and the fight goes on.

Hester's Royal remuneration

Robert Peston | 09:25 UK time, Monday, 22 June 2009


Royal Bank of Scotland's board is this week expected to approve a remuneration package worth up to £9.6m for the chief executive who replaced Sir Fred Goodwin (RBS is holding board strategy meetings on Tuesday and Wednesday).

This anticipated formal decision on the pay of Stephen Hester follows a meeting on Friday at the bank's London office between RBS's chairman, Sir Philip Hampton, and representatives of the bank's leading shareholders - which has been the culmination of months of negotiations on an issue that has become fraught and controversial for all big banks.

Stephen Hester

Shareholders who gave their assent to the package proposed for Mr Hester included UK Financial Investments, the arm of the Treasury, which manages taxpayers' 70% stake in Royal Bank.

What's mildly amusing is that UKFI was - I am told - adamant that the package should be worth marginally less than "double figures millions", presumably as insurance against the more sensational of headlines about the apparent return of boom time for bankers.

The package for Mr Hester has three elements: basic pay of £1.2m per annum; up to £2m of bonuses, payable in subordinated debt rather than cash (because RBS agreed with the government last year not to pay cash bonuses for a period); a maximum of £6.4m in long-term incentives, payable if share price targets are hit over the next three years.

In respect of the £6.4m long-term part, half is payable if the share price were to hit 70p (compared with 37.5p this morning) and half if the return to shareholders over the coming three years were to be superior to most of Royal Bank's competitors.

However, the payments wouldn't be automatic: Royal Bank's board would have the discretion to claw some or all back, if directors didn't believe the share-price rise had been caused by the sensible management decisions of Mr Hester (so his reward might be reduced if Royal Bank's share price was inflated by takeover speculation, for example).

Now let's stray into the land of the bloomin' obvious, to look at why Mr Hester's package will be controversial.

First and most obviously, Royal Bank is cutting thousands and thousands of jobs, perhaps up to 30,000 in the coming two years or so.

Second, Royal Bank is 70% owned by taxpayers. And at a time when the public sector is expected to be squeezed hard, it may look odd to be paying so much to the boss of a publicly controlled bank.

Third, all the banks are under pressure to increase their lending to businesses and households. For example the governor of the Bank of England agonised in public last week about how economic recovery might be put in jeopardy by the inadequacy of credit made available by banks.

Why is that relevant? Well, for the chief executive of a bank, the safest way to increase profits and the share price at this stage of the economic cycle - apart from slashing costs and cutting jobs - is borrow from retail depositors at close to 0% and then lend to the government by buying relatively risk free long-term gilts paying 4%.

The Treasury is aware of this risk. Which is why it has forced Royal Bank to agree quantitative targets for the amount of credit it will make available to businesses and households. But there is a piquant question whether Mr Hester's remuneration incentives will deter the bank from providing more than this minimum.

All that said, one paradoxical reason for paying that kind of money to Mr Hester is also - funnily enough - that taxpayers own the majority of the shares.

He is widely regarded as that rarest of animals, an untarnished world class banker. And we surely can't complain if a competent individual is running a state institution (and he insisted on writing into his contract that if he were to turn out to be a dunderhead, he would not receive a penny on being sacked).

Also, if Mr Hester were to make the full £9.6m, Royal Bank's share price would need to have risen to more than 70p over a sustained period - which would yield a profit for taxpayers on our 70% stake of £8bn.

Which looks a reasonable deal for the state - unless you think, as many do, that because bankers were to a large extent to blame for the economic mess we're in, it's too early for any of them to be earning this kind of money (even if, like Mr Hester, they are being paid to clear up the mess created by other bankers).

Goodwin: The final pension sum

Robert Peston | 15:33 UK time, Thursday, 18 June 2009


With any luck this will be my last word on the issue of Sir Fred Goodwin's pension.

Sir Fred GoodwinFirst, it is possible to do a calculation that shows he has given up all the enhancement to the value of his pot that came when he left by mutual agreement rather than being sacked.

Here's the maths.

His enhanced pot at the end of 2008 was worth £16.6m.

Without the enhancement, the pot would have been worth £10.2m (this is not a number that has ever been published).

The gap between the two is therefore £6.4m.

Today he is giving up £4.7m.

And in October he gave up around £2m in contractual pay and further associated pension contributions.

Hey presto: the gap is closed.

Which is the sort of calculation that really matters to the government, because it was so adamant that Sir Fred should only receive his contractual minimum.

However the rest of the world will note that his contractual minimum - a £2.7m tax-free lump sum (worth £4.5m before tax) and £342,500 per annum - is pretty handsome.

Second, while it is the case that RBS's internal review found no evidence of wrongdoing or misconduct by Sir Fred, the bank was advised by leading counsel that there was a reasonable legal basis for suing him for the return of some of the pension pot - and Sir Philip Hampton, RBS's chairman, told Sir Fred he was happy to seem him in court.

Reducing Sir Fred Goodwin's pension

Robert Peston | 11:12 UK time, Thursday, 18 June 2009


Sir Fred Goodwin, the former chief executive of Royal Bank of Scotland, has offered to reduce his pension.

Fred Goodwin, 23 April 2008Under the threat of legal action from RBS, Sir Fred has offered to reduce what he receives by £200,000 per annum.

This would reduce the value of his pension pot by around £4m.

However, he has already taken out a tax-free lump sum of £2.7m in cash from his pension pot.

And even after reducing his pension by £200,000 or so, he would still receive a pension of around £350,000 or so.

I understand that Royal Bank would be minded to agree this deal.

What's less clear is whether the government - which owns 70% of RBS - will say that the concession is adequate.

Ministers may not wish to agree the deal, because Sir Fred would still be receiving more than would have been the case had he been dismissed rather than leaving on agreed terms.

Update 1152: Because Sir Fred Goodwin retired from Royal Bank of Scotland at the request of the board, rather than being sacked, the value of his pension pot doubled from just over £8m to £16.6m.

Under the threat of legal action from the new management of Royal Bank, he is now offering to give back roughly half of that increase, or around £4m.

What's unclear is whether the government - which, as noted above, owns 70% of the bank - will give the deal the thumbs-up. It had been saying that he should receive no more than would have been the case had he been sacked.

As for RBS, it would probably be minded to accept Sir Fred's proposal, to draw a line under this messy dispute.

Update 1202: I understand that the government will accept the offer made by Sir Fred. So the threatened legal action against him will be dropped.

Update 1213: Here are more precise numbers for what Sir Fred has agreed to give up.

His new pension will be £342,000, versus the £555,000 he had been drawing.

And don't forget he has already taken out a tax-free lump sum of £2.7m.

In essence, he has given back around £4.5m of that notorious £8.2m increase in the value of the pension pot, which was triggered by the board's decision to ask him to retire early rather than dismissing him.

Why King changed his mind

Robert Peston | 09:29 UK time, Thursday, 18 June 2009


George Osborne is rather enjoying the spectacle of the chancellor being periodically duffed up - on the risks associated with the increase in public-sector borrowing; on reform of financial regulation - by the governor of the Bank of England.

If Mervyn King's waspish remarks damage the economic reputation of the government, surely that must be good for the Tories.

But the shadow chancellor probably shouldn't cheer too loudly as Alistair Darling squirms: a governor who has a licence to attack a Labour chancellor would have exactly the same licence to muller a Tory one; the forthright independence of Mervyn King might not seem so attractive to Osborne if he achieves his dream of taking up occupancy in Number 11.

As for the meat of what King said last night at the Mansion House: in calling for more authority to boss banks around, he has support from the Liberal Democrats and - although less publicly as yet - also from the Tories.

So King's argument about how to promote the stability of the financial system has been turned into something more political.

Because up to now, the government has been defending the structure of regulation - what's called the tripartite system - that was created by Gordon Brown in 1997.

mervyn king

The governor's argument is that analysing threats to financial stability - a legal duty given to the Bank only in the past year - isn't enough.

If the Bank of England can't instruct a bank to mend its ways when that bank is doing something perceived to be too risky, then what chance is there that the bank would cease and desist?

Well, the obvious answer is that the Bank of England would presumably ask the Financial Services Authority to intercede with the miscreant bank on its behalf.

After all, it is the FSA's primary responsibility to curb the dangerous enthusiasm of banks.

But, for whatever reason, the governor plainly doesn't trust that this separation of powers between the Bank of England and the FSA would work well enough.

Is he right?

That's tricky.

It's certainly the case that today's banks are much less in awe of the Financial Services Authority than they were of the Bank of England 15 years ago, when the Bank of England had formal responsibility for supervising banks.

But that was probably as much to do with the more inward-looking, domestic structure of the City back then, as with the intrinsic authority of the Bank of England that was built up over the 300 years of its history.

And, for the avoidance of doubt, the Bank's record as a supervisor and regulator of banks wasn't unblemished (a big hello to BCCI).

Today's unavoidable truth is that banks the size of Barclays, Royal Bank of Scotland and HSBC - with balance sheets rather bigger than decent-size economies like the UK - aren't much in awe of anyone or anything.

Which, of course, is part of the problem.

And that is probably the best argument for giving the Bank of England much greater sway over big banks, in partnership with the FSA.

Normally duplicating the activities of regulators is a recipe for waste and even possibly for confusion.

But maybe in this case, it would be better to have two sets of big boots wielded by two regulatory bodies delivering swift blows to the tender parts of a mega-bank, to keep that mega-bank in line.

That said, it wouldn't be easy to establish a modus operandi between the FSA and the Bank of England, if they were to have more overlapping responsibilities: Bank of England officials speak with wounded pride about how the FSA has warned them off visiting financial institutions in the past.

Finally, and for those who care about these things, Mervyn King has somewhat changed his mind about all this.

Just a few years ago, he was clear that Gordon Brown was right to de-merge from the Bank of England its substantial banking supervisory department.

Like Brown, King believed that effective regulation required the creation of a super-regulator, which would bring together the hotchpotch of different regulators with responsibility for securities firms, insurers, banks and so on.

And he felt that the Bank of England could not be that super-regulator, because as an institution it would have become unmanageably complex and large - and also too powerful.

So it was better for the super-regulator to be outside the Bank of England, in the form of the FSA. And the FSA, of course, couldn't be a super-regulator if it didn't absorb the Bank of England's supervision department.

Since then he - and quite a lot of others - have spotted that it's tricky for a central bank to deliver economic stability if it has no role in promoting financial stability.

And, as he's made clear, King's view today is that it's pretty tricky for the Bank to deliver financial stability if it has no power to tell an HBOS or a Royal Bank of Scotland that it doesn't like the risks they're running.

Perhaps King would say that his views have evolved, rather than changed. But what is crystal clear is that he didn't spot how the growing size and increasing connectedness of financial institutions was making the Bank of England's sterling work in controlling inflation the equivalent of re-arranging deckchairs on the Titanic.

Governor criticises government (again)

Robert Peston | 20:01 UK time, Wednesday, 17 June 2009


Mervyn King has tonight said that the Bank of England has insufficient powers to carry out its new legal responsibility to promote financial stability.

In remarks that are likely to prove highly embarrassing for the government, he said at the Mansion House tonight that: "It is not entirely clear how the Bank will be able to
discharge its new statutory responsibility if we can do no more than issue sermons or organise burials."

His reference to "burials" is a reference to the Bank of England's role as the administrator of the assets of banks that have collapsed.

He is bound to be seen as attacking the man sitting next to him at the annual Mansion House dinner in the City of London, the Chancellor of the Exchequer - in that the Treasury has resisted significant changes to the allocation of regulatory responsibilities between the Financial Services Authority, the Treasury and the Bank of England, the so-called Tripartite.

However, what he said may well be music to the ears of the shadow Chancellor, George Osborne, who is understood to have been planning to call for more powers to be given to the Bank of England to oversee financial institutions.

Mr King's complaint is also particularly resonant today, because the US President is announcing that he would be giving sweeping new authority over financial institutions to the US central bank, the Federal Reserve.

The Governor appeared to differ from the Chancellor - in tone if not explicitly in content - in respect of another hugely important area of banking reform, which is whether some banks have become far too big for the health of the economy.

The Governor said: "If some banks are thought to be too big to fail, then, in the words of a distinguished American economist, they are too big. It is not
sensible to allow large banks to combine high street retail banking with risky investment banking or funding strategies, and then provide an implicit state guarantee against failure."

By contrast the Chancellor told the same City audience that "The solution is not as simple, as some have suggested, as restricting the size of banks. We have learnt that you don't necessarily need to be a big bank - or indeed a complex one - to threaten to bring the system down."

Mr King also gave a sound ticking off to his City audience for the way they had let down the people of Britain. This is what he said:

"The costs of this crisis are not to be measured simply in terms of its impact on public finances, the destruction of wealth, and the number of jobs lost. They are also to
be seen in the lost trust in the financial sector among other parts of our economy.

"For a generation or more, businesses and families up and down the country were told, not least by the City, that the disciplines of the market economy were essential, even if painful in the short run, for greater prosperity in the longer term. That belief in the merits of a market economy was embraced and for many years was not misplaced.

"But out of the blue - in this case the financial sector - came a crisis that did not stem from weaknesses in the real economy. It has wreaked havoc on those same businesses and families. Unemployment, as we saw in today's figures, is rising sharply.

"And yet it is the banking system that has received financial support on an almost unimaginable scale. We who work in the financial sector have much to do to regain the trust of those who work outside it. "My word is my bond" are old words, but they were important. 'My word is my CDO-squared' will never catch on."

Rebuilding the foundations of finance

Robert Peston | 08:16 UK time, Wednesday, 17 June 2009


For the avoidance of doubt, the chancellor of the exchequer is not saying today that there won't be big changes to the way that our banks are regulated.

They will be subject to much more intrusive scrutiny by the City watchdog, the Financial Services Authority.

They will be required to hold much more capital as a buffer against losses, especially in the parts of their businesses that trade in securities and debt.

But we've known all that for months.

Those changes were announced in the spring by the chairman of the FSA, Lord Turner, and have already been underwritten by the Treasury.

Alistair Darling

What's new (well sort of) in what Alistair Darling will tell the City tonight - in his Mansion House speech - is that he does not propose to change the structure of the regulatory system.

He will say that the so-called tripartite approach - with responsibility divided between the FSA, the Bank of England, and the Treasury - is not to blame for the financial crisis that precipitated the worst global recession since the 1930s.

As it happens, he's already tinkered a bit with the distribution of chores between those three: the Bank of England has been given a more formal responsibility for maintaining the stability of the financial system and it has new powers to administer the assets of banks that are deemed by the FSA to have failed.

But these reforms can be seen as shoring up the status quo.

Whereas the Conservative Party wants much more fundamental reform. And the Tories would very significantly increase the power of the Bank of England to boss big banks around (though we are yet to hear the Tories' detailed proposals).

The Tories may well boost the position of the Bank of England in the regulatory system in an analogous way to what the US president will today announce as his prescription to enhance the role of the US central bank, the Federal Reserve.

The Fed will be given sweeping authority to oversee more-or-less any individual financial firm in the US - which is well beyond what the Bank of England is able to do right now.

That said, President Obama is streamlining and rationalising a crazy hotchpotch of regulatory bodies. And many would say his overhaul is long overdue.

By contrast, a similar centralisation of powers took place in the UK in 1997, when Gordon Brown as chancellor created the tripartite system. That said, bankers and others in the City have complained of that tripod that the division of responsibilities between FSA, Treasury and Bank of England have been confused and blurred.

Or to put it another way, to judge the different reforms being proposed today in Washington and London it is important to remember that the deficiencies of their respective systems are not identical.

Even so, and as I pointed out here on Monday ("Should we trust the regulators"), there is a pretty close alignment of views in the US and UK governments on the new rules banks have to follow, in respect of how much capital and liquidity (or cash) banks have to hold to protect them against shock.

And neither Washington nor Whitehall is suggesting the enforcement of profound structural change at banks: there's no desire to break them up into smaller, more narrowly focused businesses, as some reformers (such as Vince Cable of the Liberal Democrats) have suggested.

Finally, what's also striking is how far we still seem to be from seeing detailed plans for what's called "macro-prudential" regulation - or new institutional arrangements to prevent the recurrence of bubbles in lending and asset prices.

For some months it has seemed very likely that this kind of credit policy committee for curbing lending booms will be created, in that both the governor of the Bank of England and the chairman of the FSA have given the idea their blessing.

It would have the power to vary with the cycle the amount of capital that banks in general hold - so that when the economic going was perceived to be too good, banks would find themselves fettered in the amount they could lend.

But although there's a fairly wide consensus that such arrangements are needed, we are a long way from seeing the architect's plans.

It's not even been confirmed by the Treasury that such a body would probably be attached to the Bank of England.

Don't expect too much from the Treasury's planned policy paper on all this, which is due in a fortnight or so. It will be more green than white - more discursive, rather than prescriptive.

Perhaps there is no rush. After all, the risk to the economy at this particular juncture is not that the banks are lending too much, but that they are lending too little.

That said, a restoration of economic confidence to more normal levels - the restoration of the appetite to take sensible risks by businesses and households - requires a widespread conviction that the foundations of the economy have been rebuilt in a robust way.

The construction work is still at a preliminary stage.

Britain's media obsession

Robert Peston | 08:51 UK time, Tuesday, 16 June 2009


The minister for communications, technology and broadcasting sees his White Paper on "Digital Britain" as a possibly unique event in the history of British government.

Lord CarterBrainy, personable Lord Carter views the report he has written (and it is a surprisingly personal evaluation) as an attempt to promote a particular industrial sector, the media and digital technology sector - which the government estimates contributes around 8% of our national output, our GDP.

Its rareness is that he can't recall any previous White Papers that were focused exclusively on the needs of a particular sector.

In a technical sense, he may be right - although successive government reviews of the UK's competitiveness have agonised over the perceived weakness of British manufacturing, and there have been endless studies of how to promote financial services and the City of London.

So on the day that Carter's conclusions are published, one question is why the digital industries are more deserving of ministerial attention than - say - pharmaceuticals, or defence, or motor manufacturing, or food and drink, or civil aviation.

If you work in those industries, you may think "thank goodness ministers aren't meddling with us".

But you might also be a bit miffed that the government doesn't seem to think that what you do is as important to the UK's prosperity as what those flashy boys and girls do in advertising, TV, telecoms, chip-making and so on.

That said, Carter's White Paper will in practice do a great deal more than endeavour to promote the needs of a bunch of companies perceived to be particularly important to Britain's longer-term prosperity.

Because, of course, the development of the so-called digital economy - especially the internet - has implications for the competitiveness of all our companies, for the skills of British people, for the healthiness of our cultural life, and for democracy.

The big point is that the broadband network is an important public utility - though perhaps the prime minister over-egged it this morning (surely not) when he wrote in the Times that "a fast internet connection is now seen by most of the public as an essential service, as indispensable as electricity, gas and water".

It will be fascinating to see how Carter reconciles his desire to provide a benign terrain for the commercial players in the digital industries with the imperative of correcting market failures, so that uncommercial but vital public needs are met.

In no particular order of importance these public goods include:

• access to a fast connection for the 2.5m or so people who currently have no such access (and not just households, but broadband-deprived businesses too);

• diverse sources of regional and local news, that are not unimportant to the prospects for local democracy;

• a feast of public-service programmes provided through a variety of channels and "platforms" (not just those provided by my employer, I suppose).

There are tensions between the commercial interests of companies and the cultural and social priorities of the nation. It would be naïve to pretend otherwise.

How Carter and the government choose to reconcile those tensions matters to most of us.

Should we trust the regulators?

Robert Peston | 09:23 UK time, Monday, 15 June 2009


There is a remarkable similarity between reforms of the financial system that are likely to be proposed in the coming days by the US and British governments.

FSA buildingWhich, in one sense, is both predictable and sensible - because in a world of globalised finance, it would be almost impossible to have our biggest banks subject to radically different regulatory constraints in different parts of the globe.

But what about the essence of what's recommended to prevent the excessive risk-taking by banks and other financial institutions that propelled economies from America, Europe and even Asia into the worst recession since the 1930s?

We may have uniformity between London and Washington - but are the chancellor of the exchequer and US treasury secretary being bold, far-sighted and wise or timid, myopic and ineffectual?

What's striking is that both the British Treasury and the White House are not contemplating the kind of structural reforms of the banking industry that the US adopted towards the end of the Great Depression.

There will, for example, be no formal prohibition on what the banks insured by all of us as taxpayers can do.

Those big banks that are so big and important to the economy and therefore benefit from a de facto guarantee that they won't be allowed to collapse, well those banks will still be permitted to engage in what the governor of the Bank of England (no less) has described as "casino" banking in wholesale markets.

Nor will there be a simple rule that says something like "the value of no bank's loans and investments should ever be bigger than the economy of its home country" - even though it's not exactly been comfortable for the UK that bailing out Royal Bank of Scotland, whose balance sheet was almost 50% bigger than our GDP, linked the credit-worthiness of the country to that of a bank (if RBS failed, the UK failed).

US Federal Reserve buildingInstead there will be lots of new powers for regulators, like the Financial Services Authority in the UK and the Federal Reserve in the US. And there will be myriad new rules that endeavour to cut the financial industry down to an appropriate size by making it more costly to engage in certain riskier activities.

Thus the securities trading bits of commercial banks will be forced to hold lots more capital in respect of these supposedly speculative activities - which makes it more expensive for them to play in the governor's wholesale-markets casino.

Also there may be a simple so-called "leverage" rule, which says that gross loans and investments - unadjusted for the riskiness of particular asset classes - should not be more than a certain multiple of capital.

Which of course is common sense: it was the height of folly to permit Royal Bank of Scotland to lend and invest 50 times the value of its core equity; a mere 2% fall in the value of its assets wiped out the institution.

But here's the thing.

There was a grotesque failure of regulation and regulators over the past few years.

And one reasonable response to that failure would have been to dismantle and simplify a global financial industry that had become too complex and byzantine - to cut it down to size by government edict, by fiat.

Instead the leaders of the US and the UK, whose financial services industries are the world's most important, are arguing that regulators can and will do a better job than hitherto.

They are asking us to trust that a new generation of watchdogs, armed with new and improved rulebooks, will do a much better job than the last lot.

Some may say that they could hardly do worse.

But what may not reassure everyone is that the soundness of the financial system - a system, remember, which has held the global economy to ransom for the past 20 months - will remain dependent on the ability and zeal of a regulatory priesthood.

It would be better perhaps, you might think, to limit the human factor in keeping banks safe and sound: just possibly, a more reliable, long-term basis for sanitizing finance would be simplify it and shrink financial institutions.

Blavatnik offers Setanta lifeline

Robert Peston | 14:03 UK time, Friday, 12 June 2009


Len Blavatnik, the American tycoon with links to some of Russia's best-known oligarchs, has offered Setanta a £20m lifeline, I have learned.

football fans watch football soccer ball game in pubBlavatnik, whose media interests include Top-up TV - the pay channels on Freeview - and an Israeli sports channel, has written to Setanta's owners offering to put in £20m in return for a controlling 51% stake.

His hope is that - at the very least - his intervention will buy Setanta some time, and will persuade creditors of the sports television business to hold off pulling the rug.

Blavatnik - who works with former senior executive of BSkyB, David Chance - hopes that creditors and the owners of Setanta would want to examine what he has in mind as an alternative to closing the business.

Of Russian descent (he and his family left Russia in the 1970s), Blavatnik has not emerged unscathed from the credit crunch.

LyondellBasell, a huge petrochemicals maker that he backed, has collapsed, foisting eye-watering losses on its creditors, which include Royal Bank of Scotland.

UPDATE 19:23

I am hearing that the Blavatnik plan has a reasonable chance of succeeding. Apparently other investors have signalled they may be prepared to put in a further £20m or so - which may be enough to refinance the business.

So news of Setanta's demise, to coin a phrase, may have been a bit premature. There may be life in this business yet.

West Brom: Three-quarters mutual

Robert Peston | 08:08 UK time, Friday, 12 June 2009


The Barclays sale of BGI may be today's whopping deal (see my earlier note), but the rescue of West Bromwich is more interesting.

How so? Well it's the conversion of £182.5m in subordinated debt into a brand new form of capital - approved by the FSA - that sets the pulse racing (well, it does if you are a sad obsessive about these things - a big hello from me).

West Bromwich building society

The point is that the Profit Participating Deferred Shares to be issued to institutions in exchange for the subordinated debt look a good deal like shares. They give their holders up to 25% of West Brom's future profits, at the discretion of the board.

In other words, West Brom has semi-demutualised without all the fuss of going through a stock market listing or obtaining the approval of its members.

The debt-for-equity swap will therefore be pretty controversial, I would expect.

And it will be fascinating to see if other capital-constrained societies take the opportunity to strengthen themselves by swapping debt for what looks and quacks quite a lot like ordinary shares.

In fact, the FSA has said this morning that societies may be able strengthen themselves by simply selling these almost-shares to new investors - even, just possibly, retail investors, including building-society members.

So perhaps these Profit Participating Deferred Shares will be the salvation of the beleaguered mutual sector - in that they will at last allow societies to raise capital from outside sources, thus bringing to an end the cruel cull of any society that makes a loss.

That said, there will be concerns that those societies which issue this stuff will have less ability to pass on all the financial benefits of their business to members.

They will therefore become semi-mutuals, a hybrid - and who knows what effect this cross-breeding will have on the behaviour of the beast over the long term?

For West Brom, however, doing this deal was probably a no-brainer. The alternative would have been the end of a 160-year history - with the business broken up and the assets put into run-off under the stewardship of the Bank of England.

As it happens, West Brom's results for 2008 (also just published) show that new management - appointed in the autumn of last year - has done a pretty impressive job of correcting the booboos of the last lot.

Reliance on flighty wholesale funding has been reduced. And the group has turned its back on racy, risky commercial property and buy-to-let loans to return to its roots as a substantial regional savings and mortgage provider.

In fact, it's just possible that this debt-for-equity swap is more than just a short-term rescue: it may allow West Brom to remain independent for the foreseeable future.

Presumably some in its home town will be looking to see if a similar fix can be found for the eponymous, relegated football team.

More protection for Barclays

Robert Peston | 06:36 UK time, Friday, 12 June 2009


Barclays has sold one of its jewels, Barclays Global Investors or BGI, to raise capital as a protection against further losses on the loans and investments it made in the bubble years - and to provide a bit more insulation from what other financial storms may lie ahead.

The buyer is BlackRock of the US, and the deals turns BlackRock into the world's biggest money manager, with a striking £1.9 trillion of funds under management - which is more-or-less the size of the entire hedge fund industry.

Just under half the price of £8.2bn is payable in cash, with the rest in BlackRock shares - so Barclays will emerge with 19.9 per cent of this vast enlarged financial machine.

If BlackRock does well, Barclays will benefit - although there has been a sacrifice in reducing its stake in an industry which is expected to grow over the coming years.

But, the price doesn't look too bad, relative to BGI's earnings and its implicit share of Barclays' overall market value.

The most controversial element of the deal is the £16m reward it yields for Bob Diamond, the head of Barclays' investment bank.

It's not really a hairshirt year for Diamond, even though he has curbed his other remuneration, for a bit.

West Brom may escape break-up

Robert Peston | 17:16 UK time, Thursday, 11 June 2009


West Bromwich has just put out a statement which implies that it will - almost certainly - avoid being broken up and put into the Special Resolution Regime run by the Bank of England.

Instead it appears to be on course to persuade holders of its so-called subordinated debt - some £182.5m of it - to convert this debt into capital.

It's a clever way to avoid insolvency, by creating new capital that can absorb future losses on imprudent lending.

This doesn't mean that West Brom will remain independent however. A merger with the likes of Coventry BS may still be the best way forward.

But it would buy West Brom the time to make the decision on its future in a controlled an orderly way.

Here's the West Brom statement:

"West Bromwich Building Society is in advanced discussions with holders of the Society's subordinated debt to exchange the full outstanding principal amount of the Society's subordinated debt, totalling £182.5 million, for a new instrument which will qualify as core tier 1 capital.
"Such a transaction would materially strengthen the Society's core tier 1 capital ratio as well as improving quality of the Society's capital base. The Society expects to make a further announcement with respect to this transaction in due course."

UPDATE, 17:30: The moment of most acute difficulties for Britain's banks and building societies is passed.

But that doesn't mean it's plain sailing for all of them - especially if like West Bromwich Building Society they've become too exposed to the commercial property and buy-to-let markets.

Building societies face a particular difficulty when they incur losses - which is that it's especially hard for them to raise new equity capital to absorb such losses, to say afloat.

So what's happening at West Brom today may represent something of a breakthrough.

The society seems to be on course to persuade holders of £182.5m of so called subordinated debt to convert this debt into what it calls "a new instrument" which would be the equivalent of core capital.

This may sound like mumbo jumbo.

But what it means is that West Brom is acquiring a buffer to absorb losses and avoid insolvency.

If it succeeds there will have been a last minute escape from a grisly fate. Because the alternative for this 160-year-old pillar of the Midlands economy was to be broken up, with West Brom's savers going to another society and its assets wound up, under the management of the Bank of England.

West Brom BS to be rescued

Robert Peston | 14:33 UK time, Thursday, 11 June 2009


West Bromwich Building Society, Britain's eighth largest building society, will be rescued within the coming days, I have learned.

West Bromwich Building SocietyAn announcement could even come later today.

The UK's eighth largest building society may be broken up, with its savers transferred to another building society and its assets taken over by the Bank of England under the so-called Special Resolution Regime.

This was what happened to Dunfermline Building Society earlier this year.

However the Financial Services Authority and the Treasury are also exploring the possibility of converting some of the debt provided by investors and financial institutions to West Brom into a new form of capital.

This could allow West Brom to keep its independence or to merge with another society in a more normal kind of way - because the new capital would be available to absorb whatever losses the society incurs on its loans.

I am told that right now it is touch and go which of the two solutions will be adopted.

Either way, it is clear that savers at West Brom will not lose a penny - and that it should be business-as-usual for the society's mortgage borrowers.

West Brom has around 350,000 customers, 46 branches, 850 staff and total assets of just under £10bn.

It has run into difficulties because of actual and potential losses on its substantial portfolios of commercial-property loans and buy-to-let mortgages.

West Brom is also more dependent than some societies on wholesale funding, which has become harder to obtain. Just over 30% of its funds come from wholesale sources, as opposed to ordinary retail savers.

The society has lent £1.5bn to commercial property companies and projects, at a time when the property industry is suffering its worst recession for decades.

It also has made £3.1bn of buy-to-let mortgages: many analysts predict that arrears on buy-to-let loans are set to escalate.

West Brom's stock of prime owner-occupied mortgages is just £2.6bn.

The building society sector is going through something of a reconstruction.

The very biggest societies, Nationwide and Britannia, have coped well with the difficult credit-crunch conditions of the past 22 months.

And the very smallest societies, which did not diversify into commercial property and did not raise funds on wholesale markets, have also remained pretty robust.

But the FSA, the Bank of England and the Treasury fear that many of the medium-size societies are perhaps a bit too small to thrive in an economy where access to funding has become more difficult.

So there are likely to be further building society mergers in the months ahead.

That said, West Brom is the only society which is in need of fairly urgent repair.

UPDATE, 15:33: If West Brom is rescued by what would in effect be swapping debt for equity, the Treasury would probably subscribe for some of this newfangled Tier 1 capital too.

So there would be a bit of a first: taxpayers would have a stake in a building society (we'd own the equivalent of preference shares, or - for the delectation of the wonks among you - some kind of reconstructed permanent interest bearing shares, the legendary PIBS).

UPDATE, 16:38: The Treasury won't on this occasion subscribe capital to the rescue. Taxpayers won't be taking a stake in West Brom.

So the choice for West Brom's institutional creditors is to convert some of their debt into quasi-equity or see the society broken up and put into the Bank of England's Special Resolution Regime.

Where will the savers end up? Well in the industry the neighbouring Coventry Building Society is tipped as the new home for West Brom's savers.

Bossing bosses' pay

Robert Peston | 08:27 UK time, Thursday, 11 June 2009


Is it the best job in the world or the worst job in the world?

Kenneth Feinberg has certainly been given an odd job, as the Obama administration's "Special Master for Compensation".

This particular sensei has the intriguing task of adjudicating on whether senior executives at companies bailed out by the US government are being paid too much.

He'll be a de facto Judge Dredd over the material rewards for the bosses of some of the world's biggest and best-known companies - that have been propped up by American taxpayers - including General Motors, Citigroup, AIG and Bank of America.

If he rules that they're being paid too much, there's no right of appeal: he is the law!

Many of you might well feel that this would be the best possible fun, and that you're unsurprised that he doesn't feel the need to be paid for his own pains.

But I'm sure he won't be capricious or mischievous - and won't be motivated by any unworthy desire to humble erstwhile masters of the universe.

In fact, the US Treasury Department says he'll make his rulings on the basis of whether risk is being properly rewarded, whether the relevant company is paying the competitive rate, and whether the structure of remuneration is likely to increase the value of the relevant business over the long term.

All good sound stuff. But, my goodness, those running Citi, GM and the rest will hate the idea that they've lost what they see as their fundamental right to set their own pay.

Some might point out that Special Master Feinberg's appointment provides a bit of cover for the president's mildly embarrassing decision to drop his previous insistence that there should be a $500,000 cap on the compensation of those running firms that are in receipt of bailout funds.

Apparently, it was too messy to insist on this cap at a time when Congress has slightly different ideas on how to limit bonuses and pay excesses.

Also, whisper it gently, it seems that the world's most powerful man thinks that the US has something to learn from the way we do pay at big companies here in the UK.

The White House is to promote legislation that would give votes to shareholders on corporate remuneration practices and increase the independence of board committees that set executive pay.

This is - in broad terms - the British remuneration system for listed businesses.

Many would say that how we do it here ain't exactly perfect. Quite a few British bankers were handsomely rewarded for breaking their respective banks, for example.

Which probably only goes to show how profoundly sub-optimal the US remuneration system has been.

Osborne and a corporate tax revolution

Robert Peston | 09:41 UK time, Wednesday, 10 June 2009


George Osborne has said it twice now in major speeches, so I think the City has to take the threat seriously: a Conservative government is likely to make it much more expensive for companies to finance their activities by borrowing vast amounts rather than through equity funding.

George OsborneIn his address yesterday to the Association of British Insurers, the shadow chancellor said he wanted companies to reduce their "reliance on debt and leverage to increase returns" - and that he would do this by "reducing the bias in our corporate tax system against equity and towards debt financing" (for an acute and amusing insight into the rest of what he said, see Stephanie Flanders' note of yesterday).

Plainly one route would be to provide additional forms of relief for equity investment or to abolish stamp duty on share trading (which Osborne has in fact long favoured).

But tax revenues are bound to remain tight for some time to come, so it is difficult to see Osborne as a new chancellor (should that be his fate) choosing to reduce revenues for the Exchequer - especially since he would be seen to be rewarding capitalists, while almost certainly squeezing public services at the same time.

Much more likely, as he said in a little-noticed speech in March, is that he would reduce the amount of interest payments that companies can claim as an allowable cost to reduce their tax bills.

Here's what he said in the spring: "the UK is widely regarded as having the most generous tax treatment of debt interest of any major economy", so it was "time to look again at the generosity of interest deductibility in our corporate tax system".

He acknowledged this wouldn't be easy, in a technical sense. And there would have to be serious and diligent consultation on the detail.

But here's a striking insight into his instincts: "one of the most damaging impacts of the credit boom" he said "was that real venture capital in exciting new businesses was squeezed out by highly leveraged private equity".

In other words, Osborne - unlike either Alistair Darling or Gordon Brown - has signalled strong distaste for the private-equity boom of 2005-7, when many of our biggest companies were taken private in deals that saw them loaded up with debt (if you go back to the archives of this blog for the first half of 2007, you'll find a good deal about all this).

Right now, many private equity firms are in a spot of bother: some of the over-borrowed companies they own are floundering under the weight of their debts; as credit bubble has turned to crunch, they're not finding it easy to finance new deals.

If private-equity firms expected life to be any easier for them under a Tory government, well Osborne has made it clear they can expect no favours from him. His mooted tax reforms would undermine their business model, which relies to a great extent on the tax-deductibility of interest on the borrowings they take out to buy businesses.

That said it would not be "ouch" for the entire private sector. Which is pretty fortunate, since demand for goods and services may remain fairly fragile after the next election.

Osborne has an aspiration to reduce the headline rate of corporation tax to a significant extent - which is a laughable ambition given the frightening weakness of the public sector's balance sheet.

But if he were to reduce the tax breaks on corporate debt, just possibly slashing corporation tax would be more than the idle daydream of a wannabe Tory chancellor.

Executive rewards, for what?

Robert Peston | 08:50 UK time, Tuesday, 9 June 2009


For the global collective of superstar corporate executives, Jeroen van der Veer has just uttered the worst possible heresy.

Jeroen van der veerThe chief executive of Shell has said - according to a report in today's Financial Times - that the way he performed for his colossal oil company was neither improved or worsened by the substantial sums of money he is paid.

Here's the intriguing quote: "you have to realise: if I had been paid 50% more, I would not have done it better. If I had been paid 50% less, then I would not have done it worse".


It rather begs the question why it made sense for Shell's remuneration committee to put in place all sorts of reward schemes whose effect was to increase his total compensation last year by more than 50%, from €6.5m to €10.3m (or, in Shell's own translation, form £4.5m to £8.2m).

And, by the way, Mr van der Veer isn't particularly highly paid for a boss of a big British or big multinational company.

Now he's about to retire from Shell, so some might note that he doesn't have a great deal to lose from speaking as he finds.

Also he is presumably a bit shaken by the humiliation recently suffered by Shell, when its shareholders reacted with fury after learning that senior executives - including Mr van der Veer - had received substantial rewards under an incentive scheme even though Shell had missed the relevant target.

In a non-binding vote, a majority of investors manifested their displeasure by voting against Shell's remuneration practices (and see my note, "Executive gravy train stalls").

As it happens, Mr van der Veer hasn't returned the £1.2m that most shareholders feel he didn't properly earn. And some of them may be a touch bemused that he appears now to have conceded he didn't actually need several million other pounds that he received.

But he has shone a light in the right place.

As I recently pointed out (see "Bosses' pay and WPP"), the average remuneration of FTSE 100 chief executives has risen 295% over the past decade, compared with a 44% rise in the typical pay of a British employee.

It is counter-intuitive that the productivity of those at the top has risen so much faster than the productivity of everyone else.

And if you needed evidence, the average value of FTSE 100 companies - which is supposed to capture the effects of management genius over the longer term - fell 23% over those 10 years.

In other words, the owners of FTSE 100 companies - that's millions of us through our pension funds and savings schemes - have not been paying for performance.

We've been rewarding these chaps (and they are mostly chaps) for value destruction on a colossal scale.

Doubtless Shell's remuneration committee would insist that Mr van der Veer and his colleagues have to be paid these sums, so that Shell and other businesses can attract the best talent on the putatively international jobs market.

But perhaps it's time for remuneration committees to question whether that jobs market provides relevant benchmarks.

Mr van der Veer implies that the international market for executive talent is ludicrously irrational and inefficient, since by his own admission it puts a price on him that is considerably more than is necessary to get the best out of him.

UPDATE, 11:09:

George Osborne has fired a shot across the bows of the big banks about how they reward their top executives.

In a speech to the Association of British Insurers this morning, the shadow chancellor said:

"Some banks are now making big profits again from higher margins, underpinned by taxpayer guarantees. It would be a huge mistake if they pay out huge bonuses this year-end on the back of these government-supported profits.
"The City should remember that the inter-bank guarantees, the liquidity operations, the insurance schemes and the large equity stakes exist to protect the wider economy.
"The banks should be using their profits to rebuild their balance sheets, not to hand out huge bonuses while the rest of the economy picks up the pieces for the follies of finance."

Note that this is a warning to all the big banks and not just Royal Bank of Scotland, Lloyds and Northern Rock, or those banks in which taxpayers have a big stake.

Osborne is pointing out that all our substantial banks have been kept alive by unprecedented financial support from taxpayers in the form of loans and guarantees.

And he is insisting that none of them should pay big bonuses until they have weaned themselves off their dependence on taxpayers in this broad sense.

This may infuriate those who run our biggest banks, because there's evidence from Wall Street that the big bonus culture is waking fairly rapidly from its short slumber over there.

Sugar and Hornby: why they're hired

Robert Peston | 18:45 UK time, Sunday, 7 June 2009


It's a tale of two appointments - and of two rather different controversies.

Gordon Brown's "you're hired" to Sir Alan Sugar has elicited - as the most polite reaction - wry smiles and chortles from the business leaders I've asked about it.

Of course, they must all be bloomin' snobs and stinkin' elitists.

But I think if Sir Alan were judging the vague statements from the government about what he'll actually do as official "Enterprise Champion", I suspect he would launch one of his characteristics tirades against a business plan that seems a bit lacking in detail and firm commitments.

But he apparently thinks we should be a bit more tolerant of G Brown than he is of the contestants on his show.

The other appointment - which is pretty certain but not yet signed off - is that of Andy Hornby as the new chief executive of Alliance Boots.

The owners of the business, Stefano Pessina and the private equity firm, KKR, are extremely keen to have him - even though he's what you might describe as a brave choice. Pessina has wanted him for weeks.

As the erstwhile chief executive of HBOS who was at the helm when it avoided full nationalisation only by being swallowed up by Lloyds, well his reputation isn't quite what it was.

Now it's fair to say that the £11bn of losses HBOS announced for 2008 weren't all his fault. Some of the strategic errors that led to the loss were the legacy of his predecessor, Sir James Crosby.

But he's not blameless.

The counter-argument is that until he became HBOS's chief executive, he had an outstanding track record as retailer (as evidenced by Boots's attempt to poach him from HBOS to be CEO as long ago as 2003, when he was the most golden of the UK's young execs).

Apart from being brainy, Hornby is likeable and self-effacing.

There's just that slight problem of having broken quite a substantial bank.

He's almost certainly unemployable at a substantial publicly listed company: the big investment institutions wouldn't have him in a business they control (or so leading headhunters and brokers tell me).

But Alliance Boots is a private business and can do what it likes.

Although given that it'll want to sell the company back to the stock market in three or four years, Hornby will have to go on something of a charm offensive over the coming years - if that is he has the stomach for taking a job that will see him back in the spotlight and will not elicit the kindest of commentary from much of the media.

We get £2.3bn back from Lloyds

Robert Peston | 16:24 UK time, Friday, 5 June 2009


Far be it from me to spoil this government's quite astonishingly consistent run of bad news, but there is something mildly positive to say about taxpayers' massive investment in those bashed up banks.

On Monday, and barring an unexpected and improbable disaster, the Exchequer should see approximately £2.3bn returned of the capital it invested in Lloyds Banking Group last autumn.

Or to put it another way, we as taxpayers will get £2.3bn back. Hooray.

Now I know £2.3bn is peanuts in the context of the eyewatering £175bn the Treasury expects to borrow this year (and many economists believe the deterioration in the public finances will be even worse).

But as Tesco might put it, every billion helps.

When this repayment happens, the UK government will be the first government in the world to retrieve some of the cash that's been invested in banks to rescue them from collapse.

It's another sign that - as far as the banking system is concerned - we seem to have passed the moment of most extreme stress.

Here's why I can talk about the Lloyds prepayment as a racing certainty.

Lloyds has been raising £4bn from all its shareholders by selling them new shares, in order to redeem the £4bn of its preference shares held by the Treasury (and managed on the Treasury's behalf by UK Financial Investments).

However, because the Treasury owns 43.38% of Lloyds' ordinary shares, it will buy its pro-rata allocation of the new shares, at a cost of £1.7bn.

Also the Treasury promised that it would buy the remaining £2.3bn of new shares if other shareholders were to spurn the offer.

That said, there's no risk of it having to honour the promise. Other investors are certain to buy these new shares.

How do I know that? Well the new shares are priced at 38.43p, or 43% below the 67.8p market price of Lloyds' existing shares. So shareholders would only choose not to buy them if they were absolutely determined not to make money (I know many of our big investment institutions seem awfully talented at losing money, but it's not actually what they set out to do).

This is the maths: Lloyds is paying taxpayers £4bn in total, but £1.7bn of that is actually being provided by taxpayers (I know this is confusing, but stick with me); so the net repayment to taxpayers will be £2.3bn.

Jolly encouraging.

But it would be premature to crack open the bubbly, in that we are sitting on a stonking loss on our stake in Lloyds' ordinary shares.

The effective purchase price for taxpayers' 43% of Lloyds is 115p per share (or so), compared with a market price that is 41% lower.

So although it's splendid that we as taxpayers are reclaiming £2.3bn, we are still sitting on a £3.5bn loss on our holding of the ordinary shares.

It's just as well then that the Treasury is in no hurry to sell this stake - because it could take years for Lloyds's share price to rise comfortably above what we paid.

UPDATE 17:43

Mea culpa. I should have mentioned in the piece that a few small US banks have already repaid the bailout funds they received from the US government. But none of the substantial US banks have yet succeeded in doing so, although Goldman Sachs, Morgan Stanley and JP Morgan are on course to do so.

It should also be said that Goldman, Morgan Stanley and JP Morgan are in rather better shape than Lloyds.

Spanking bank investors

Robert Peston | 09:39 UK time, Thursday, 4 June 2009


There's been a bit of fuss about a decision by the government to suspend interest payments on £325m of its liabilities - which to some looks like the state defaulting on its debts.

But don't panic.

This isn't the Treasury announcing that it can't afford to keep up the payments on its great mountain of new borrowing, which grows ever-larger as tax revenues dwindle and social security payments escalate.

This isn't a declaration that the state is bust.

No. What's happened is that Bradford & Bingley, the nationalised mortgage bank, has stopped paying interest on £275m of subordinated notes and £50m of perpetual subordinated bonds.

Bradford & Bingley logo

Which may sound dull and technical, but it matters quite a lot - partly because it's very much a first.

Up to now, the government has made sure that payments were kept up on all such bonds issued by banks that have been nationalised or in which it has a big stake.

For example, Northern Rock is still paying interest on its subordinated debt.

So why is Bradford & Bingley inflicting serious pain on investors in its subordinated bonds when Northern Rock is not?

Well, the reason is that Bradford & Bingley is being wound up whereas Northern Rock is being managed as a going concern.

However, that difference between B&B and the Rock is based on nothing more than the impotence of the Treasury at the time that the Rock was collapsing, in that it did not then have the legal powers to dismantle the Rock in a way that both protected depositors and allowed for an orderly liquidation of assets.

The Treasury acquired those powers in the legislation that nationalised the Rock - and then exploited them in the way it took control of B&B last September.

So the Rock lives on more-or-less as a matter of luck.

That said, it's not altogether clear that some great injustice is being meted out on B&B's bondholders. Arguably what's unfair is that equivalent pain hasn't been inflicted on holders of the subordinated bonds sold by the Rock, and even on holders of HBOS and Royal Bank of Scotland bonds too.

Here's why.

These bonds count as what's called Tier 2 capital - which means that under global banking rules negotiated painstakingly over the past 25 years, they were deemed to be risk capital, or part of the buffer for banks to protect them when they incur serious losses on loans and investments.

As someone who has been a banking journalist at various times since the early 1980s I can speak with weary authority about the many years of intellectual toil invested by an elite financial priesthood of central bankers and regulators in devising complex rules on the capital that banks should hold.

These are known as the Basel Rules. And since the late 1980s, they have been the foundations of how banks operate: they determined how much banks could lend relative to their capital resources.

Few can now doubt that they have been calamitously inadequate foundations, made of paper and feathers rather than stone and concrete. They have been a monumental failure - in that they didn't prevent the worst banking crisis the world has seen since just before the First World War. Worse, they may have contributed to that crisis.

One element of the Basel Rules that turned out to be utterly fatuous was the idea that subordinated debt is any kind of buffer or protection for banks. When the going got tough for banks after the summer of 2007 - and especially in the autumn of 2008 - that subordinated debt, that Tier 2 capital, even some of the supposedly better quality capital classed as Tier 1 - well, it all turned out to be irrelevant, no protection at all.

As banks crashed, all that mattered in respect of their ability to survive was how much "core" equity capital they had. Their viability was assessed by investors, markets, regulators, central bankers and finance ministers in the way that banks' viability has been assessed for almost 200 years, which is whether their traditional share capital and reserves were sufficient to absorb the losses.

In an instant, the many thousands of hours of theological debate that led to the Basel rules were more-or-less consigned to the dustbin of history.

More extraordinary still, banks that were to all intents and purposes bust decided that it was absolutely imperative to keep up the payments on the Tier 2 subordinated debt - and they were backed in this respect by governments and regulators.

In other words, banks did everything they could to bail out professional investors who had bought the subordinated debt. As the going got tough, banks simply abandoned the commonsense principle that providers of risk capital have to take the rough with the smooth.

Which is pretty rum.

If professional investors can't be punished for failing to prevent our banks from taking excessive risks, what chance is there that market discipline can ever succeed in maintaining banking stability?

Of course I can see why holders of B&B's bonds should be crying foul. Naturally they think it's appallingly unfair that they should be punished when providers of Tier 2 capital to the Rock, RBS and HBOS are sitting pretty.

But for the long term health of the global banking system, it might actually have been better if a few more holders of these bonds had been squeezed till their pips squeaked. Perhaps then they would have an incentive to keep a closer eye on the behaviour of those who run our banks, and might even prevent them taking the kind of mad and reckless risks that got us into this dreadful economic mess.

Bosses' pay and WPP

Robert Peston | 08:39 UK time, Tuesday, 2 June 2009


You don't need telling that the onset of the worst global recession since the 1930s has led to a sharp rise in bankruptcies among small businesses and to hundreds of thousands of job losses.

But 2008 wasn't especially painful for a typical chief executive of a FTSE 100 company, according to a new independent survey by Manifest, the "governance" service that advises big investors.

It calculates that the median total remuneration for a FTSE 100 chief executive rose 7% last year to £2.6m.

That's quite a fur coat to protect against the chill economic winds.

And it rather explodes the idea that the financial interests of the owners and managers of our big companies are closely and directly aligned: the value of FTSE 100 companies fell just under 30% in the same period.

Which is not to argue that most FTSE chief executives were personally responsible for the economic and stock-market meltdown: that particular honour was reserved for their chums in banking, financial engineering, regulation, central banking and government.

But most FTSE bosses profited handsomely - in the form of huge increases in their pay and bonuses - from the unsustainable economic bubble created by the irresponsible lending of reckless bankers.

Here's the thing.

The FTSE superstars weren't shouting loudly in the preceding few years that the increased profits being generated by their respective companies had little connection with their own brilliance but were the short-term manifestation of an overheated economy.

They weren't saying "don't reward me for profits that won't last".

So many shareholders would say that that their pay should have fallen to earth in 2008, when the laws of economic gravity reasserted themselves over the earnings of their respective businesses.

And what some will find particularly shocking is that the cash bonus paid to the typical CEO was unchanged at £514,000.

Why was any bonus paid last year?

If you say that it's because these executives hit their targets over a period of years and they were therefore contractually entitled to these payments - well, hundreds of thousands of employees did precisely what was expected of them over the same period and are now without jobs.

The burden of national sacrifice required to get us through this mess does not appear to have been evenly distributed.

Statistics can of course be misleading. So it's also worth looking at the average remuneration of FTSE chief executives as well as the median (for those who've been out of school for a bit, the median is the pay of the boss right in the middle of a league table of executives ranked according to size of pay packet, whereas the average is simply the sum of what they're paid divided by 100).

Average pay rose a bit less, by 2%, to a whisker under £4m. But it still rose.

As for the longer term trend, the average remuneration of FTSE 100 chief executives increased 295% over the past decade, compared with a rise of just 44% for employees. So the ratio of average CEO pay to employee pay has risen from 47 times to 128.

Which perhaps could be justified if shareholders had been enriched by FTSE 100 performance. But the FTSE 100 index stood at 5,896 on 31 December 1998 and it was 4,562 ten years later - a fall of 23%.

On this analysis, the typical FTSE 100 leader has been handsomely rewarded for impressive value destruction.

And what's striking is the number of companies putting in place new incentive schemes right now, when share prices and profits are at a cyclical low - which more-or-less guarantees that remuneration will be ratcheted up again in the years to come.

A conspicuous example is WPP's "third leadership equity acquisition plan".

This, as its name suggests, is the third scheme of its sort that provides potentially spectacular rewards to a smallish number of senior executives (24 last time) at Europe's biggest advertising group.

The scheme is built around the number "five": eligible executives invest up to five times their "annual target earnings" in WPP shares; the performance of the company against its leading competitors is then measured over five years; and the executives can receive a reward of up to five shares for every one they hold, with the maximum payout being made if the company performs better than 90% of its competitors.

Sir Martin SorrellSome have calculated that the reward for the chief executive and founder, Sir Martin Sorrell, could be around £60m, if all went well. But that calculation is made on the assumption that WPP's share price doesn't rise over the coming few years - which would be very odd, since presumably the worst advertising recession in living memory will end one of these days.

So Sir Martin's profit from this scheme could be a multiple of £60m.

And in this case, quantum is absolutely the point.

Sir Martin and his colleagues have done very well out of previous schemes. They've been rewarded as though they were risk-taking entrepreneurs who owned their business outright.

But they are not owner-managers. This business is controlled by external shareholders. Sir Martin and his colleagues are employed by big institutions who are stewards for the retirement savings of millions of people.

The question for these shareholders, who vote later today on whether to approve this super-generous share scheme, is whether Sir Martin and his team are really going to be demotivated if they don't have the opportunity to earn five times the return of other investors in the company.

At this dire stage of the economic cycle, where exactly would Sir Martin and his team pitch up to receive the job security and perks of a giant multinational and the rewards of a small entrepreneurial company?

Today's WPP vote will be a bit like taking an X-ray of the big investment institutions: will it show that they've had the operation and that they've had their spines re-implanted?

UPDATE, 16:41: A majority of shareholders this afternoon voted in favour of WPP's stunningly remunerative share scheme. So Sorrell and his top team will still have a motive to turn up for work.

Suggestions that shareholders are on a mission to impose a new puritanism in British boardrooms were a bit premature.

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