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Tuesday, February 19, 2013

EU caps on bankers' bonuses: the perfect regulatory storm?

The discussion over bank bonuses has been heating up inrecent days. Discussions between EU ministers, the European Parliament and the Commission (so-called trialogues) are restarting today as the three try to reach an agreement on the rules for bank bonuses to be included in CRD IV (the EU’s legislation implementing the Basel III rules and more).

The parliament is pushing for a stringent cap on bank bonuses of 1:1 ratio with fixed salaries, which could be increased to 2:1 with approval from a majority of shareholders.

There is a lot going on here, beyond the actual proposal, including:
  • The UK is in a clear minority in categorically rejecting a cap, but unable to block a rule with disproportionate impact on the UK - courtesy of QMV and co-decision.
  • Germany being the swing state - no surprises there - having first supported the UK's position, it has shifted as part of a wider political push to get tough on bankers, which strikes a chord with German voters. The revelation in December that Deutsche Bank hid $12bn worth of losses during the crisis and the growing Libor and Euribor rates scandals, haven't exactly helped...
  • The European Parliament flexing its muscles, successfully managing to tap into the public mood, breaking the Council common position, which is unusual. (Don't worry, any favour EP thinks it wins with the electorate, would be ruined if it voted down Ministers' proposal for a reduced long-term EU budget).
  • "Anglo-Saxon capitalism" in the docks - perception is one of a continental attack on British bankers (ironic since a large part of the talks have focused on making CRD4 more flexible to allow the UK and others pursuing tougher capital rules for banks). This will not make the City any more EU-enthusiastic.
  • No one wants to be publicly seen to back bankers - even the UK government itself is keeping a low profile.
  • Changing incentives as part of the eurozone banking union, with the club within a club dynamic again coming to the fore (see our December 2011 report to see what we mean). Looking forward, the question is, if a country decides to remain outside the banking union - therefore signalling that it will stand behind its own banks, come what may - should it not also have more discretion in getting the incentive structure in the banking sector right?
So what does the UK want?

On Friday the UK submitted a paper to its EU partners to put forward it’s case. We've seen the paper, and here are some thoughts / points - which also have been largely reported in the media:
  • The UK argues against a firm cap. Any extended remuneration should be determined by shareholders (although the UK proposal does water down the size of the majority needed to approve remuneration slightly).
  • The UK is pushing for a focus on non-cash deferred bonuses. This is included in the current proposal to some extent but the UK fears (with some grounding) that the current proposal will encourage an increase in fixed salaries and a focus on upfront cash bonuses - and reduce firms' ability to cut costs during a downturn, potentially leading to more lay-offs and less lending (on a bit less solid ground here, we think).
  • It also argues that deferred non-cash bonuses (over three years) should not fall under any cap, while also rejecting the proposal that all employee benefits, above those mandated by law, should be categorised as a ‘bonus’.
  • The government is also keen to see that subsidiaries of EU banks located in the rest of the world should not have to adhere to the rules. Furthermore, EU subsidiaries of banks headquartered outside the EU should not have to implement the rules (although their bonus plans will still need to be judged ‘prudential’ by the relevant financial supervisor).
So is this special pleading? Well, to some people in the City, the world will end if this comes into force - which is not quite the case. In fact, there's no surprise that politicians seize the opportunity to strike down on bankers' pay, given that many banks have been forced to seek taxpayer-backed bailouts and the rest of it. So the first message to the financial sector is: if you don't want to be subject to tougher regulations, stop screwing up.

But it could still be damaging and there are questions over how much difference a cap would really make on incentives and the distorting effects this could have across the board. Ultimately, the risk taken on and the decisions made by banks are dictated by much more than just bonuses - it is just a small part of a wider culture which needs to be reassessed. Targeting and correcting perverse behaviour still seems to be better done through more effective supervision and tighter regulation - the irony should not be lost that many of those pushing for a cap are also the ones advocating a maximum limit to capital levels and supporting watering down the Basel III liquidity requirements (see here for details). And there should be no doubt that this could make talent less likely to choose the EU over other part of the world, which clearly isn't in anyone's interest.
In the end, bank bonuses are also only a small part of the much larger CRD IV legislation. There is unlikely to be a formal vote on bank bonuses itself - and Ministers rarely vote in the Council - but the UK seems to be heading for a defeat on a pretty symbolic issue at a sensitive time.

On the other hand, if the UK government can pull this one off, it should be given a lot of credit. Ultimately, the final outcome of CRD IV as a whole will be the more important bellwether by which to judge UK success or failure.


Rik said...

The whole sector is sick and need urgently to be repaired.
-riskmanagement the major concern at the moment;
-longer term banks are simply using the oligopoly granted to them by government to run a very inefficient business. Like in the telecom sector before we need all over the Western world real competition to start and to start asap. The sector is highly inefficient probably 50% costcutting would be possible if nos of employees/branches and employeeremuneration is brought back to standards of very similar other sectors. With internet and the 24 hour economy coming up why do we need all those branches and all that staff and why should that staff be paid considerably more than in other sectors of the economy.
Problem is much more with the bottom 99% of banking imho than with the top 1%.
In this respect boni are hardly relevant. However in the present political discussion they have become that. The man in the street (most of them) doesnot understand why some people are paid 10-20 and more times as much as he.

For the international financial sector the ideas will likley be killing. It is the only part of the bankingsector where there is a decent level of competition. There are other problems of course but lack of competition is not really one of them. The best will move and with it likely a huge part of the sector in the countries were this kind of legislation will be imposed.

For the UK it has become time to make very clear that it will legislate its bankingsector in its own interest and come to a formula in its relation with the EU and EZ that works. Now everytime these kind of discussions come up. With alot of irritation at both sides.

All these discussions might be good for Cameron to show he is fighting a lot of clueless burocrats, but the sector likely could do with some rest. When business moves away or postpones investments it will not easily get back resp. it remains uncertain if it will be done at all.

Rik said...

The UK should probably bring it in the wider discusssion of: what has to be done at European level and what can be done nationally'.
From that pov boni could most definitely be handled nationally.

Especially since the London has de facto as only one part of the sector that is open to international competition.

For this view there are likley others more receptive. Allthough bankers remain a very unpopular breed. Also with natural allies like the Dutch and Germans.

Anyway it is another example that before what are important international treaties have simply be signed off as if it were Christmas cards.

Or bring it up in the discussion how internal market and EuroZone integration will 'live' next to each other. Or the combination of the 2.

Jesper said...

In this case it seems that a bonus is a bet whereby: Tails I win, heads you lose.

Capping the amount that can be won will not reduce the incentive to make the bet. Traders will continue to bet the bank as long as the cost of losing the bet is paid by someone else.

Who would not make a bet that could net you 20 million if the cost of losing the bet would be 0?

Introducing a malus (clawback, personal guarantees etc) would do more good than capping the bonus.

jon livesey said...

Well, as the story said, a lot of this is politicians exploiting Banker Derangement Syndrome (BDS).

People who don't think very deeply or clearly about anything have an easy target if they can just say "Banker" and have everyone assume that there is some deep dysfunctionality in the system.

My guess is that within a year or two most people will have forgotten all about the banks, and we'll have a lot fewer Banking "experts" on the Web. That can't come soon enough for me, because I am getting very weary of these long-winded harangues about banks from people who probably can't balance their own cheque-books.

And by the way, not for the first time, Cameron is the one who is getting it right here. For Banks, as for any other industry that employs non-cash incentives, the key issue is to "vest" non-cash benefits over a long enough period that the recipients are highly motivate not to take excessive risk for short-term gain.

As usual the EU has laboured long and hard and produced a mouse that anyone who has been in business can see won't do the job.

Anonymous said...

The British people want just one thing.

An exit.

Anonymous said...

Just why an organisation that cannot get its own accounts audited for 18 years and that has turned Europe into a dustbowl in a little over 13 years is allowed to produce regulation for finance is LAUGHABLE.