The public perception is that the global economic crisis was caused, at least partly, by bankers receiving large bonuses motivating them to take high risks.  That this has been definitively refuted by several global authorities and independent committees who have studied the causes is neither here nor there (see, for example, HERE and HERE). Nevertheless, the European Banking Authority (EBA) has approved restrictions on banker bonuses via a mandatory shareholder vote, possibly along the lines of the binding UK vote now being finalised by regulatory authorities (for example, see HERE).  There is also some speculation that the regulation may, in time, be extended to the pay of EU non-bank executives.

Who is affected by the EU banker bonus controls?

As noted by us HERE, the new European controls on banker bonuses will initially apply to EU banks at parent company and subsidiary levels (including their employees based outside the EU) and to non-EU banks operating in the EU.  The bonus restrictions will apply to senior management, risk takers, staff in control functions and other employees with similar levels of remuneration.  The pay clampdown may even be extended to the wider financial sector, including Europe’s fund managers. 

Impact on banker bonuses

The key elements of the new banker bonus controls are that:

·         executives with either a total remuneration package in excess of €500,000, or with variable remuneration exceeding €75,000 and 75% of fixed salary will be captured

·         the basic bonus to salary ratio must be 1:1, so that annual bonuses do not exceed annual salaries

·         the 1:1 ratio can rise to 2:1 with requisite shareholder approval (the percentage is not yet specified, however we expect that it will be 50%)

·         a maximum of 25 per cent of the bonus can be calculated at a discounted rate. This mechanism will, in effect, raise the overall cap. The option will be available to banks and other institutions where employees have agreed to defer the payments for more than five years at the point where the cap is calculated. The intention is to encourage deferral of bonuses

·         the discount rate will be set by the EBA, taking into account factors (such as inflation and risk) that will affect the value of the bonus over time. Guidelines on this will be published next year.

 

Effective date for banker bonus controls

For most banks that pay out bonuses in the first quarter following the end of a performance year, the new controls will affect the bonuses awarded in 2015 in respect of the 2014 performance year. 

Consequences

One likely consequence of the restrictions on banker bonus payments is that bankers will re-locate from the EU to other financial centres.  The banks are also likely to increase base salaries, which will have the undesirable consequence of restricting their ability to claw back unjustified pay and to cut pay where necessary (for example, in an economic downturn).  There has been talk of using new classes of shares for employees with low initial values, which would keep the bonus within the 2:1 ratio, but with the potential for significant growth.  If so, an unintended outcome would be to increase risk taking.

While it is likely that the EU legislation will have the unintended consequences of fixed pay inflation and bankers leaving the EU for other financial countries, it will also increase the fixed cost base of banks, and make them less able to respond to economic downturns.

While there has been talk of extending regulation in the EU to reduce incentive pay into the non-bank sector, we probably should not be too surprised that populist sentiment may overall result in executive pay that is less aligned with shareholder and bondholder interests than it was before.

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