‘The financial industry has the wrong incentive system.’

‘Conflicts of interest exist everywhere in the financial industry and they are essentially responsible for the financial crises of recent years,’ says Matthias van Randenborgh. However, there is a way to resolve this conflict. He leads by example with his company and his team.

‘Mr van Randenborgh, what is the central problem of the finance industry?’

Matthias van Randenborgh (MvR): ‘There is essentially a conflict of interest between the human capital of banks and asset management companies on the one hand – the people who work there – and the people who bear the risk of their activities on the other. In the case of banks, the latter are the shareholders and lenders, while for asset management companies they are the fund investors. Generally speaking, employees stand to benefit from taking disproportionately high risks in order to boost their potential bonus payments. If things go wrong, they do not partake in the negative consequences of their actions – this creates an enormous potential for moral hazard.’

‘Can you give us an example?’

MvR: ‘Take the financial crisis of 2008. At that time, banks were bundling and reselling mortgages. So they passed on the risk and charged a premium for generating business. Since they were no longer exposed to the risk but still profited from doing more business, it was only rational to carry on, no matter how poor the credit quality of the mortgage was. So what we have here is the wrong incentive system.’

‘... that parliaments are trying to get under control with increased regulation and controls.’

MvR: ‘Yes, but that cannot work. It is bound to fail, simply because it is effectively impossible for regulatory authorities to identify the true risks that someone has taken. In my view, the only way of solving this particular problem is by installing appropriate incentive schemes for the people managing the risks – no level of control can replace that. Incidentally, the moral hazard issue is particularly acute for asset classes with an asymmetric return profile – investments that generate a steady income for long periods, but which are interrupted by short episodes of severe losses. Short volatility concepts are a typical example. Here it is especially important to find a healthy level of risk. A systemic crisis was caused by failures in this area on at least two occasions: the insurance company AIG in 2008 and the LTCM hedge fund in 1998. Both had sold too much volatility, using credit default swaps in the case of AIG, and were grossly overleveraged. In both cases, the risk managers acted rationally, as they were not exposed to the losses, but had much to gain in normal markets – they were and still are strongly misaligned to the interests of the risk bearers.’

‘But you also sell volatility. What do you do at RP Crest to counteract this moral hazard?’

MvR: ‘First and foremost, the articles of association of RP Crest prohibit variable bonus payments. In addition, our salaries are very low compared to the financial industry. At the same time, however, we are required to pay out at least 80% of our annual profit, half to the employees and half to the shareholders. This is also set out in the articles of association.’

‘How does this solve the conflict between your fund investors and your employees?’

MvR: ‘We now come to one of the key points of our incentive scheme: all employees receive half their profit participation in the form of shares in the Partners Blend fund. The shares are subject to a minimum holding period of three years. But above all, the Partners Blend fund borrows money from the depositary bank – at least the amount that was paid into the fund. All proceeds are then invested in the RP Vega fund at exactly the same conditions as our clients. As a result of this leverage requirement, all RP Crest employees are themselves overproportionately exposed to the risks they manage which ensures that they apply proper risk management at all times. Of course, risk managers cannot stop things from going wrong, but it reduces the probability. And, more importantly, we forge a trust relationship with our investors as a result. Incidentally, as the majority shareholder, I also have to invest half my dividends and profits from share transactions in the Partners Blend fund – and I am the only person who has to keep them invested there until at least 2021. The idea is to ensure that everyone involved works towards the same objectives – our shareholders, the management team, our employees and our fund investors are all aligned.’

‘Don’t you find it difficult to recruit good employees?’

MvR: ‘No. The people who work at our company are satisfied and very committed. We receive a torrent of applications from strong candidates. The abolition of a bonus system that promises to deliver high bonuses regardless of business performance only ensures that if performance is reasonable, RP Crest will always be able to generate a profit that is not reduced disproportionately in advance by overpriced human capital. Things are very different at some investment banks, where in many cases more than 90% of ‘profits’ are handed over to employees as bonuses and only a meagre percentage is left over for the shareholders.’

‘Who decides how the profit share is to be divided among the staff?’

MvR: ‘Everyone in the team is indexed to each other, including me. The index values indicate how employees at Crest RP share in the profit pool in relative terms, and they are negotiated at the outset when someone joins the company. So there is nothing arbitrary about the distribution. Effectively, these index values are like phantom shares in RP Crest. I am convinced that profit-sharing creates more satisfaction than traditional bonus concepts. Ultimately they make the staff feel that they are involved in the development of the company and that they are being treated fairly.’

‘Is this also popular with your clients and the shareholders?’

MvR: ‘Yes. We have found a way to balance the interests of all the parties involved – shareholders, employees, managers and clients of RP Crest. This is reflected in the fact that our clients had already entrusted us with 300 million euros before the RP Vega fund had a three-year track record. We also have 12 private shareholders who provided venture capital to establish RP Crest and who hold 40% of the shares. It is worth noting that they have waived usual control rights. I believe that this degree of confidence in us proves that we are on the right track with our concept.’

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