Ten times as many bank staff may be affected by bonus cap restrictions than previously thought, says expert

Employment law specialist Christopher Mordue of Pinsent Masons, the law firm behind Out-Law.com, said that proposals set out by the European Banking Authority (EBA) may not tackle the issue of bank staff being rewarded for risk-taking. He said, though, that up to 10 times as many bank staff would be subject to new rules on curbing bank bonuses than was previously thought.

The EBA has laid out draft technical standards (25-page / 545KB PDF) which would act as criteria for determining which staff employed at banks could be considered to be 'material risk takers'.

The definition is important as EU laws will require regulators to review remuneration policies at banks in relation to senior bank staff, "risk takers" as well as those staff who are earning similar amounts of money and whose "professional activities have a material impact on their risk profile". The regulators are responsible, under the CRD IV package of laws, to ensure the remuneration policies do not encourage excessive risk-taking, among other things.

Earlier this year MEPs and EU Ministers 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).

Under the EBA's proposals, bank staff would be identified as 'material risk takers' if they earned more than €500,000 a year in total remuneration, if they are within the top 0.3% of earners in a single financial institution or if their earnings are in the same "remuneration bracket" as the lowest-earning senior manager or risk taker in the company.

In addition, bank staff who earn €75,000 in bonuses or other "variable remuneration" where that sum exceeds 75% of their fixed salaries would be classed as 'material risk takers'.

Mordue said that the EBA's plans represent a "controversial shift in scope" and would "confirm the City's fears" about the impact of the bonus cap being "far greater than initially thought".

"Included within the definition of 'material risk takers' are firm employees earning €500,000 or more and those whose variable pay is more than €75,000 and 75% of fixed pay," Mordue said. "This means that some financial institutions could have up to 10 times as many staff affected by the cap than previously thought."

"This is a controversial shift in scope – until now 'material risk takers' have been defined by role rather than earnings, the focus being on their actual ability to directly impact the firm’s risk profile. This new proposal means that staff whose roles are not linked to risk will still be subject to the cap if they hit the various thresholds linked to their remuneration. This makes the proposal look more about controlling levels of pay than securing financial stability and resilience," he said.

"Over recent years, banks have been addressing the issues caused by the financial crisis by strengthening clawback provisions, and deferring greater amounts of variable pay for longer periods to improve their ability to self-regulate pay against performance and reduce the incentive for short term, high risk approaches," Mordue added.

"The irony is that the bonus cap could reverse this positive trend if fixed pay is simply increased to beat the cap and retain current overall remuneration levels," the expert said. "That would increase the firm’s fixed costs – adding millions to the payroll – without the ability to make performance adjustment or claw back payments in the event of regulatory failure. So the unintended consequence of this measure could be a return to remuneration practices which do little to control risk or maintain a sustainable link between pay and sound financial practice."

Mordue said that there would also be concern about the timing of the EBA's consultation on its plans. The consultation is not due to close until 21 August and Mordue said that there will be " very little time between finalisation of the rules and the date by which new remuneration practices will have to be in place" if the rules are to come into force on 1 January 2014, as has been proposed.

"The EU regulators must be careful to ensure that any regulatory measures they introduce are proportionate and in line with other global financial centres, of which London plays a key role," financial services expert Monica Gogna of Pinsent Masons added. "It is now up to the UK government to speak up and ensure that London remains at the forefront of the financial community’s mind when thinking of doing business."