Employment derivatives: Difference between revisions

{{Drop|W|hen midway through}} midway through his annual rant about the meaningless of life as viewed through the lens of his income, Hunter Barkley had an epiphany. For sure, his own pay packet was a material, unhedged contingency in his life. The perpetual disappointment that it rained upon his sorry existence had, he knew, little to do with how good he was at it (work, or existence for that matter). He knew, too, that his experience was common to the great dreary sweep of humankind as myopically it crawled across the clanking gears of the global machine.  

But that was not the revelation. It was this: just as Barkley and the great collected horde of mortgaged servants were severally at the whim of wanton Gods — so too, necessarily, was an employer who stood the other side of the trade, only at far greater scale. Businesses — particularly ''boring'' businesses — were at the mercy of the fickle tides of hysteria that regularly flood the market.

A turgid employer of multitudes — a good-sized bank, for example — was in a constant war to prevent essentially pedestrian operations personnel from being lured by exciting but basically stupid enterprises chasing the latest techno-craze. Just stemming this outflow might inflate its total wage bill by ''billions'' of dollars.<ref>The maths was like so: assume 40,000 people at an average total compensation of about $300,000, with a ratio of discretionary to fixed of between 20% and 50%</ref> As the inflated expectations of the latest technology then predictably foundered the bank would find itself spoilt for choice in a buyers’ market, and its wage bill would collapse.

In any case this volatility bore little relation to the bank’s own performance, none at all to its employees’. It was a simple measure of background market euphoria. Barkley reasoned that different types of firm were “long” or “short” this babbling hysteria, which he labelled ''π'',<ref>From the Greek παράνοια, (''paranoia''). It was also pleasing that π conveys circularity, running on a hamster wheel and so on, all of which Barkley recognised to be fundamental properties of the employment relationship.</ref>  at different points in the hype cycle.  

At its onset, “trad-fi”, “bricks-and-mortar” firms were short, and delusional start-ups long, ''π''. As the lunacy levelled off, reality set in and employment relations [[Mean reversion|reverted to mean]], the ''π'' curve would flatten and then eventually invert. If one could only match off long and a short exposures, Barkley realised, firms on either side of the bid could hedge their exposure to π.   

In one of those cruel ironies to whose martial cadence our lives keep time, before he could figure out a way of monetising his idea, Barkley was laid off and, shortly afterwards, imprisoned for manipulating [[LIBOR]].

On release, he was obliged to find work wiping tables by night as he worked on his [[Fi-Fi]] novels and developed his derivative ideas.

==== The first [[employment rate swap]] ====

{{Drop|B|arkley’s fortunes would}} change following a chance encounter in an upscale cocktail bar in West London. As she neared her [[Schwarzschild radius of alcohol consumption|gin horizon]], HR manager Anita Dochter, was bellyaching to her old pal and erstwhile colleague [[Cass Mälstrom]], about the unstaunchable stream of defections from her firm, a sleepy mid-market broker headquartered in Peterborough.  

At the time the firm was haemorrhaging hundreds of compliance and onboarding staff each month to venture capital-funded dot-com start-ups. Mälstrom herself had been plucked from the firm’s client money compliance programme to be [[Co-head|Co-deputy CIO]] of legaltech darling [[lexrifyly]] not three months earlier. [[lexrifyly]] had no product to speak of, no business model, customers or plan but was flush with stupid amounts of cash, a great [[Microsoft PowerPoint|deck]] and an unshakable conviction in goosing its burn-rate by overpaying for bums it didn’t need on seats it didn’t yet have.

“But,” complained Dochter, “we actually ''need'' our people. They actually do productive things for us. You know: [[MIS]] reports. Operational [[deep dive]]s. [[Netting]] audits. But unless we pay ''your'' stupid rates for them, which we cannot afford to do —” at this point she fell off her stool briefly — “and give them free fruit, unlimited working from home and a soft play area — they won’t stay with us. But, ''you'',” she hissed, clambering back up and jabbing [[Cass Mälstrom|Mälstrom]] on the lapel, “right now, ''you'' don’t need ''any goddamn'' staff: you just need to show your investors you are clever, imaginative and on point doing fashionably insane things. That does not take actual staff. So stop taking ours.” 

As luck would have it, Barkley was attending their table that evening. As he presented them with the check and some after dinner mints Barkley cleared his throat and dropped a document on the table.

Dochter fell off her stool again.  

Mälstrom indicated the booklet. “What’s this?”  

“[[NDA]]. Call me.”

So was the first “[[employment rate swap]]” conceived. For an initial period of three years, Wickliffe would pay its entire operations wage bill, controlled for performance, to lexrifyly. In return, lexrifyly would pay its absurd, grossly inflated but as yet unallocated wage budget for an equivalent sized-team — there was no such team, of course: this was exactly the point — to Wickliffe Hampton.<ref>This was slightly complicated as it was denominated in [[crypto]] and needed to be converted back to Sterling.  </ref>  

This way, Wickliffe Hampton had the cash required to preemptively bid back restless staff, and lexrifyly could, in time-honoured fashion, guilelessly piddle its investors’ cash up a wall without troubling the operating resiliency of the banking sector, or for that matter, needing an [[Human resources|HR department]].   

If this seemed like a bad trade for lexrifyly, but in actuality it was not. Firstly, it didn’t care: what was money? Secondly, the economics would change markedly upon the onset of a more hawkish monetary policy, the dissipation of hysteria or any of the other things that could precipitate a tech winter, and the widescale redundancies and hiring freezes that was sure to follow it.  And ironically, at that point, a counterparty short ''π'' in an ERS would have sensible amount of cash coming in  it could use to hire some people.  

There remained a problem: it was easy enough to quantify a bank’s presumptive wage bill (once it was controlled for hysteria) as it was more or less static. But what about the ever-changing hypothetical wage bill of a startup? How to gauge that in real time? And could not a startup not game this very easily, by just pretending its actual preparedness to pay stupid money was lower that it really was?  

{{Drop|W|hat was needed}}, Barkley reasoned, was an observable, objective measure of startup insanity, ''π''. He had just the means for achieving it. Under the auspices of the British Human Capital Managers’ Association (BHCMA) a committee of fashionable startups would meet each afternoon in a WeWork in Shoreditch for an kombucha martini and to state publicly, in front of a live panel of venture capitalists, how much they would be prepared to pay an underperforming settlements and reconciliations specialist to join them and drive customer engagement.  

The BHCMA would trim the top and bottom estimates, average the remainder and compile and publish the trimmed arithmetic mean rate as the [[London Inter-Employer Basic Offered Rate]] ([[LIEBOR]]). LIEBOR quickly become the ''de facto''  measure of ''π'' and was soon factored into the “floating” leg of [[employment rate swap]]<nowiki/>s as standard.

The banks could even sell these derivatives directly to employees, saving the banks the bother of having to hedge themselves. By the same token employees could hedge away their intrinsic loyalty discount, and restricting their need to find new jobs to genuine changes in role or idiosyncratic hatred of their bosses. But there was no need to simply “benchmark” themselves periodically any more.

{{Drop|L|IEBOR was not}} the only component of an individual swap: each employee would also have a performance-related “credibility spread” over (or under) the prevailing [[LIEBOR]] rate. This was a competence assessment made by [[human capital]] analysts. Mispricing this could lead to staff defections, to it was routinely marked to market and adjusted by way of a 360° [[performance appraisal|credibility appraisal]] process.

For portfolio transactions (like the first ERS, which was departmental-wide) analysts would assign a  weighted average credibility spread. This could yield occasional anomalies. Though HR departments assiduously segmented staff according to an internal 5 point scoring metric (a “credibility rating”), and would force rank staff to a given curve there remained risks that exposure to employee “alpha” could be mispriced or too overly concentrated.

Interdepartmental secondments were beset by credibility rating and diversity arbitrage and [[cheapest to deliver]] scandals especially over quarter end.

Meantime, while periodic RIFs were greatly reduced they were not eradicated entirely, but now could be handled quantitatively without reference to individual performance or value — as that was baked into one’s credibility rating.  

This led to the curious phenomenon of staff with the ''highest'' credibility ratings — ergo those who were, “pound for pound”, most expensive — being the first to go.  This was of a piece with the theory that firms actively discouraged excellent employees, preferring those to meatheaded to do anything rash like using initiative.

Barkley also saw the opportunity to trade the instrument as an abstract benchmark, for which one did not need exposure to the employment market at all.  Thus was made possible by offsetting nature of ERS transactions. You needed to be neither long or short actual staff but could trade directionally on abstract [[π]].

This led to a proliferation of exotic ERS products, many with me practical utility and unintuitive consequences. So began the sad chronicle of employment rate swap mis-selling. In this dark episode banks would separately hedge out their employee’s π risk, to the employee herself<ref>Self-referencing employment derivatives are now not permitted in many jurisdictions, and attract penalty risk weighing in the UK.</ref>and then peremptorily lay the employee off, leaving her holding a twenty five year out of the money employment rate swap. And badly exposed should crypto go tits up.