The Advisors' Blog

– Subodh Mishra, ISS Governance Exchange

European Union lawmakers and regulators provisionally agreed late on Wednesday to controversial limits on bankers’ bonuses that would cap awards at one year’s salary or double that amount if approved by shareholders. The agreement, still to be approved by member states and the full European Parliament, has served to deepen a schism between Brussels and London over regulation of pay across Europe’s financial services industry.

Under the plan, bonuses would be capped at one times salary, unless approval by 65 percent of shareholders owning one-half the company’s outstanding stock is secured (or a 75 percent supermajority if a one-half quorum is not reached). In such cases, the maximum bonus could be two times salary, though bankers would have to defer one-quarter of any awards above the one times multiple for at least five years.

Proponents of the proposed rules argue they will “encourage bankers to take a long-term view” and will curb excessive risk-taking. If approved, the caps would be the most rigorous, globally, and would apply to all staff of European banks whether based inside or outside the EU, while staff of foreign-domiciled banks based in the EU would also be subject to the caps. “We have achieved the most comprehensive bank regulation package in the EU,” said Othmar Karas, an Austrian member of the European Parliament who sits on its Committee on Economic and Monetary Affairs, in a statement announcing the proposed measures. “Banks will be stabilized and more resistant to crises.”

Rules in place for Europe’s financial services industry since late 2010 have limited the amount of bonuses paid in cash to under one-third of the full award, and have required the deferral of some portion of total reward for up to five years. The proposed rules also include new provisions to raise the threshold of “high-quality,” Tier-1 capital banks must maintain to 8 percent effective Jan. 1, 2014. New disclosure rules will also force banks to report to the European Commission and, beginning in 2015, the broader public, details including profits made, taxes paid, country by country subsidies received, turnover, and the number of employees.

U.K. Dissent
British politicians, business groups, and bankers are voicing deep consternation over the EU proposal, with some suggesting shareholders will suffer, arguing banks’ ability to align pay and performance will be weakened. London, Europe’s financial center and home to many of world’s largest banks, stands to lose considerably under the provisional deal. An analysis of bonuses paid in 2012 for the 2011 fiscal year by the London-based Centre for Economics and Business Research found that of 4.2 billion pounds ($6.4 billion) in bonuses paid to banking staff in London, more than half the amount–2.5 billion pounds ($3.8 billion)–went to the U.K. Treasury in taxes. Moreover, roughly 27 billion pounds ($41 billion) of bonuses were spent over the past decade on real estate in London, according to data compiled for Reuters by property firm Savills.

British officials have for years fought to maintain leeway over bankers’ remuneration in a bid to preserve London as a financial center and prevent the flight of top-earners and their firms to other jurisdictions. This week’s proposal is the latest salvo in a row between London and Brussels over regulations with the potential to harm Britain’s economic interests, though U.K. politicians appear more critical of this week’s agreement compared with past measures.

“This is possibly the most deluded measure to come from Europe since Diocletian tried to fix the price of groceries across the Roman Empire,” London Mayor Boris Johnson said in a Feb. 28 statement. “Brussels cannot control the global market for banking talent. Brussels cannot set pay for bankers around the world.” Johnson, like many of those in the private sector, suggested the move to curb bonuses will backfire on Brussels by retarding EU capital markets’ growth prospects. “The most this measure can hope to achieve is a boost for Zurich and Singapore and New York at the expense of a struggling EU,” he said.

Meanwhile, the Confederation of British Industry blasted the proposal for its potential to damage jobs and growth, while also flying “in the face of efforts to align pay and performance.” The proposed rules “would significantly constrain shareholders’ ability to hold companies to account by voting on pay policy and implementation, and to select board members,” warned Matthew Fell, the confederation’s director for competitive markets, in a Feb. 28 statement. Caps “will also make it harder for companies to respond to a downturn by adjusting pay, which undermines financial stability.”

One of a few options available to opponents to block the proposal may be through the courts. Under the 2007 Lisbon Treaty, provisions regarding the EU’s ability to modify or give effect to social policy are limited and cannot cover remuneration, the BBC reported. Article 153, Section 5, states that the European Parliament and the Council’s ability to modify policy in this area “shall not apply to pay.”

In comments to the BBC, Robin Chater, secretary-general of the London-based Federation of European Employers, argued that “what EU negotiators have failed to appreciate is that such an action is beyond the powers vested in the European Union under the EU Treaty.”

Next Steps, Eyes on Switzerland
In the absence of judicial rescission, approval of the rules is virtually guaranteed, observers suggest. The provisional agreement must be approved by a majority of the EU’s 27 member states and then a majority of the European Parliament. Britain has no veto, and few continental European parliamentarians have come out against the draft regulations. Parliament is expected to vote on the proposal come middle April.
More immediately, Swiss voters passed a referendum yesterday on executive remuneration that will have implications for banking and other sectors’ pay across Europe. The referendum, spearheaded by politician Thomas Minder, includes a mandate for binding say-on-pay vote for both directors and executives and bans all forms of severance payments as well as “golden handshakes.” In addition, Minder’s plan requires directors to be elected annually and force pension funds to vote shares held and publicly disclose their votes.