Green light for EU bonus cap proposals
EU legislators have given the green light for EU-level rules to cap bankers’ bonuses as part of the “CRD4” reform package. The bonus cap will be set at 100% of fixed pay, with the possibility to allow bonuses of up to 200% of fixed pay with shareholder approval.
Subject to some final formalities, the rules look likely to apply from 1 January 2014 and will apply to bonuses awarded for performance from 2014 onwards. In practice this means that the rules are likely to apply to bonuses actually paid in 2015.
In March 2013 came the news of the political agreement reached for EU-level rules to cap bankers’ bonuses in the “CRD4” reform package. As well as implementing Basel III reforms relating to banks’ regulatory capital, counterparty credit risk, leverage and liquidity requirements across the EU, CRD4 will also tackle pay levels in response to concerns that CRD3 has been too lenient in this area.
Member States will be required to implement the new bonus cap rules from 1 January 2014 assuming (which looks likely) CRD4 is published in the EU Official Journal before 1 July 2013. However, since the rules will only kick in for bonuses awarded for 2014 performance, firms have some breathing space as the first bonuses to be affected will be those payable in 2015.
Who is caught?
Consistent with the scope of CRD3 rules, CRD4 rules will have wide cross-border reach. EEA-based “firms” (credit institutions and investment firms) must apply them across their group operations, including to non-EEA branches and subsidiaries. Non-EEA based firms must apply them to EEA subsidiaries (and potentially to EEA branches if required by local rules).
Only categories of staff whose professional activities have a material impact on firms’ risk profile such as senior management, risk takers, control function staff and high-earners will be affected. The European Banking Authority (EBA) will issue regulatory standards with criteria to identify these staff in response to concerns that regulators and firms have been taking an inconsistent and minimalist approach. It is currently consulting on draft standards which would significantly widen the net by including, among others, those whose bonus potential exceeds EUR 75,000 or 75% of their fixed pay.
How the cap will work
“Variable pay” of affected staff will be capped at 100% of their fixed pay, but can be higher – up to 200% of fixed pay – if the firm’s shareholders explicitly agree. This would require a “yes” vote from 66% of shareholders holding at least 50% of shares or, if no 50% quorum, from 75% of shareholders present. Firms that seek shareholder approval will need to make a detailed recommendation justifying their request and its impact. National rules can set lower variable pay caps. Up to 25% of “variable pay” (or any lower maximum percentage specified by national rules) can consist of long-term deferred instruments which must be delivered in the form of equity or debt. Such long-term instruments must be deferred for at least five years and must be subject to clawback. However, the face value of the instruments may be appropriately discounted for the purpose of applying the cap.
Finding solutions
Aside from seeking shareholder approval to utilise the 200% limit, increasing fixed pay or introducing “fixed-pay allowances” are possible solutions to mitigate the impact of the cap. Understanding how local regulators interpret “fixed pay” will be key before proceeding with structures such as temporary fixed pay allowances, as will considering the impact of any proposed changes on salary-related benefits and pension provision.
Further flexibility could be achieved by benefitting from the discount to be applied on long-term deferred instruments, thereby allowing headroom to award other forms of variable pay. The EBA will confirm in future technical guidance how the discount should be calculated for the purposes of the cap – clarification that will obviously be keenly awaited by firms.
Consistent with CRD3, firms are likely to grapple with generic anti-avoidance provisions for CRD4’s remuneration rules that give them no comfort on whether specific remuneration structures are permitted. Whilst this does allow some discretion, the more innovative or unusual the structure proposed the higher the risk that this will be scrutinised by local regulators.
What next?
Much of the detail is still missing and will only be fleshed out as EBA guidelines and local implementation proposals are published in the coming months. Although, to that extent, firms have to play their planning process by ear, they will have a busy time ahead in order to have plans in place (together with necessary contractual amendments and shareholder approvals) for the 2014 bonus year. Aside from bonus caps, these will also need to address other aspects of new CRD4 remuneration rules, such as requirements to withhold or recover bonuses in a broader range of situations using "malus" and clawback provisions.In the meantime, we can expect further progress towards bonus cap rules for other parts of the financial sector. In July 2013, the European Parliament is scheduled to vote on the proposed "UCITS 5" directive including provisions that UCITS investment fund managers bonuses are capped at the level of their salary.
In the meantime, we can expect further progress towards bonus cap rules for other parts of the financial sector. In July 2013, the European Parliament is scheduled to vote on the proposed "UCITS 5" directive including provisions that UCITS investment fund managers bonuses are capped at the level of their salary.
