Eight ways in which the Europe Union would like to curtail investment banking pay more heavily, soon

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Europe, scourge of compensation

Europe, scourge of compensation (Photo credit: Wikipedia)

Despite the fact that the European Union already has the most punitive investment banking pay restrictions in the world, machinations are afoot in the European Parliament to make the restrictions even more punitive still.

Yesterday, the European Banking Authority (EBA) released a large document based on a survey of the remuneration policies of banks in EU member countries.  Reading carefully between the lines, there are several ominous signs. These are as follows:

1. Far more people must be designated ‘code staff,’ or, ‘identified staff,’ especially traders. These people MUST have 40-60% of their bonuses deferred

‘Identified staff’ (known in the UK as ‘code staff’ – see here for a definition) are subject to the EU’s current compensation rules, stating that 40-60% of pay must be deferred over three years and that 50% of the remaining cash compensation must also be deferred.

In 2010, banks found an obvious way around this: they simply classified very few people as ‘identified staff.’ Hence, there were 6 EU countries in which ‘identified staff’ accounted for fewer than 1% of all banks’ employees, 5 in which they accounted for between 1% and 5%, and only 2 in which they were more than 10%.  In two jurisdictions, investment banks had a lower proportion of identified staff than retail banks. “This is inadequate for effective risk management,” observed the EBA.

Henceforth, therefore, the EBA would like to clarify (and tighten) the definition of ‘identified employees’ so that fewer people are able to escape its compensation restrictions.

In particular, it would like to clarify which ‘risk takers’ (AKA traders) need to be designated as identified employees. As a result, more traders are likely to have their bonuses deferred in future.

Which traders will be reclassified? The EBA says various measurements are in use already, including:

‘Credit competence; trading limits; bounded economic capital on business unit level; Value at Risk, Risk Weighted Assets-, revenue- or Profit&Loss impact; risk capital, total remuneration, ratio fixed to variable remuneration, and various thresholds (threshold above which staff are allowed to operate; amounts of revenue; assets under management). Qualitative criteria which are used by the institutions are the seniority of staff; hierarchy in the institution; type of responsibility of staff members; type of activity; and employee rating.’

There are already signs that banks are categorizing more people as code/identified staff. Deutsche, for example, decided all its MDs were identified staff for the purpose of 2011 bonuses.

2. Banks have been evading rules banning guaranteed bonuses. This must be stopped

The EBA doesn’t allow guaranteed bonuses beyond the first year of employment. It says most countries have implemented this edict. And yet, banks have found ways of avoiding this rule.

“In practice also the classification of payments as guaranteed bonuses may not always be obvious,” says the EBA. “Supervisors notice cases where certain payments are presented as fixed payments, but where further examination of the characteristics of these payments leads to re-assessment of that qualification.”

There will be no fixed payments in future.

3.  Everyone’s pay must be disclosed

Right now, banks operating in Europe have to disclose how they pay their code/identified staff.

This has led to various revelations. Notably, US banks pay their code staff a lot more than European banks. And RBS pays its code staff badly.

In future the EBA would really like it if pay for all staff, not just code/identified staff were disclosed like this. “Effective disclosure in fact allows the market's awareness on remuneration to increase,” it observes perspicaciously. “…It is therefore important to ensure an equal level of application of the disclosure requirements. Today, this is still hampered mainly by the fact that disclosure requirements relate to those categories of staff selected as Identified Staff.”

If the EBA gets its way, a lot more information about pay in each bank operating in Europe will be disclosed in future. From our perspective, this would be no bad thing.

4.  Bonuses must be reduced a lot more

Bonuses have been cut since 2009, but they have not been cut enough. There has not been a sufficient “breach” with the past, says the EBA, the “variable part of remuneration” still “exceeds the fixed remuneration considerably.”

5. Bonuses must be restricted to less than 50% of total compensation

Until now, the European Parliament has been pushing to restrict bonuses to 200% of salaries.

Now, it would like bonuses to be less than 100% of salaries.  “If the potential variable remuneration is the dominating part of the total remuneration, this could incentivise staff to take too much risk in order to assure a certain minimum pay level,” it insists.

The EBA has turned against bonuses after finding that the median ratio of bonuses to salaries for identified staff is 313% and that some identified staff are getting bonuses equal to 914% of their salaries.

Restricting bonuses to a fixed and minor proportion of salaries will have a two-stage effect: firstly, salaries will rise; secondly, banks will make redundancies or shift traders to locations like Hong Kong, where they can manage compensation more effectively.

6. Clawbacks must be far more punitive

The EBA wants clawbacks to be triggered not just be a loss at company level, but by losses at “business unit and individual level.”

7. Everyone must have risk adjusted bonuses

At the moment, only senior staff have their bonuses properly adjusted to take account of risk.  Risk adjusted bonuses must be democratized: they must be applied at lower levels.

8. Countries like Germany might have to include more companies in their remuneration rules

The EBA notes that different countries have very different rules with regards to what kinds of organisation their compensation edicts apply to. Germany is very lax. Italy is very strict.

In Germany, institutions with less than €10bn in assets don’t have to impose compensation restrictions related to performance criteria, deferrals, restricted stock, or risk adjusted pay.

In Italy, banks with less than  €3.5bn in assets can escape the requirement that 40-60% of compensation for identified staff has to be deferred and that at least 50% has to be paid in shares, but they have to adhere to the rest of the EBA’s rules.

In future, it seems, far fewer organizations across the EU will be able to escape the rules. Far more people will find their compensation deferred. In Germany especially, this may come as a shock.