Stirrings of revolution on the Street

It turns out that some of the guys who run some of Canada's biggest securities firms are just like most Canadians: They also think investment bankers make too much money.

With bonus season upon us as the fiscal year end approaches, amid estimates that some people at Bay Street firms could be in line for as much as $10-million in pay after a hot year, some of the bank bosses are looking to cut back. Their view is that too much money goes out the door to employees and not enough goes into corporate coffers.

It's hard to believe that a firm such as Royal Bank of Canada's RBC Dominion Securities or Bank of Nova Scotia's Scotia Capital, considered among the most profitable because each has annual earnings of around $1-billion most years, are not very profitable when it comes to investment banking, as one senior executive put it. But compared with the core Canadian banking operations of the Big Six, investment banking activity such as advising on mergers and acquisitions and leading stock sales are relatively low margin - and pay is the big culprit.

For example, Royal Bank of Canada in the first nine months of this year kept 26.5 cents of every dollar made in its Canadian banking business. Scotiabank's number was similar. In pure investment banking, the margin is more like 15 cents on the dollar.

Yet bankers in the securities arms make millions while tellers have to fight to be paid overtime. The talk on the Street is that there will be a number of people paid more than $10-million at firms like RBC that have big dealings in fixed income, the hottest area of capital markets in the past year. That's leading to pressure from boards at some banks to exercise some restraint, lest the headlines be too cruel.

No heads of securities firms are talking about the heresy of cutting pay down to the levels of the schmoes in the banks' branches, but any talk of moderation is welcome, both to shareholders and to regulators.

One idea is to tie more pay in good years to what traders term "alpha" - the value that bankers add over and above what any Joe could be expected to generate in a given market. The idea is to cut back on the huge paycheques that come purely from being in the right place at the right time.

With huge spreads between interest rates in the past year, it didn't take a genius to make a lot of money trading bonds. The same is true when it comes to bankers who help companies sell debt and stock, because companies were clamouring to do the deals. It didn't take much selling.

Conversely, the push is also to pay less in bad years, to make compensation truly variable. Firms talk a good game on this front but often when the time comes, they cough up much more than is justified by the revenue an employee generates in order to ensure that the employee doesn't walk out the door.

If big firms such as Scotia Capital, BMO Nesbitt and RBC do try to cut pay, they'll be taking the risk that bankers will jump. But if all the banks move together voluntarily, or regulators push them to do it, a Street-wide pay cut could work.

Either way, bank management is courting a revolution on Bay Street.

If paycheques are out of proportion to the economic climate, shareholders are likely to revolt. If the paycheques aren't, it's the investment bankers who will revolt. Bank management will have to decide whose side they are on.