Under the agreement, bonuses will be capped at a year’s salary, but can rise to two year’s pay if there is explicit approval from shareholders. It is also important to note that the impact will be partly softened by giving more favourable treatment to long-term deferred pay linked to the health of a bank, which is now a part of all banks’ bonus schemes.
Capping bonuses in this way may be applauded by many who see bankers’ bonuses as a fundamental cause of the financial crisis, but the public and politicians should be careful what they wish for. If the scope of bonuses is limited, the likely result will be significant pressure in the City to increase bankers’ basic salary. Ironically, having more of their package guaranteed in the form of salary may empower bankers to take more rather than less risk because their pay will not be so dependant on results. Legally, banks have a very wide discretion when deciding bonuses and can take many factors into account, including personal performance and the overall performance of particular business areas or the bank as a whole. Fixed salary is payable regardless of results and it is very difficult not to pay an employees’ salary (or a portion of it) without facing legal claims (either for breach of contract or an unlawful deduction from wages).
The current bonus rules contain many safeguards, including the ability to defer and claw back bonuses. This would seem to be a better way of ensuring that banks and other financial institutions control their risk as it enables employers to take expected financial performance into account when setting bonuses and to reduce or claw back bonuses if actual performance is worse than expected. In recent months banks appear to be increasingly willing to use these powers, but they will be weakened or even obsolete if a strict, low salary to bonus ratio is introduced. The EU is in danger of throwing out the baby with the bathwater.
In any event, according to Federation of European Employers (FedEE) the capping of bonuses is beyond the powers vested in the European Union under the EU Treaty as Article 153 (5) of the Treaty clearly states that EU legislative powers shall “not apply to pay”. This may overstate the position as the prevailing view is that, although Article 153 (5) states that EU legislative powers shall “not apply to pay”, this only prevents the EU from setting limits on overall pay amounts rather than enforcing fixed ratios between fixed and variable pay. However, there is scope for argument and it may be that we see a legal challenge to the EU’s proposals. In the current climate, it would seem likely that the European courts would side with the EU in its interpretation of Article 153 (5).