What the bonus cap really means for Europe’s banks

Author: Gemma Varriale | Published: 25 Mar 2013
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Europe is set to adopt the toughest bonus regime in the world, after the UK last week failed to secure a compromise on proposals to cap bankers' bonuses. But what exactly do the rules mean, and will the regulation allow for any work-arounds?

The only concession to emerge from the March 20 announcement of the technical rules related to timing. Although the rules will be implemented on January 1 2014, they will not apply to bonuses paid in 2014 for 2013 performance.

The bonus cap forms part of Europe’s implementation of Basel III. It will ban banker bonuses that are more than twice fixed pay, and limit the maximum portion of variable pay that can be discounted to 25%.

“The delay is welcome but the rules themselves don’t appear to have changed,” said Linklaters employee incentives lawyer Alex Beidas. “Bankers had hoped the proportion of variable pay subject to a discount would increase from 25%.”

The proposals are a major concern for banks, especially for those operating outside Europe.

“Although banks had hoped to get a dispensation that their operations outside Europe wouldn’t be caught that hasn’t been accepted,” said Beidas. “All European banks with operations in the US are going to struggle to compete with US banks that will not have to implement this cap in the US.”

Within Europe, there is concern that the rules will drive the top talent to other financial centres. The cap poses the biggest threaten to those based in London, the bloc’s financial hub.

This is exacerbated by the fact that the European Union (EU) is now looking at extending the cap to other directives such as the Alternative Investment Fund Managers Directive (AIFMD) and Undertakings for Collective Investment in Transferable Securities (Ucits).

Robin Chater of the Federation of European Employers, an advisor to the European Commission (EC) for ten years, said there was a failure to understand the purpose of high level remuneration in financial institutions. “While it’s unpopular in the public view, it has one essential purpose,” he said. “It stops bankers being tempted to put their hand in the till.”

To Chater, the EU’s move to clampdown on bonuses is ultra vires – or beyond the powers granted to the EU by the Treaty of Lisbon. The Treaty, said Chater, is very specific.

“Various people are claiming that it’s really under the banking regulations that the bonus issue has been raised,” added Chater. “I’m afraid there’s no carte blanche in this respect, the Treaty has to be seen in its entirety: one part of the Treaty cannot be at odds with another, otherwise it would be a nonsense.”

However, the EC has been firm on its position that it’s not limiting the amount of pay but requiring that a ratio is set between fixed and variable pay.

Beidas said the EC seemed quite confident that it’s within the rules. “There’s no clear definition of pay so the point can be argued either way,” he said.

A work-around?

According to Chater, the solution was simple. “The obvious result, unless the legislation is written in a very careful way, would be to increase base salaries so you effectively have a bonus system in reverse,” he said.

This would be achieved by means of a conditional base salary set at a higher level paid provided the employee meets a set of targets.

“So the bonus cap achieves nothing really but it does stir things up a bit and makes people come out against the City even more,” Chater added.

Firms will have to be careful about how they structure arrangements, however.

Beidas told IFLR there were anti-avoidance provisions. The current wording in the draft legislation also has very specific definitions of fixed pay and variable pay. “Fixed pay is meant to be in respect of fulfilling the job description and variable pay is what employees get in respect of performance,” he said.

“It will be necessary to justify an increase in salary and if it’s made conditional then it might actually be considered to be variable pay,” added Beidas.

Like many, Beidas believed the cap is politically driven. “We’ve made significant progress over the last two years in the way banks pay their staff and it’s now much more about pay for performance and aligning staff with the long-term interests of the banks,” said Beidas. “The concern is that this cap is actually going to lead to a move back from that.”

On what steps banks should take in light of recent news, the Linklaters lawyer said they shouldn’t rush into changing remuneration policies. “At this stage we haven’t seen the final legislation or the guidance from the European Banking Authority yet,” she said.

Basel III is expected to take effect by January 2014.

See also:

Banking sector reform: a definitive guide to the latest developments http://www.iflr.com/Article/3107360/Banking-sector-reform-a-definitive-guide-to-the-latest-developments.html