Employment derivatives

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Employment derivatives
/ɪmˈplɔɪmənt dɪˈrɪvətɪvz/ (n.)
A financial instrument developed in the early part of this millennium by derivatives pioneer and perennial boiler of pots, Hunter Barkley.

Genesis

When midway through midway through his customary annual rant about the meaningless of his life and meagreness of his pay packet, it struck Barkley — an amateur fi-fi novelist and financial services naturalist — that just as the variable cost of his own employment was a material, unhedged contingency in his own life — Barkley believed himself, rightly, to be short a very ugly option to the Man — so too was everyone else’s in including, on the other side of the trade and at far greater scale, his employer’s.

A good-sized bank, he reasoned, would have an annual variance in employee compensation, without accounting for any changes in employment, in the billions of dollars.

This variable cost of employment had little to do with the bank’s own performance, let alone that of its employees, and a lot to with everyone else’s performance. The market. Hence human capital management staff are apt to talk about “benchmarking”, as if there is some indexed rate.

Perhaps there should be, reasoned Barkley.

A firm having a bad year while its competitors feasted had no option but to hike pay to stop flush rivals piratically raiding its meagre stocks of human capital. By the same token, a firm that was knocking the ball out of the park while its competitors floundered, did not need to pay its own staff outsized bonuses. Where were they going to go?

Legend has it, should she ever be asked for a raise, the Vampire Squid’s fearsome GC would theatrically throw open a draw stuffed with unsolicited resumes. “I am sure we’ll find someone to do your job if you’re too good for it.”

Now this only works when the industry is not in the grip of some mania or other. History tells us usually it is: dot-com startups, hedge funds, crypto and private equity have all skewed the market for unremarkable drones in recent times. This is why magic circle firms pay guileless trainees two hundred grand and then have to charge them out at £600 an hour. But I digress.

Expansion

In any case, the option is ugly, whether you are long or short, on either side. Even for a Vampire Squid. Usually, banks were structurally short a rising bid. If rapacious private equity firms or gormless crypto startups were swiping mid-ranking harness bulls from their operations department, banks had little choice but to follow the bid — for replacement hires. They thereby had “duration risk”: current staff would put up with a certain amount of stiff-arming, but there were limits: human capital management desk traders priced staff like fixed rate term debt with a three-month call. New staff would come in at the prevailing astral rates, so HCM hedging strategies were vital.

Enter Barkley’s invention: employment rate swaps promised to change that by tanking lateral movements — which were necessarily highly entropic in that they cost a lot in transaction friction, institutional leakage and so on and which could be avoided by just paying the employees more.

The first employment rate swap was between the mid-market broker Wickliffe Hampton and then start-up darling lexrifyly. WH swapped its discretionary pool for Lexrifyly’s — complicated cross-currency issues as it was denominated in crypto.

The banks could sell these derivatives directly to employees, saving the bother of having to hedge themselves.

Barkley also saw the opportunity to trade the instrument as an abstract benchmark, for which you need not be employed at all. So did banks, unfortunately, and so began the employment rate swap misselling scandal during which banks would separately hedge out their employee risk and then peremptorily terminate the staff member’s employment, leaving her holding a twenty five year out of the money employment rate swap.

The LIEBOR rate was not the only component of an individual swap: each employee would also have a credibility spread over or under the prevailing LIEBOR rate. This was a competence assessment made by human capital analysts if the staff. Mispricing this could lead to staff defections, to it was routinely marked to market and adjusted by way of a 360° credibility appraisal process.

It led to anomalies. HR departments would segment staff according to an internal 5 point scoring metric (a “credibility rating”), and would force rank staff to a curve, lest the banks exposure to employee “alpha” became too concentrated.

Interdepartmental secondments were beset by cheapest to deliver strategies and diversity arbitrage, particularly over quarter end.

Meantime while periodic RIFs were greatly reduced they were not avoided entirely, and now could be handled quantitatively without reference to performance or value as it was baked into the credibility rating. This led to the curious counterintuitive phenomenon that the staff with the highest credibility ratings — ergo the most, well, “pound for pound” expensive — were the first to go. This assisted also in the force ranking process.

“LIEBOR” submission process

They would be like interest rate swaps. A bunch of large employers would submit, daily, how much they would be prepared to pay to hire established categories of worker, to derive some kind of London Inter-Employer Bid-Offer Rate (can we call this LIEBOR?). Then the British Human Capital Managers Association would compile and publish a list of rates. Employers could swap out their fixed costs for a floating rate, thereby hedging employment costs. Employees could do the same, hedging against their intrinsic loyalty discount, and restricting employee moves to genuine changes in role, or idiosyncratic hatred of boss, rather than just the need to rebenchmark periodically.

See also

• Interest rate swap mis-selling scandal
• Credibility derivatives