'No exemption' from bank bonus cap says EBA, as it confirms approach to ‘proportionality’ for smaller firms

These rules include the senior staff bonus cap, which is 100% of the individual’s salary or up to 200% where member states permit and shareholders agree. At present, smaller, less risky and less complex firms of all kinds can disapply some remuneration rules. However, only the investment firms and not the banks in those categories can disapply the bonus cap.

National regulators will, however, be allowed to exempt smaller institutions from some aspects of the remuneration rules set out in the EU's latest Capital Requirements Directive (CRD IV), if the European Commission and EU legislature accept proposed amendments to CRD IV set out in the EBA's final opinion on proportionality (29-page / 383KB PDF). Its final guidelines on sound remuneration policies (172-page / 1.2MB PDF) will now come into force one year later than planned, on 1 January 2017, to give firms sufficient time to make the necessary changes to their remuneration policies, the EBA said. This will also give the Commission, the Council of the EU and the European Parliament time to consider amending CRD IV as the EBA proposes. They are due to consider amending the CRD IV remuneration rules in 2016 already, under a provision of the Directive itself.

Firms and individuals covered by the EBA's proportionality opinion would not have to apply rules requiring payment of bonuses to be deferred for a minimum number of years, or for a percentage of the bonus to be paid in shares or share-like arrangements rather than cash, the EBA said. The EBA is also recommending some other alterations to CRD IV, including allowing listed firms to use "share-like instruments" (ie, cash-settled contractual awards that track share value) rather than shares, to partly pay senior staff bonuses, as required under CRD IV.

"It is now less urgent than feared for potentially affected firms to prepare for the expected withdrawal of the existing 'proportionality' disapplication of certain CRD IV remuneration rules for smaller, less risky and less complex firms," said remuneration expert Graeme Standen of Pinsent Masons, the law firm behind Out-Law.com. "It would be wise, however, for firms to make some provision for this in their 2016 remuneration documents, in order to prepare the ground to be able to comply from 1 January 2017 if necessary."

"Smaller, less risky and less complex firms will continue to press for some continuing relief for them from the bonus cap, which under the final guidelines will be imposed on investment firms in this category for the first time from 1 January 2017, even if the EBA’s legislative amendments are enacted." he said.

The regulator said that national supervisors' attempts to implement CRD IV in a proportionate way had created an "uneven playing field between institutions" across the EU. It said that clarifying the "specific exemptions" it would allow for smaller firms would lead to a consistent regulatory regime.

"The EBA believes that a proposal for legislative change should be considered to explicitly support specific exemptions on the application of deferral arrangements and pay out of instruments, where certain criteria are met," the EBA said in a statement. "In particular, it is the EBA's opinion that the disapplication of these requirements should be possible for small and non-complex institutions and for staff that receives only a small amount of variable remuneration."

"However, the opinion clarifies that the application of the so-called 'bonus cap' should not be subject to any exemption," the EBA said.

If the European Commission accepts the EBA's recommendations, it will have to draft legislation to give them legal effect. The EBA has not defined the 'small and non-complex' firms, or the 'small amount' of variable pay, that may be excluded from the full rules, but there are existing approaches to defining both for similar regulatory purposes.

The guidelines will apply on a 'comply or explain' basis, with national regulators given two months from their introduction to inform the EBA of their compliance or to explain why they have not complied or only partially complied. Although the EBA cannot take enforcement action against national regulators itself, it will be able to refer them to the European Commission if it is not satisfied with their reasons for non-compliance.

The CRD IV bonus cap came into force at the start of 2015, and restricts senior staff bonuses to 100% of their fixed remuneration in any given year, or 200% with the agreement of shareholders. The EBA has subsequently clarified that 'role-based allowances' (RBAs), paid to senior employees of banks and investment firms and "linked to the position and organisational responsibility" of the employee, should be included within the bonus cap and not classed as part of fixed pay packages.

The EBA's draft guidelines on the remuneration rules, which were published for consultation in March, interpreted the concept of 'proportionality' as included in CRD IV to take away the scope some firms had to escape the full application of the rules. Under the earlier CRD III, and the EBA's existing guidelines, proportionality was interpreted as allowing many "smaller, less risky and less complex" firms not to apply some of the rules to their pay arrangements, if appropriate.

The UK's Prudential Regulation Authority (PRA) has consistently objected to the introduction of a bonus cap as counter-productive, arguing that it will drive up fixed pay and therefore banks' fixed costs. Pushing up fixed pay also takes a much greater proportion of total pay outside the scope of 'malus' and 'clawback' provisions, which allow firms to reduce the amount of deferred variable pay or recover variable pay already paid on certain grounds.

"The EU bonus cap is the only aspect of the CRD IV remuneration rules that is not derived from the G20/Financial Stability Board (FSB) 'sound compensation' principles, and there are no similar provisions to the bonus cap in other jurisdictions that host major financial services centres," said Graeme Standen. "International Monetary Fund research pointed out previously that there was no evidence that the bonus cap would achieve its stated purpose, and a theoretical risk that it would thwart that purpose, in contrast to other, better-supported elements of the G20/FSB compensation principles."

"While the FSB's promised 2016 review of the efficacy and side-effects of various measures that have been adopted to better align financial sector remuneration with sound risk and prudential capital management will be welcomed by EU firms and advisers as a possible ally in seeking reform of the bonus cap, the proverbial caution about what you wish for should not be forgotten. Another item on the FSB agenda is likely to be the possible extension of malus and clawback to elements of fixed pay, as well as variable pay, at least for the most senior managers," he said.