Sunday 12 January 2014

Bankers and bonuses - the outlook for 2014



The cap
 
Europe now has the most stringent pay practices for financial institutions in the world.  Since 1 January 2014, UK banks have been subject to a rule meaning that bankers’ annual bonuses cannot be greater than their salary – or double their salary if approved by shareholders.  The first bonuses to be affected will be awarded in 2015 for work undertaken in 2014.

The cap represents a significant change to the remuneration structures of affected institutions and signifies the willingness of the EU to adopt an increasingly interventionist approach to remuneration in the financial sector.

Avoiding the cap

Now that the cap has been implemented, the focus of media attention has shifted to how banks plan to sidestep the cap. 

Curbs on remuneration in the banking sector are nothing new.  Nor is the fervent work going on behind the scenes at banks to structure remuneration packages in a way that balances adherence to the rules while minimising their impact.
 
Barclays

In October 2013, news broke that Barclays was already making plans to sidestep the cap.  According to Sky News, this would see Barclays splitting remuneration into three separate elements, rather than using the conventional structure comprising basic pay and annual bonuses.[1]  A non-pensionable sum determined by seniority and responsibilities would be paid monthly and would not count towards the basic pay from which bonus sums would be calculated.
 
RBS
 
Royal Bank of Scotland (‘RBS’) was the next bank to come under scrutiny and was forced to deny reports published in the Sunday Times last December that it was initiating a widespread increase of base salaries in order to sidestep the cap.  The level of interest in RBS’ plans is no surprise given that 81% of RBS’ shares are owned by the UK government following the bailout in 2008. The bank also previously faced a storm of criticism over the remuneration package of its former boss, Stephen Hester, who was at the banks’ helm as the Libor-rate fixing scandal unfolded.
 
HSBC

More recently, reports have been published alleging that HSBC, Europe’s biggest bank, is preparing to hand out multi-million pound share awards to 1,000 of its top staff in order to bypass the new rules.[2]  HSBC – more so than other banks – has made its stance on the bonus cap very clear. 

As HSBC announced its interim results in August 2013, chairman Douglas Flint stated that that cap could be ‘very damaging’ and make it difficult to maintain a competitive edge in the global market.[3] Indeed, within the financial sector, a key concern arising from the cap is the ability of banks to recruit and retain the best talent.  Over three quarters of bank staff earning over €1 million are based in the UK and concerns exist that the cap creates an ‘unequal playing field’[4] and an uncompetitive environment in which professionals will be drawn to work outside of the UK or Europe.

In light of this issue, in a question and answer paper form the HSBC annual general meeting last August, HSBC openly revealed that it was consulting on the issue of pay and has since toyed with the idea of increasing base salaries.[5]

As the new rules bite for work and performance in 2014, firms will invariably continue to reformulate their remuneration packages in ways that adhere to the rules but dramatically minimise their impact and undermine the purpose of their implementation. 
 
UK legal challenge
 
As banks continue to re-formulate their remuneration packages in earnest, the UK’s legal challenge against the cap will rumble on in the background.  

In September 2013, the UK Treasury launched a legal challenge against the cap by filing a claim at the European Court of Justice.  The brief announcement published by the Treasury on 25 September 2013[6] highlights the main areas of concern: (i) the cap will merely lead to an increase in fixed rate pay, (ii) the lack of proper consultation and impact assessment undertaken before the introduction of the cap and (iii) the unlawful delegation of policy-making powers to the European Banking Authority going beyond its remit of setting technical standards.

The Treasury’s case also challenges the lack of legal certainty surrounding the proposals, its wrongful application outside the EU and its potential contravention of data protection laws.
 
The outcome of the legal challenge will not come to fruition in the near future.  Such cases normally take between 18 months and 2 years to be heard.
 
Outlook
 
The government’s concern that the bonus cap will simply lead to an increase in base salaries for top earners seems realistic.  On top of that, firms will continue to reformulate their remuneration packages in novel but legal ways in order to adhere to the rules but significantly reduce their impact. 
 
The cap was introduced to address the effect of poorly designed remuneration structures on the management of risk and control of risk-taking by individuals at financial institutions.[7]  However, as firms continue to look for ways to avoid an exodus of key staff to locations such as Asia or the US, an increase in fixed salaries (which, unlike bonuses, cannot be clawed back if the institution gets into financial difficulties), together with the adoption of alternative pay schemes, seems likely. 

The legislation behind the bonus cap comes with a pointed message, but the rule itself appears to be something of a blunt instrument.
 


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