Leiden Law Blog

UK government challenges bankers’ bonus cap

Posted on by Tom Dijkhuizen in Private Law
UK government challenges bankers’ bonus cap

The financial crisis has sparked off a debate on the remuneration policies and incentive models in the financial sector. The main problems related to those policies and models, as stated in the De Larosière Report, are the often excessive level of remuneration in the financial sector and the structure of this remuneration. The structure of the remuneration is regarded ‘to have induced too high risk taking and encouraged short-termism to the detriment of long-term performance’. The focus of the politicians and the general public has been on the level of remuneration, whilst regulators and policymakers have been concentrating on the structure of the remuneration as the latter ‘has had an adverse impact on risk management and thereby contributed to the crisis’. However, the level of remuneration has also attracted the attention of the regulator and a provision for a ‘bonus cap’ is introduced under article 94 of the Fourth Capital Requirement Directive (CRD IV) that will come into force on January 2014.

The provision for a ‘bonus cap’, entails that the variable remuneration cannot exceed 100% of the fixed remuneration for any individual staff member. You have to keep in mind here that not every employee is to be identified as staff to whom the remuneration provisions apply. The identified staff members are those who have a material impact on the institution’s risk profile, such as senior management and staff engaged in control functions. This ‘bonus cap’ can be increased to 200% percent of the fixed remuneration with the approval of the shareholders. The shareholders can approve such an increase by a simple majority unless fewer than half of the shares are represented. In that case a 75 per cent shareholder approval is required. Moreover, the shareholders can only act upon a detailed recommendation by the financial institution giving the reasons for, and scope of, an approval sought, including the number of staff affected, their functions and the expected impact on the requirement to maintain a sound capital base.

Although a majority of the Council agreed to the ‘bonus cap provision’ in order to reach agreement on CRD IV, the UK government stated that it could not support the package if it included the provisions on remuneration. The UK argued  that the provisions were not supported by any evidence or impact assessment and that they would merely encourage an increase in basic pay. Furthermore, the UK government emphasized that it would not be possible to clawback remuneration in the form of basic pay or to reduce basic pay when a bank is in dire straits. In other words, the provisions ‘will make banks themselves riskier than safer and they may undermine responsibility in the banking system rather than to promote it’.

As these fears are still present, the UK government has lodged a legal challenge with the European Court of Justice. The government thinks that the currently drafted legislation is not fit for purpose, to improve the stability across the banking system, as the increase in fixed salaries will do the opposite. It will be interesting to see how the ECJ decides.     

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