Out-Law News 3 min. read

Bank of England reiterates concerns over EU bonus cap plans


The Bank of England (BoE) has reiterated its concerns that EU rules that cap bankers' bonuses do not address risk-taking or "poor conduct" in the industry.

The bonus cap rules, set out in the EU's Capital Requirements Directive (CRD IV), have been in force since the start of 2015 and restrict senior staff bonuses to 100% of their fixed remuneration in any given year, or 200% with the agreement of shareholders.

In response to a broad European Consultation on the EU's regulatory framework for financial services, which also suggests other regulatory improvements, the Bank of England repeated concerns it has expressed previously. It has said the bonus cap is counter-productive, because it drives up fixed pay, reduces firms’ cyclical cost flexibility and perversely makes material risk takers less personally accountable for risk management failures, by reducing the proportion of their pay that can be lost as a result of any failure.

"The CRD IV bonus cap may have the unintended consequence of encouraging higher fixed pay through salary increases," the Bank of England said (8-page / 304KB PDF). "The Bank believes that variable remuneration should constitute a substantial portion of overall pay in order that a meaningful amount of pay can be deferred for a significant period of time. In the UK, variable pay of senior managers will need to be deferred for up to seven years."

"If financial risks or poor conduct materialise, deferred variable pay can be reduced through the application of ‘malus’ by firms. In this way incentives can be better aligned with the longer-term interests of society. The bonus cap is counter-productive as it reduces the scope for this re-alignment of incentive," it said.

Under CRD IV, the European Commission must report by 30 June this year on the impact of the Directive's rules on remuneration, including in relation to the bonus cap. As part of its review, the Commission must table proposed legislative changes to CRD IV, "if appropriate".

The Bank of England said that "inputs to this review by regulators and firms should provide scope for making the case for the negative impact of the cap on the achievement of the objectives of the CRD provisions" as well as with principles and standards established by the Financial Stability Board around compensation for risk-taking.

In December last year the European Banking Authority (EBA), ahead of the Commission's CRD IV review, published its final opinion on the application of principles of proportionality to the remuneration rules under the Directive. In its paper, the EBA said national regulators should be allowed to exempt smaller institutions from some aspects of the remuneration rules in CRD IV. However, the bonus cap rules would, for the first time, apply to investment firms within the scope of the proportionality principles, from 1 January 2017, under its plans.

At present, smaller, less risky and less complex firms of all kinds can disapply some remuneration rules. The investment firms have more scope than the banks in those categories to disapply the bonus cap, however. Guidance from the Prudential Regulation Authority, which is part of the BoE, states that investment firms can disapply the bonus cap, but does not state that banks can do so, although this has been permitted at some smaller UK banks.

The EBA's final guidelines on sound remuneration policies will now come into force one year later than planned, on 1 January 2017, to give firms sufficient time to make the necessary changes to their remuneration policies, the EBA announced at the time. This gives the Commission and EU law makers time to consider amending CRD IV as the EBA proposes.

Other recommendations the EBA made include enabling firms and individuals covered by its proportionality opinion to opt out of rules that otherwise require payment of bonuses to be deferred for a minimum number of years, or for a percentage of the bonus to be paid in shares or share-like arrangements rather than cash.

The EBA also recommended some other alterations to CRD IV, including allowing listed firms to use "share-like instruments" (ie, cash-settled contractual awards that track share value) rather than shares, to partly pay senior staff bonuses, as required under CRD IV.

Remuneration expert Suzannah Crookes of Pinsent Masons, the law firm behind Out-Law.com, said: "It is significant that the Bank of England has reiterated its opposition to the bonus cap, even though it has accepted EBA proposals to thwart bonus cap work-arounds in the form of 'role-based allowances', by requiring these to be treated as variable remuneration for bonus cap purposes unless they are genuinely fixed remuneration."

Executive incentives expert Graeme Standen, also of Pinsent Masons, commented: "Bank of England governor Mark Carney also chairs the global Financial Stability Board (FSB), which plans to review and research the effectiveness of various regulatory approaches to aligning remuneration with financial sector risk management later this year. As the bonus cap is the only part of the CRD IV remuneration provisions that does not reflect the G20 / FSB principles on bankers’ compensation, it seems possible that this review will increase pressure on the EU to reconsider its bonus cap during the 2016 review of CRD IV".

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