Out-Law News 3 min. read

Bonus cap plan could drive talented staff away from UK banks, say experts


Plans to put constraints on the levels of bonuses that can be awarded to bank staff would have huge implications for HR departments and could end up driving talented employees away from London-based institutions, legal experts have warned.

On Wednesday evening MEPs and EU Minister provisionally agreed a deal which would introduce a general cap on the amount of bonuses bank staff could earn at a level not exceeding their annual salaries (1:1 ratio). Bonuses worth up to double what staff are paid in their salaries could be awarded if authorised by bank shareholders (1:2 ratio).

The agreement has yet to be formally approved by EU member states and the European Parliament, but if it is backed the rules on bonus caps could take effect from as early as 1 January next year.

Employment law expert Christopher Mordue of Pinsent Masons, the law firm behind Out-Law.com, said that if the plan is progressed it would create a challenge for HR departments in how to deal with staff uncertainty over earnings.

"This news creates a huge HR issue for the banks," Mordue said. "The question 'how much will I be paid next year?' is pretty fundamental and the answer 'we’re working on it' is not going to cut much ice for long. There’s an urgent need to get to grips with what these rules mean – and crucially to identify any wriggle room – and then devise a new remuneration structure which works within a complex mesh of different regulatory restrictions and also sits favourably in the market."

"Those banks who manage this quickly, with effective communication processes with affected employees, will have a significant competitive advantage in recruiting and retaining talent. So managing those communications and dealing with uncertainty – especially if the final shape of this deal won’t be known until ministers approve it in May – is a business critical task," he said.

Incentives expert Judith Greaves of Pinsent Masons described the EU plans as "the perfect storm" for UK-listed banks, and warned of a talent drain to other financial centres around the world.

"It looks as though in 2014 UK banks could face both the first binding shareholder vote on policy for directors' pay and the need to seek explicit shareholder approval on raising the ratio of fixed to variable pay from 1:1 to 1:2, all against a background of EU rule changes affecting pay structures from 1 January and the uncertainty of a shareholders' vote that would normally not take place until the spring," Greaves said. "There will be even more complexity: for instance the new EU rules and the new UK changes affecting directors' pay will require different amounts to be recognised at different times for different purposes and against different limits in relation to the same element of remuneration."

"It sounds as though long-term incentives delivered in shares, or bonds structured to bolster capital in times of crisis, deferred over a long period, may be valued for the purposes of the fixed to variable ratio on a basis that reflects both the risk and the deferral. If so, long term incentive plan (LTIP) awards and deferred incentive plans will assume an even greater importance in banks' remuneration structures," she added.

"In the short term, these changes are likely to mean the UK banking sector is seriously hamstrung in the war for senior talent: financial institutions based outside the EU will be rubbing their hands. A top position in a financial institution may seem much less attractive than one in a different sector," Greaves said.

Those concerns were echoed by financial services expert Helen Farr of Pinsent Masons. She said the EU proposals would be "sending shock waves across the banking sector" and that institutions may have to confront potential breach of contract issues.

"For most bankers, the bonus element is a core element of their remuneration package," Farr said. "As a result, there is a possibility that certain bankers may threaten action for breach of contract when their employer introduces this change. Although this is a risk that banks will have to consider, given that this change is being introduced as a result of change in law and that most bankers do have a contractual right to participate in a discretionary bonus scheme which is likely to be subject to a variation clause, it should not be a risk that should concern those implementing the changes unnecessarily."

Christopher Mordue said that it may be too simplistic for banks hoping to keep hold of talented staff simply to pay those staff larger annual salaries.

"Commentators are already suggesting that the real result of this curb on bonuses will simply be higher salaries," the expert said. "While that may well prove true to some extent, it is likely that banks will need a more sophisticated response. The role of bonuses is to incentivise future performance and reward against actual results - a crude increase in basic pay doesn’t help to achieve those aims and simply creates a fixed cost for the bank and guaranteed earnings for the employee."

"Current bonus arrangements also leave room for awards to be clawed back in the event of regulatory breaches – that’s much harder to achieve in respect of salary that has already been paid. So banks will need to square that particular circle as well, ensuring that their remuneration structures not only incentivise the right behaviours but leave room for adjustments in cases of malpractice or misconduct," Mordue added.

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