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Why the EU’s new compensation regulations are dreadful, and why they’re tame

If you tell a senior banker that between 40% and 60% of his or her bonus must be deferred over three to five years and that the cash portion will be limited to 20-30%, he or she is unlikely to bat an eyelid. After all, Bank of America reduced the cash component of its bonuses to just 15% last year, and most banks deferred at least 50% of 2009 bonuses for three years’ minimum.

Tell the same thing to a junior trader, and he or she is likely to choke on his Red Bull.

Unfortunately, the EU’s new bonus legislation extends to junior traders, making it advisable to stand clear. The new rules are being voted on in the European Parliament next week and are expected to come into force; they will be implemented from January 2011.

What they say

An opaque announcement on the EU Parliament’s website stipulates that:

– Between 40% and 60% of bonuses must now be deferred for at least three to five years.

– Half of the non-deferred bonus has to be paid in shares or securities linked to the banks’ performance.

– As a result, cash bonuses will be capped at 30% of the total bonus and to 20% for ‘particularly large bonuses’.

– Bonuses will have to be capped relative to salary, on the basis of (yet to be specified) EU wide guidelines.

What’s dreadful

What the announcement doesn’t make clear is whether the new regulations will apply to everyone in banks, or just high earners.

A spokesperson from the office of Arlene McCarthy, the Labour MEP who helped negotiate the new rules, says it will apply to, “everyone whose activities affect the risk profile of an institution.” He says junior traders will be implicated. In 2009, most junior bankers escaped the worst of bonus deferrals.

Hedge funds, however, won’t be affected. Robert Peston and the BBC have been getting excited this morning about the rules extending to hedge funds, but McCarthy’s colleague says this isn’t the case: “The BBC have made a mistake.”

What’s tame

However bad the new rules appear, they could have been worse. Last month the Economic and Monetary Affairs Committee was proposing to cap bonuses at 50% of pay, and defer at least 40% of them for five years.

“A bit of reality has crept in,” says Nick Dent, a financial regulation partner at Barlow, Lyde and Gilbert. “If the cap had gone ahead, you would either have pushed up basic salaries even higher than they’ve gone already, or you would have had a brain drain – to Switzerland in some cases, or to New York.”

How this differs to what we’ve got already

The FSA’s rules only apply to the 27 largest institutions. The EU’s rules apply to all banks.

The FSA’s remuneration rules (requiring that 40 – 60 percent of variable compensation will be deferred over three years, with at least 50% in shares / share-linked instruments), apply only to people in positions of ‘significant influence,’ or who earn more than 500k (above 500k 40% has to be deferred, above 1m 60% has to be deferred). As noted above, the EU rules also cover junior traders.

The nasty prospect of an EU bonus watchdog

A sideeffect of the legislation is the likely formation of some kind of EU bonus monitoring body

“The announcement talks about banks establishing limits on bonuses relative to salary in line with EU wide guidelines. It therefore sounds rather as if there’s going to be a new EU watchdog set up to issue these guidelines,” says Dent.

This can only be bad.

Predictable outcomes

At this point, it looks like the rules will have several outcomes.

1) Salaries will rise again

2) 2010 bonuses may be paid early, before the rules come into effect in January

3) New York’s appeal will increase – US regulators have refused to specify that a particular percentage of bonuses must be deferred.

Comments (8)

Comments
  1. this is nonsense without a proper ROE assessment of each individual (sr. or jr) that is properly assessed against the costs of utilizing the bank’s facilities (balance sheet for one) or the accuracy of the PnL (i.e., MTM issues). Limiting bonuses doesn’t solve the problem?
    it’s also nonsense because it’s just precommitting – prior to performance outcome – to paying out more for non or mediocre performers – and we all know how strong the labor unions and pension systems are in europe so here’s to pay staying elevated? just for “sticking around” and waiting your turn?
    european banks are so YOURS.

    ex-european bank employee Reply
     
  2. so if youre starting as a sales analyst your bonus wont be all cash sarah?
    seems doubtful

  3. if it goes through , it is just going to be a disaster for european banks, they are going to lose everyone decent …

  4. Is Corporate Finance (mainly M&A) considered as an activity that “affects the risk profile of an institution”?

  5. @jimbo and ex-European bank employee – this will apply to US banks too. Most (all?) operate in Europe under local businesses governed by European regulators.

    Sarah, Editor, eFinancialCareers Reply
     
  6. ..Does it apply to Middle & Back office staff like IT personnel

  7. @Gary – no, only to people in ‘risk taking’ positions.

    Sarah, Editor, eFinancialCareers Reply
     
  8. I ti s not clear if Eu banks operating in the US will be affected?

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