July 14, 2010
European Lawmakers Vote to Cap Bank Bonuses
– Subodh Mishra, ISS’s Governance Institute
European Union parliamentarians voted last week to approve new caps on bonuses paid to bankers that will take effect beginning in 2011. Advocates of the new EU-wide law say it will “transform the bonus culture and end incentives for excessive risk taking.” The rules are largely similar to pay restrictions promulgated by some national regulatory bodies, including the U.K. Financial Services Authority, and those voluntarily adopted by many of Europe’s largest banks in the wake of the global financial crisis. Consequently, the impact of the EU rules will likely be most pronounced at small to medium-sized financial services firms.
Under the new rules, upfront cash bonuses will be capped at 30 percent of the total bonus and at 20 percent for “particularly large” bonuses, EU officials said in a July 7 statement. Moreover, between 40 and 60 percent of any bonus must be deferred for at least three years and can be recovered if “investments do not perform as expected.” At least one-half of the total bonus would be paid as “contingent capital” (funds to be called upon first in case of bank difficulties) and shares, EU officials said. The new rules also stipulate that bonuses be capped as a proportion of salary. Each bank will have to establish limits on bonuses related to salaries, on the basis of EU-wide guidelines, “to help bring down the overall, disproportionate role played by bonuses in the financial sector.”
“Exceptional” pension payments must also be held back in instruments such as contingent capital that link their final value to the overall strength of the bank. This, EU officials said, will avoid situations that occurred in the past, in which some bankers retired with substantial pensions unaffected by the crisis their former employer was facing.