UK Government begins legal challenge against new EU rules on bankers' pay and bonuses

It has begun a legal challenge against the new rules, which are due to apply to bonuses paid from the start of 2015 reflecting performance in 2014, at the Court of Justice of the European Union (CJEU).

The action is based on the compatibility of the bonus cap provisions with the EU Treaty, and whether powers delegated to the European Banking Authority (EBA) go beyond its remit to set technical standards. It is the fourth recent challenge to EU financial services legislation by the UK, following similar actions in relation to the Short Selling Regulation and the proposed Financial Transactions Tax.

"Regulation of pay in this manner goes beyond what is permitted in the EU Treaty," a Treasury spokesperson said. "That's why we are challenging these rules in the European Court, to ensure the legislation respects the EU Treaty and actually achieves what it's meant to: a more stable banking system that serves the economy, businesses and consumers."

"Britain has been at the forefront of global reforms to make banking more responsible, including big reductions in upfront cash bonuses and linking rewards to long-term success. These latest EU rules on bonuses, rushed through without any assessment of their impact, will undermine all of this by pushing bankers' fixed pay up rather than down, which will make banks themselves riskier rather than safer. In other words, as the Chancellor has said, they may undermine responsibility in the banking system rather than promote it," the spokesperson said.

The new rules form part of a package of measures designed to bring European banks into line with the Basel III international banking agreement. They will limit bonuses to 100% of salary in any given year, or 200% of salary with the agreement of shareholders. In addition, a minimum of 25% of any bonus exceeding 25% of salary will have to be deferred for at least five years.

In a statement, the Treasury said that action taken by the UK Government had already resulted in "real improvements in the alignment of bankers' pay with risk and performance", including a "substantial reduction" in upfront cash bonuses. The Centre for Economic and Business Research has estimated that bonuses paid by firms in the City of London fell by more than 60% between 2011/12 and 2012/13, and are now more than 85% lower than the £11.5 billion estimated to have been paid in 2007/08.

The Government has also pledged to implement recommendations made by the Parliamentary Commission on Banking Standards (PCBS) in relation to pay and performance. The PCBS, led by Treasury Select Committee chair Andrew Tyrie, recommended the creation of a new Remuneration Code for senior bankers, under which more remuneration would be deferred for much longer periods and paid in forms which favour long-term performance.

Incentives expert Matthew Findley of Pinsent Masons, the law firm behind Out-Law.com, said that although doubts had consistently been expressed about the legal basis for the bonus cap, most commentators had thought that a formal legal challenge from the UK Government was unlikely "partly for domestic political reasons and partly because it was thought that the European courts would look to back the political will of Brussels".

"Both commentators and industry alike will be keen to know how the challenge being made on prudential grounds will be addressed, give the expectation that many banks are looking at ways to push up fixed pay so as to maintain overall reward levels," he said.

The UK Government has said that it will implement the provisions once they come into force despite its legal challenge, due to its "obligations under EU law".