Best practice | Pay caps
upset, when the annual bonus season begins in London in January 2015, the eye-watering windfalls that have become a standard feature of remuneration for the industry’s best or scarcest talent will be a thing of the past. The so-called bonus cap, which limits bonuses
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to a maximum of one times salary - or two times with the permission of shareholders - will have a broad reach. It applies to all EU banks, no matter where in the world they operate, as well as non-EU banks doing business in Europe and affects any bank employee earning over 500,000 euros a year. According to the European Banking Authority, the new rules will capture some 4,800 risk-takers and high-paid individuals in 23 banks, and are therefore likely to have a major impact in London which has a much higher proportion of big earners compared to other European financial centres. Designed by EU regulators to curb the worst
excesses of risk-taking in banks, the bonus cap has found support not only among voters in austerity-ridden Europe but also in some influential areas. According to Re-Define, the think-tank set up by former investment banker Sony Kapoor, it is life-changing, skewed bonuses and incentives that have driven excessive risk-taking among traders, promoted marginal, sometimes value-destroying merger deals by investment bankers and the sale of inappropriate products by retail bankers. Support for a type of bonus cap as a tool for
limiting bank risk has also come from academics such as Dr John Thanassoulis at Oxford University. He argues that if banks were prevented from paying out more than a fixed proportion of their shareholder equity in bonuses, pay at the weakest institutions would be restrained, the bonus “arms race” between banks would end and banks would still have flexibility as to how they motivate and reward individuals. More generally, however, the bonus cap has
come in for fierce criticism in London. “This cap will not be effective at all in reducing risk”, says Carl Sjöström, head of executive reward at Hay Group.
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“Unless there are wider changes in banks, there will still be high earners taking high risks. All the bonus cap will do is increase fixed pay at a time when pressure on pay in the sector has been downward. Freezing incentives will lead to bizarre pay structures where some top earners are overpaid and, because a bigger proportion of pay will be fixed not variable, cost structures will become more rigid and harder to manage in difficult times.” A recent poll of institutions attending Towers
Watson’s Global Financial Services conference supports Sjöström’s view that fixed pay will rise with over half of City HR professionals saying they expect higher salaries to rise to offset the shortfall in employee incentives.
Unintended consequences The bonus cap though could also have other perverse outcomes. “A cap will only force banks to do what they have done in the past and to look for other, more covert ways to reward employees whether it’s housing allowances, loyalty payments, holidays or yachts,” says Kent Matthews, Julian Hodge professor of banking and
Best Execution | Summer 2013
he Sword of Damocles that hovered menacingly over the pay packets of Europe’s bankers has finally fallen. Barring a major
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