Banks risk provoking EU with bonus get-arounds

September 2, 2014

By Dominic Elliott

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Investment banks that are too successful in mitigating the impact of Europe’s new bonus curbs could be setting up another fight over pay. Most big banks are now paying so-called allowances to circumvent European Union rules, which bar firms from paying bonuses worth more than double base salary. If policymakers conclude that bankers are still wrongly paid, they could do something about it.

Banks are worried that the bonus cap creates regional pay inconsistency. To keep European remuneration competitive, two get-arounds have emerged. One is to raise base salaries, which has the downside of raising fixed costs in a cyclical industry. The other is allowances. These are fixed for only a few months and can also be reviewed regularly, whether up or down.

This regulatory arbitrage could move the pay debate away from hysteria about mega-bonuses into a highly technical discussion, as banks might well wish. Bonuses will come down, but overall pay quantum will remain high.

The European Banking Authority is already concerned that allowances, though defined as fixed and not variable pay, could in fact be bonuses in disguise. It plans to produce guidelines at the end of the year to head off sharp practice. One method of converting an allowance into de facto variable pay could be to adjust the stated role of the recipient frequently. Another form of bonus transfiguration might be to invoke changing market conditions as grounds to reduce or hike an allowance.

Such sophistry would be a provocation to Brussels. European officials stopped short of capping total levels of pay at investment banks after legal advice that it would be discriminatory to intervene in a single industry’s pay. It could, however, return to the idea. One option would be to use systemic risk arguments to cap bank compensation as a proportion of revenue, perhaps 40 percent, says a leading European employment lawyer. Turning that into a workable policy would be hard. Exemptions would be needed for economic downturns or crises. And mid-ranking employees would presumably bear the brunt of any pay reduction in moderate years.

Banks were surprised when the bonus cap became a reality. They should be careful not to underestimate Brussels again.

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