- What is proposed?
The proposals are not a cap in the traditional sense because there is no fixed maximum amount that someone affected by the proposals will be entitled to earn. The proposed rules will require that the ratio of basic salary to bonus should not exceed 1:1. In other words, the value of the bonus should be no greater than the value of the banker’s basic salary.
However, the ratio can be raised to 1:2 with the express permission of the shareholders. The proposals stipulate with some care the majority necessary to pass any proposal to permit the higher level of remuneration. Where permission is obtained for the more generous entitlement, 25% of the bonus must be deferred for at least 5 years.
- Who has agreed these proposals?
European Parliament and Council negotiators. On 5 March 2013, George Osborne failed to persuade the EU’s Economic and Financial Affairs Council to re-open negotiations. It is thought that some limited further tweaking may be possible. The political agreement will require the agreement of the Member States and the European Parliament in April 2013. The UK will not be entitled to veto the proposals. If the political agreement is ratified, the UK will have to introduce implementing legislation by 1 January 2014.
- What is the significance of this announcement?
Commentators’ views have covered every part of the spectrum from talk of the cataclysmic destruction of London as a financial centre through to prosaic predictions that amending pay structures may well leave the sector relatively undisturbed. From an employment lawyer’s point of view the notion of direct control of UK workers’ maximum remuneration by Europe is, at first glance, an unsettling one. It is worth bearing in mind, however, that there has already been some limited domestic regulation of bonuses (see the FSA Remuneration Code).
- Is this an attack on the free market? Are other sectors subject to such limitations?
It depends to some extent on how free the market you are envisaging is. No-one believes that banks and their activities should be beyond the reach of regulators. The background to the package of reforms of which the bonus proposals form part is the widely perceived need (to quote the Bank for International Settlements) to “strengthen the regulation, supervision and risk management of the banking sector”.
The proposals include new requirements in respect of retained capital and transparency which are intended to move banking in Europe towards compliance with the regime developed by the Basel Committee on Banking Supervision and favoured by the G20, known as Basel III.
The controversial question is whether, as part of this package of regulation, there is any need for direct control of bankers’ pay. The European perspective is that the global economic crisis was at least in part caused by bank employees taking on too much risk. It is thought that the emphasis on remuneration by bonus within the sector incentivized irrational risk taking. Neither proposition is uncontroversial. The causes of the crisis are unlikely to be quite so simple and the suggestion that bonuses increase risk-taking seems to be based more on intuition than study.
- The UK government was the sole voice of dissent, is there any way in which the government could challenge or limit the effect of the decision?
It would be very surprising if the Government were not able to find a lawyer willing to advise them that the rules on bonuses may fall outside the competence of the European Union. A legal challenge to the validity of the rules cannot be ruled out. The length of the shrift that the European Court may give the challenge is a different question.
There has also been talk of the UK invoking the “Luxembourg Compromise”. It sounds like the title of the world’s dullest thriller but refers to a convention, the present scope of which is itself controversial, for there to be a veto where a proposal adversely affected a state’s “very important national interest”. It remains to be seen whether George Osborne would be prepared to risk playing that card. To play it and lose would likely have very considerable political consequences.
- What impact will this have on remuneration structures in the banking sector?
They will adapt to meet the new regime. The likelihood is that banks will seek shareholder approval for proposals to allow them to use the 1:2 ratio and fixed salaries will increase.
- What are the relevant merits/downsides of the various options:
- Higher basic salary
The principal merit of this approach is that it allows the same total remuneration to be implemented as had previously been in place without any requirement for shareholder approval. It should enable employers, therefore, to forestall the possibility of significant desertions. If one accepts the premise that variable pay encourages risk taking increasing the proportion of income that is fixed should cause employees to take fewer chances.
From the bank’s point of view, decoupling remuneration from results may have a number of disadvantages. When an employee’s performance falls off, the impact on income is lessened. When the bank’s overall performance is affected, cost cutting may require re-negotiation of terms and conditions rather than changing the often non-contractual terms of a bonus policy.
- Shareholder permission to exceed basic cap
This approach does not, by itself, allow replication of previously more generous remuneration arrangements (although it can be combined with increases to basic salary). Arguably, subsequent changes to bonus arrangements may require fresh shareholder approval complicating negotiations with high-value employees in circumstances where competitors based elsewhere may have greater immediate freedom of action.
- Supplementary (non-cash) benefits
Non-cash benefits may be unattractive to employees, can have complex taxation treatments and are difficult to operate with sufficient flexibility to allow total remuneration to be closely correlated with performance.
- Do you believe financial institutions will leave Europe?
Whether individual bankers want to leave will depend on whether the amount of money they are paid is the determinative factor for where they work. It has to be admitted that it would not be entirely surprising if the people with that worldview were disproportionately represented amongst the group of highest paid bank employees. A degree of international mobility is already commonplace in the banking industry. If institutions fear the loss of individuals or, worse still, of teams, they may be persuaded that replicating existing business in a less restrictive jurisdiction makes good commercial sense. In the meantime, they may wish to put lawyers specialising in team poaching cases on speed dial.