28 February 2013

FT: Five essential questions on the bonus cap

1. How is the cap calculated and applied?

The bonus text runs to just half a side of A4. The core measure is a mandatory 1:1 ratio on fixed/variable pay is applied to all EU banks and subsidiaries around the world, as well as non-EU banks operating in Europe. This ratio can rise to 2:1 with a 66 per cent shareholder vote, with a quorum of more than 50 per cent. If turnout is lower, the majority must be 75 per cent. Up to a quarter of the variable pay can be paid in long term instruments (deferred for more than five years), which track the health of a bank and can be clawed back. The value is discounted at a rate set by the European Banking Authority, which must take account of inflation and risk. Some details still need to be fleshed out. But MEPs predicted that even with the discount the maximum ratio would be closer to 2:1 than 3:1.

2. Are there any loopholes?

There are always loopholes. The question is whether it would make a material difference and allow banks to operate relatively unscathed. The obvious one is just raising fixed pay, but it has obvious shortcomings. The incentives for long term pay within the cap will likely be aggressively used. But even with the most banker-friendly discount rate calculation the ratio will not move much above 3:1. Other points of vulnerability could be the definition of fixed pay: could some of that effectively be a bonus? How the rules apply outside the EU and to non-EU institutions will also be important in determining whether bankers can be shuffled around the world to avoid the restrictions. Finally there is talk of some banks taking legal action against the provisions, but there will surely be a public relations downside to that.

3. Will it pass? Is there any prospect of the bonus deal being unpicked?

The fundamental points of this deal are almost certain to survive. It is a provisional pact between Ireland, which is negotiating on behalf of EU member states, and the European parliament. It still must be approved by a majority of EU states and the full parliament. There will be a discussion at the meeting of finance ministers next week and in theory there could be a revolt. But that is highly unlikely. Most countries have secured their top priorities on other parts of this complex law, which sets capital rules for Europe’s banks. They want the deal done. There are, however, serious reservations about the transparency rules applied to banks. This is not a British issue — Luxembourg, Belgium and potentially France and Germany have concerns. If a coalition forms to revise those rules, the UK could sneak in some tweaks to the remuneration curbs as well. But they will be tweaks.

4. What does it mean for Britain?

There is a Dunkirk spirit to the UK’s diplomacy on financial services. On almost every big EU reform, they are left isolated or outgunned in the closing straight of the negotiation. Typically a few concessions are secured at the last moment and victory is declared. For this reason, London has never been outvoted on a financial services issue. This time may be different. George Osborne, the UK chancellor, is cornered on an issue that is politically toxic but of vital importance to parts of the City. There is little hope of him convincing the other ministers to back Britain on this and risk the wrath of voters and indeed the parliament, which will block the rest of the capital reform deal. Osborne will have to decide whether this is the moment to force other EU states to outvote him — a move that breaks a taboo that he might think is better left in place. Given the UK’s priority in this was always flexibility to raise capital levels on banks and implement Vickers, pushing it to the vote seems improbable. He will be fighting next week, but fighting for technical scraps.

5. What does it mean for the City?

This crackdown has been looming over the City since the summer. But the shock of it actually happening — without any major loopholes — should not be underestimated. Banks will be weighing up where to move and how to restructure to avoid an exodus of staff. The real horror will be the imposition of these rules on bankers in New York or Hong Kong, who could easily be poached by higher paying US banks. During the lobbying to stop these curbs, British officials and senior bankers warned MEPs that it could lead to a big EU bank decamping and moving to Asia or New York. The whispers were about Standard Chartered, which does most of its business outside the EU. But the likes of Barclays and Deutsche Bank will also be weighing up the pros and cons of basing their wholesale operations in Europe.

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