Bank Bonus Cap: Apparent Win for EU Regulators but More Unintended Consequences for Shareowners

Categories: Corporate Governance, EMEA, Executive Compensation, Standards, Ethics & Regulations (SER)
European Union

To the surprise of the banking industry, a consensus emerged in the negotiations between the European Parliament and the European Council on executive remuneration for banking institutions, mandating caps on bonuses in relation to fixed pay.

The latest revision to the Capital Requirements Directive (CRD IV) was published by the European Commission in July 2011 to implement Basel III capital adequacy requirements in the European Union. It also included some rules on remuneration, but left to banks the determination of the ratios between fixed and variable remuneration. During its discussion of the text, the European Parliament introduced a cap on bonuses on the basis of a 1:1 ratio of variable to fixed remuneration. Flexing its muscles, it stood firm and managed to get agreement from the Council, where the U.K. was outvoted and left isolated in its rejection of the cap.

The ECOFIN Council on 5 March voted to endorse the result of the negotiations carried out by the Irish Presidency with the European Parliament and agreed to the 1:1 fixed to variable pay cap, which would apply also to the staff of subsidiaries of European banks operating outside the European Union. The 1:1 ratio can be raised to a maximum of 2:1 if a quorum of shareholders representing 50% of shares participates in the vote, and a 66% majority of them supports the measure. If the quorum cannot be reached, the measure can also be approved if it is supported by 75% of shareholders present. Some technical details still need to be negotiated, but almost all the “hot” issues have been settled, so progress towards a final vote in Parliament and Council adoption should be swift.

Reflecting deep concern that some banks would relocate out of London to avoid EU rules, the U.K. has threatened to challenge the remuneration cap in court. When asked about this possibility, Commissioner Michel Barnier ironically wished them good luck.

In the meantime, resignation is setting in, and the banking industry is quickly working towards the implementation of new remuneration packages to present at the upcoming shareholder meetings. As the Financial Times reports, the race is on to get approval, but the new remuneration packages present serious challenges.

One of the possible ways to soften the blow to bankers’ pay might be the inclusion in variable remuneration of long-term deferred instruments which could be appropriately discounted (guidelines on the discount factor are to be developed by the European Banking Authority). However, in general the trend towards higher fixed remuneration (at the expense of variable pay) is sure to continue. This trend had already started after the first remuneration measures adopted in the EU in CRD III to decouple remuneration from excessive risk taking for short-term gains at the expense of long-term results and risk control. They required bonus payments over several years, linking them to the firm’s performance, and enabling claw-backs. Hopefully these measures will not be undermined further by the new bonus cap.

After two rounds of EU regulation on bank remuneration, what can we expect? Excessive remuneration for bankers will continue to make front-page news and upset public opinion, legislators will continue to be frustrated, short-termism and risky behavior will continue to be rewarded, and shareholders will continue to pick up the tab … unless of course they finally wake up and vote against “business as usual” remuneration packages at the next general meeting.


Photo credit: ©iStockphoto.com/richterfoto

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