The UK Treasury has dropped its lawsuit against the EU’s strict banker bonus rules. The move came after an advocate general (“AG”) for the Court of Justice of the European Union’s (“CJEU”) stated that the restrictions on bonuses as a ratio of fixed pay were legally sound, and suggested that the UK’s pleas should be rejected and the CJEU dismiss the action.
While the AG’s opinion is not binding on the CJEU, in the majority of cases the Court will follow the opinion, and Mr. Osborne has stated that he is “not going to spend taxpayers’ money on a legal challenge that is unlikely to succeed.” However, the decision should not be seen as a resolution; instead, it serves to highlight the distinct approaches taken by the UK and EU on the structure and regulation of bankers’ pay.
The Ratio Cap
Since January 2014, EU banks have been required under the Capital Rights Directive IV to limit variable pay to a maximum of 1x fixed pay, or 2x fixed pay with shareholder approval. While it applies across Europe, the rule has been particularly controversial in the UK, both because of the concentration of financial institutions in the City of London, and because of the somewhat disproportionate impact of the rule, UK pay structure having historically been weighted more towards performance-based variable pay and less towards fixed entitlements, as compared to European peers.
The Case Against the Case Against the Cap
The primary pleas against the limit, which came into effect under the Capital Rights Directive IV and caps variable pay for financial institutions on a 1:1 ratio to fixed pay (or 2:1 upon attainment of shareholder approval), argued that the EU had erred in selecting the legal basis for the cap, and had interfered in the social policy of the Member States by determining the level of pay for individuals. On the former, the AG opined that due to the potential impact of variable remuneration on the risk profile of financial institutions operating across the EU, the measures challenged by the UK related to the functioning of the internal market, and as such were correctly founded in Article 53(1) of the Treaty on the Functioning of the EU.
Perhaps more interestingly however, was the opinion provided in regard to the challenge on the EU overstepping their remit by determining levels of pay in Member States. In response, AG Niilo Jaaskinen stated that: “fixing the ratio of variable remuneration to basic salaries does not equate to a ‘cap on banker bonuses’, or fixing the level of pay, because there is no limit imposed on the basic salaries that the bonuses are pegged against.” Mr. Jaaskinen also rejected the UK’s arguments that the measures were disproportionate, breached privacy rights by setting certain disclosure requirements, impaired employment contracts prior to the legislation and overstepped the regulatory authority of the Eurpean Banking Authority.
The UK Approach
Concurrent with the EU reforms, UK regulators have taken a different approach to restructuring bankers compensation, focused on discouraging “excessive risk-taking and short-termism”, principally by ensuring that a significant proportion of pay is at-risk for an extended period, and that issuers have the capability to adjust payout levels. In setting out its now abandoned challenge, the treasury referenced this approach, noting that the use of deferral requirements and recoupment provisions had already “contributed to real improvements in the alignment of bankers’ pay with risk and performance.” The UK Remuneration Code has subsequently been revised to further extend both the length of deferral requirements and the scope of recoupment provisions, with effect from 2015.
A Third Way?
Speaking earlier this week, Mark Carney, the governor of the Bank of England, noted that CRD IV has “the undesirable side effect of limiting the scope of remuneration to be cut,” and suggested that a portion of fixed pay be made at risk, potentially by delivering it in performance bonds or other instruments.
Major UK banks are a step ahead of him, having adjusted their pay structures earlier this year to include a ‘fixed share allowance’ in an effort to offset the reduction in total pay, and in alignment with performance, resulting from implementation of the variable/fixed ratio.
However, it seems unlikely that regulators on the continent will be receptive to Mr. Carney’s suggestions; in recent months the European Banking Authority has criticised the use of fixed share allowances under the view that they serve to circumvent the pay ratio, and issued guidance that fixed pay should not be revocable. With UK and European regulators divided on both the definition of fixed pay, let alone the appropriate overall pay structure for bankers, a planned referendum on the UK’s membership in the EU may be the only potential ‘resolution’ on the horizon.