On 20 June 2013, the European Council adopted new rules limiting bank bonuses to twice annual salary as part of its amendment to its CRD IV legislation (Capital Requirements Directive) on bank capital requirements designed to enshrine international Basel III rules into EU law.
The official press release summarised the new rules as follows:
Bonuses will be capped at a ratio of 1:1 fixed to variable remuneration, i.e. no greater than equal to fixed salary. This 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. The first bonuses to be affected will be those paid in 2015 in respect of performance in 2014.
For the purposes of applying this ratio, variable remuneration may include long-term deferred instruments that can be appropriately discounted. The EBA will prepare guidelines on the applicable discount factor, taking into account all relevant aspects, including inflation rate, risk and appropriate incentive structures. Moreover, long-term instruments have to be fully “claw-back-able” and “bail-in-able”. Member states may allow institutions to apply the discount rate to a maximum of 25% of total variable remuneration provided it is paid in instruments that are deferred for a period of at least five years.
These provisions will also apply to the staff of subsidiaries of European companies operating outside the European Economic Area and the European Free Trade Area.
The Commission will review and report on the impact of this provision, in close cooperation with the EBA, taking into account its impact on competitiveness and financial stability.
Could lower bonuses mean higher overall cost and greater risk?
Some, especially in the UK, where banker’s pay is much higher than in the rest of Europe, argue that lower bank bonuses could actually cause higher costs and more instability. As employers try to retain key people, they say, they will be forced to raise fixed salaries, meaning the bonus is no longer so highly geared to performance. As a fixed cost, this would also therefore imply a greater financial burden during economic or market downturns.
However, fixed salaries are also subject to review and shareholder approval (though in the US shareholders legally need only be consulted every three years) so the idea that any pay, fixed or variable, would continue year-on-year without review is at best disingenuous. It is merely an attempt to deflect the pressure from virtually all sectors of the public to address the issue of huge pay gaps between workers and the most highly-paid bankers.
Regardless of whether one accepts the justification of up to 500 times pay differential, the public revulsion of such payouts cannot continue to be ignored if banks wish to continue to operate as they do in what is still a free market.
The fact is, the bonus is a key element in remuneration as it allows banks to keep staff in bad times instead of laying them off. The danger in the current situation is that we risk the baby going out with the bath water as the excesses of the elite lead to excessive regulation which places Europe in a potentially uncompetitive situation.
Bank bonuses may be an easy target, but it should be within the capacity of the industry to create an acceptable solution before one is imposed on it.