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Clampdown on 'role-based allowances' threatens ability of EU financial centres to compete for talent, says expert

European financial centres such as London and Frankfurt are at greater risk of losing skilled bankers to other financial hubs around the world as a result of a further refinement of the EU bonus cap for bankers, two legal experts have said. European banks' operations outside Europe are similarly affected.16 Oct 2014

Specialists in banking remuneration Matthew Findley and Graeme Standen of Pinsent Masons, the law firm behind Out-Law.com said the refinement and the bonus cap itself could lead to an increase in banks' fixed payroll costs and undermine financial stability, contrary to the object of the bonus cap rules, reiterating concerns already expressed by the Bank of England and the UK government on the issue.

Findley and Standen were reacting to criticism by the European Banking Authority (EBA) of the way some EU banks, including those based in the UK, classify 'role-based allowances' (RBAs) within their remuneration packages. Some banks have taken to paying senior employees RBAs that are "linked to the[ir] position and organisational responsibility", the EBA said.

Reporting on the findings of an investigation (10-page / 184KB PDF) it had conducted into EU bankers' allowances, the EBA raised concerns with the way some EU banks are treating RBAs within their remuneration structures.

It said some banks were classifying the allowances as part of bankers' fixed pay packages and that this may be allowing the institutions to pay more to those staff in bonuses that they are permitted to under EU law.

In a new opinion it has issued, the EBA said that it believes RBAs qualify as variable remuneration (3-page / 86KB PDF) and do not fulfil criteria that would merit their classification as fixed remuneration. How RBAs are classified is important as the maximum amount of variable remuneration that banks can pay staff is calculated on the basis of what their fixed earnings are.

The EBA has called for banking regulators across the EU to "use all necessary supervisory measures" to force banks to update their staff remuneration policies by the end of the year to reflect its view on the classification of RBAs and ensure "that payments of such allowances are not causing institutions to contravene the bonus cap and other CRD requirements".

Under the EU's capital requirements directive (CRD IV), bankers' bonuses must not exceed 100% of their fixed remuneration in any given year, or 200% of salary with the agreement of shareholders.

The EBA said: "In order to qualify as fixed remuneration, the conditions for their granting and the amount of the role-based allowances should be predetermined, transparent to staff, permanent, i.e. maintained over time and tied to the specific role and organisational responsibilities, not provide incentives to take risks and, without prejudice to national law, be non-revocable."

"The EBA is of the view that ‘role-based allowances’ which are not predetermined, are not transparent to staff, are not permanent, provide incentives to take risks or, without prejudice to national law, are revocable, should not be considered as fixed remuneration but should be classified as variable in line with the letter and purpose of [EU law]." it said.

Standen and Findley said the timing of the EBA's announcement could create a legal compliance headache for banks but more importantly may also have commercial implications.

"It could be pretty bad for this to be made to bite towards year end, and as we approach bonus season, since some institutions may now overrun their bonus caps if they pay the bonuses they intended," Standen said. "As the RBAs should be discretionary, banks will be able to revise down these payments, but may still struggle to comply with the bonus cap rules, even though reducing RBAs will now reduce variable pay."

"This is because reclassifying RBAs also reduces the expected fixed pay, so narrowing the scope to pay bonuses that have always been regarded as variable. Nevertheless, this effect will have been recognised from the start, and the banks have probably prepared for it," he said.

Findley, head of share plans and incentives at Pinsent Masons, added: "The real fallout from the EBA's announcement could be commercial rather than legal. These RBAs were meant to help cope with the bonus cap, keeping pay up while retaining the cost advantages of bonuses, which fall naturally in a downturn. Basically, the banks tried to steer between the EU definitions of fixed and variable pay, hoping for something that legally could count as 'fixed' but still be flexible, without an explicit link between payment and business performance. The banks have now had that approach rejected, perhaps sooner and more decisively than they feared - the cap only came into force at the start of 2014."

"How carefully did banks warn key staff that RBAs might not allow them to be paid as hoped, given that effective communication about incentives is often surprisingly difficult? There could be an immediate increase in the risk that some EU banks could lose important staff, disappointed with their bonus package, from EU locations or elsewhere, to unconstrained competitors operating in financial centres outside the EU, such as New York, Hong Kong or Singapore. The cap applies to all banks operating within the EU, but only to EU-based banks operating outside it, which has always been seen as unfortunate," he said.

Findley said that UK banks will now been watching for how the Bank of England's Prudential Regulation Authority (PRA) reacts to the EBA's opinion in the short term. For all banks in the EU, the larger question is what chance of success the UK has with its legal challenge to the bonus cap, he said.

"We will know more about this in November, when the Advocate General of the CJEU will publish their non-binding opinion on the case," Findley said. "The PRA has always had misgivings about the cap, fearing it may be self-defeating, but it has limited room for manoeuvre. As a national regulator, it has to work towards a common supervisory approach across the EU."

"The EBA has now issued an opinion as to what that approach should include. It is not legally binding, but expects compliance by the end of the year. However, the opinion will be folded into the EBA's new guidelines on sound remuneration policies, to be published in the next few months. These guidelines will have much greater weight for the PRA than the recent EBA opinion, under CRD IV and perhaps also under another power of the EBA which imposes a high duty of compliance on both regulators and banks," Findley said.