Antonio Horta-Osario, chief executive of Lloyds Banking Group, and Antony Jenkins, chief executive of Barclays, are to receive £1m each in shares in addition to their salaries. In this context, many are questioning if the so-called ‘bonus cap’ is having any impact on City bankers’ remuneration
The widely anticipated bonus cap, set out in the European Commission’s Capital Requirements Directive IV, came into effect on 1 January 2014. The CRD IV ‘cap’ works to restrict bonuses of staff to a maximum amount equal to their fixed remuneration.
Only if shareholder approval is obtained can the bonuses awarded to qualifying staff be increased to an amount equal to twice the level of fixed remuneration. It is important to remember that the so-called bonus cap does not set any maximum rate of pay for bankers and therefore it is not strictly speaking a cap at all. It is a mechanism for linking bankers’ guaranteed fixed pay to the size of their bonus payment.
Given that three-quarters of bankers in the EU earning over the threshold are located in the UK, it is not surprising that the introduction of the CRD IV cap caused political and public furore in 2013. Public opinion remains divided between those who welcome the restriction on the perceived excesses of bankers in the City, and those who see the cap as another blow to the status of the City as the global financial centre. Many City leaders have labelled the cap as “crude”. The concern is that talented financiers will relocate to Asia and the US.
The major political parties are also divided about whether a cap is appropriate or effective as a measure to prevent another financial crisis by reducing risk-taking behaviour. The government launched a legal challenge to the CRD IV bonus cap in December 2013 which is currently working its way through the UK courts.
One of the driving forces behind the introduction of the restriction is clear – it is an attempt to appease the (perhaps misconceived) public perception that highly paid bankers were the cause of the 2008 global financial crisis. Reducing the bonus culture will reduce further risk-taking behaviour.
This view is over- simplistic. The introduction of the bonus cap must be considered in light of the overarching objective of CRD IV – to strengthen the capital base of financial institutions.
Given that it is possible to ensure that bankers’ pay does not fall overall by simply increasing the element of fixed remuneration, surely the introduction of a ratio between fixed to variable pay, and the pressure to increase fixed pay, may weaken the capital base of certain financial institutions.
This concern is borne out by the evidence. The European Banking Authority has published research which estimates the bonus cap could increase fixed costs by more than €1bn (£827m) across Europe, as banks adjust pay to remain competitive compared to their overseas challengers. This increase in fixed costs must surely put pressure on certain institutions.
So what will be the true implications of the CRD IV cap to the City? Will it result in a seismic shift in how those in the financial sector are paid, or will it result in an exodus of bankers to more “friendly” jurisdictions where they can be better paid?
While there is no doubt that the introduction of the cap will put pressure on banks to increase the fixed element of the compensation packages awarded to its bankers, financial institutions will need to be satisfied that a substantial hike in salary is justifiable when there is no longer a link to the banker’s performance.
For this reason, rather than adjusting the fixed element of bankers’ salaries, many banks are instead focusing on alternative variable options which fall outside the CRD IV cap. As Stuart Gulliver’s package shows, one option is to introduce ‘allowances’, as opposed to awarding a substantial bonus. Such allowances permit banks to retain an element of discretion and flexibility, as the allowances can be varied without reference to the restrictions in the CRD IV.
Banks are also looking at awarding contingent convertible (‘coco’) bonds as an alternative to bonuses. Coco bonds, which convert into equity when a bank’s capital ratio falls below a pre-agreed trigger, are a more palatable form of discretionary compensation because the employee’s interests will be more aligned to those of the bank’s shareholders.
Many organisations, including Lloyds Banking Group, have announced they will be asking their shareholders to vote on increasing the ratio between fixed and variable pay to enable them to pay bonuses at twice the level of fixed pay.
Concerns that the CRD IV cap will have little practical impact on curbing pay in the City is not restricted to London. A survey commissioned by the German financial regulator BaFin showed that, despite the implementation of the cap, many German domestic banks were continuing to implement their old pay practices.
If banks do find ways to ensure the overall pay of their staff remains the same, any alternative compensation must comply with the various regulatory limitations on remuneration – many of which were also introduced by CRD IV.
By way of example, the Remuneration Code requires financial institutions to defer elements of discretionary compensation and to ‘claw back’ deferred bonuses from employees subsequently found to have been involved in misconduct. As a result of these additional restrictions, pay in the financial services sector is clearly under greater pressure and scrutiny than in other jurisdictions outside Europe.
The introduction of the CRD IV ‘cap’, and the implementation of highly complex rules on capital adequacy and liquidity, means financial institutions in the City face significant operational and financial challenges over the coming years.
The increased plethora of burdensome regulation and restrictions across Europe has created an unequal playing field for financial institutions in the City competing against firms based in Asia and America.
Whether this factor alone will result in bankers’ institutions making a mass exodus from the City to ‘friendlier’ jurisdictions is a risk many organisations do not want to take.
Financial institutions therefore find themselves in a perfect storm. They are competing to retain staff in a global marketplace where the rules are not the same.
Helen Farr and Peter Wright are partners at City law firm Fox Williams
Key points
* The so-called bonus cap does not set any maximum rate of pay for bankers and is not strictly a cap at all.
* A survey by the German regulator BaFin showed that, despite the cap, many German banks were still implementing their old pay practices.
* Banks are also looking at awarding contingent convertible (‘coco’) bonds as an alternative to bonsues.
