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Bonus cap has 'no significant effect' on stability, says EBA

The introduction of the 'bonus cap' has had no significant effect on institutions' financial stability and cost flexibility, the European Banking Authority (EBA) has said in a report.31 Mar 2016

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. 

The rules form part of a set of requirements that aims to align pay with a more secure and stable financial system, and better management of banks' and major investment firms' business and financial risks. Other requirements include bonus deferral, malus and clawback. The CRD IV remuneration rules, including the bonus cap, are to be reviewed in 2016, and the EBA's report has been submitted to the European Commission for the purposes of that review.

In most institutions, the fixed salary of identified staff – those considered to have a "material impact on the institution's risk profile" – accounted for less than 1% of funds; and on average accounted for only 3.12% of the institutions' administrative costs, the EBA said. This is "not material compared to the administrative costs of institutions", the EBA said.

The cap has, however, affected remuneration practices. The average ratio between variable and fixed remuneration dropped significantly for all identified staff, the report said. A greater proportion of the remuneration banks are paying staff is fixed now than before the cap was introduced, bringing the ratio in line with what is prescribed by EU legislation, it said.

The average ratio between the variable and fixed salary paid to identified staff was 65.48% in 2014, down from 104.27% in 2013. At the same time, the average ratio between the variable and fixed remuneration paid to high earners dropped from 317% in 2013 to 127% in 2014, the EBA said.

Average fixed pay for members of the management body of UK institutions more than doubled to €1.51 million in 2014, while their average variable pay fell 28% to €1.67 million. This compares to average fixed pay of €220,000 and variable pay of €379,000 for comparable staff across the EU, the report said.

Remuneration expert Graeme Standen of Pinsent Masons, the law firm behind said: "As we might expect, it seems that UK institutions are in a different position from continental institutions in terms of the fixed pay inflationary effects of the bonus cap. This arises naturally from the different cultures of banking remuneration already prevalent in the two regions before the financial crisis."

"EU law has to work for all member states, of course. If the EBA relies too heavily on pooled data from the whole EU, that could downgrade concerns that affect the UK more than the continent. This could underline concerns about risks for the City and sterling arising from EU financial services regulation that may develop with a focus on regulatory impacts in the eurozone," he said.

"The Prudential Regulation Authority (PRA), part of the Bank of England, has been a vocal critic of the bonus cap. As well as the increase in fixed remuneration that the EBA report discounts, the PRA has also emphasised that the bonus cap perversely makes identified staff less personally accountable for risk management failures by reducing the proportion of their pay that can be lost as a result of any failure. To work out whether the bonus cap is a sensible and effective component of rules designed to improve risk management, we would need a careful and well-informed analysis of the net effect of two opposite consequences of the cap," Standen said.

"The first of these is the reduction of the incentive for excessive risk-taking by reducing variable pay. The underlying concern is that identified staff might seek to maximise their short-term and long-term bonus pay outs, at the same time increasing the longer-term risks for the business and the financial system. This is the core justification for the CRD IV bonus cap," he said.

"The second consequence is reducing 'skin in the game'. Where variable pay is reduced, so too is the proportion of remuneration that is deferred and placed at risk of malus and clawback. Perversely, this will reduce incentives for identified staff to prioritise appropriate management of the same longer-term risks," he said.

In most institutions, the fixed remuneration for identified staff in 2014 accounted for less than 1% of their own funds and the bonus cap has led to a very small increase in the fixed costs, the EBA said.

However, Standen said: "This fails to take account of the point that when revenues fall, being able to shave only a few percentage points off otherwise slow-to-trim fixed costs, or not being able to do that, could be the difference between paying a dividend or not, or a major factor in how comfortably an institution can cope with hard times".

The percentage of high-earners who are classed as 'identified staff', with a potential impact on institutions' risk profiles, increased significantly from 59% in 2013 to 87% in 2014; and the absolute number of identified staff went up from 34,060 in 2013 to 62,787 in 2014. This was largely due to the introduction of a more precise definition to identify staff with a material impact on the risk profile of organisations, the EBA said.

Institutions' remuneration practices are still not sufficiently harmonised across the EU, according to the EBA. In particular, the application of deferral and pay-out in instruments varied significantly across countries and institutions. This is due to differences in national implementation, which, in many cases, allow for waivers of these provisions, it said.