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Talent-flight risk as European bank bonuses to be capped

Published on Friday, 17 May 2013
Tara Grossman
Gareth Thomas

The Situation
The European Parliament has voted in favour of a proposal to introduce new rules, known as Capital Requirements Directive (CRD) IV, to put a cap on the bonuses of bankers who work for European banks anywhere in the world. The new rules have attracted a good deal of attention from both the banking community and the media.

In relation to remuneration, the European Parliament has voted in favour of several principles. Firstly, bonuses will be capped at not more than one times the employee’s basic salary. This cap can be raised to two times the employee’s salary, but only with the approval of the shareholders. The higher bonus payment would require at least 66 per cent of votes in favour, if more than 50 per cent of shareholders vote. If less than 50 per cent of shareholders vote, the resolution would need 75 per cent of votes in favour.

To encourage more of a link between remuneration and long-term risk, 25 per cent of any bonus exceeding 100 per cent of salary must be deferred for at least five years in the form of long-term deferred instruments (LTDIs).

CRD IV will apply directly to European credit institutions and to investment firms including retail and investment banks. The rules will not apply to all banking staff, but only senior management, risk-takers, staff engaged in control functions, or any employee receiving total remuneration that takes them into the same pay bracket as senior management and risk-takers.

The legislation was adopted by the European Parliament on 16 April, following the conclusion of negotiations between the European Council, the European Parliament and the European Commission in March.

The European Commission will review and report on the application of these provisions with the European Banking Authority, taking into account its impact on competitiveness and financial stability.

The final text remains subject to a detailed review of legal drafting and translation into other official EU languages, as well as formal adoption by the Council of Ministers, at which point we will be in a better position to review the detail. The rules will then be implemented by the various EU member states. Although member states have to transpose the directive into national law, the new rules are directly applicable, which means that they create law that takes immediate effect in all member states in the same way as a national instrument, without any further action on the part of the national authorities.

At present, the rules are due to come into effect on 1 January 2014, but this may be delayed if translation cannot be completed in time for publication in the Official Journal of the European Union before 1 July 2013. In the meantime, firms should plan ahead on the basis that bonus caps will be in place from 1 January 2014.

The Legality
CRD IV will have an extra-territorial impact in that it will apply to employees of subsidiaries of European companies operating outside the EU. There is a concern that this could result in a violation of international trade agreements and the risk of legal challenge.

As a concession to those firms who have been seeking an exemption for non-EU staff, the European Commission will review the implications of the extra-territorial provisions in two years’ time. In particular, it will consider whether this type of cap should continue to apply to any staff working effectively and physically in subsidiaries established outside the EU, where the parent institution is established within the EU.

Article 153, section 5 of the Lisbon Treaty 2007 states that the European Parliament and the European Council’s ability to modify social policy “shall not apply to pay”. However, the legislation has been passed as a measure to deal with systemic and macro-prudential risk, i.e. not social policy. The European Parliament may also argue that the new rules do not regulate total pay, but merely the proportion of variable to fixed pay.

The Consequences
Once the text of the legislation has been finalised, it will become clearer what strategies may be adopted to minimise the impact of the measure.

It seems that the new rules will inevitably lead to companies offering higher salaries to enable them to structure a package which is attractive enough to retain talent. A key concern for the European banks operating in Asia will be that the caps on remuneration cause them to lose their top performers to banks that do not have the same restrictions with pay.

Ideas being floated to counter these restrictions include increasing fixed pay; withholding salary during the year dependent on performance – although this runs the risk of being treated as variable remuneration and therefore subject to the new rules – and re-structuring remuneration for valued senior individuals by offering ownership or shareholdings to allow the individuals to benefit from profits alongside shareholders.

The final text of CRD IV remains subject to a detailed review of legal drafting and translation into other official EU languages, as well as formal adoption by the Council of Ministers. At that point we will be in a better position to review the detail.

Herbert Smith Freehills has 2,800 lawyers and 460 partners in over 20 offices globally. It advises on dispute resolution and employment, among other areas.

Gareth Thomas is head of the Hong Kong commercial litigation team and responsible for the Greater China employment practice.

Tara Grossman is a senior associate in the employment practice and has a wide range of experience in employment matters.

The information contained in this article should not be relied on as legal advice and should not be regarded as a substitute for detailed advice in individual cases. If advice concerning individual problems or other expert assistance is required, the service of a competent professional adviser should be sought.

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