Bonus Cap Shows How Brexit Vote Ties Banking Rules in Knots

  • EU rules set limit on variable remuneration at twice fixed pay
  • U.K. banks and policy makers say the rule skews incentives

British banks and their regulators are united in their hostility toward the European Union’s bonus cap. Thursday’s referendum on U.K. membership of the EU would seem to provide an opportunity to scrap the rule, but the reality is far from clear-cut.

The limit on bonuses at twice fixed pay has been around since 2014. U.K. banks including Barclays Plc and HSBC Holdings Plc led the way in trying to circumvent it. Bank of England Deputy Governor Andrew Bailey disparaged the rule as “bad policy,” and Chancellor of the Exchequer George Osborne tried unsuccessfully to overturn it in the EU’s top court.

If the U.K. quits the EU, its freedom to ax the cap embedded in the bloc’s prudential rules for banks could be constrained if the British government wanted to retain access to the single market, since that would require equivalence with EU rules. If it stays, the U.K. could step up efforts to get rid of the limit as part of the European Commission’s review of the post-crisis financial-regulation framework.

“In theory, equivalence is all or nothing, so if the U.K. gets rid of any part of the bank directive, including the bonus cap, then it ceases to be equivalent,” said Simon Gleeson, regulatory partner at Clifford Chance LLP in London. “It is fairly clear that equivalent does not mean identical, so there is scope for minor differences, but I personally do not think that the EU would regard this as a minor difference.”

‘New Settlement’

Financial and related services accounted for 11.8 percent of U.K. economic output, or 190 billion pounds ($278 billion), in 2014, and quitting the EU could cost as many as 100,000 jobs in the sector by 2020, according to industry group TheCityUK. With so much at stake, Prime Minister David Cameron made defending the City of London a priority in his talks earlier this year on a “new settlement” for the U.K. within the bloc.

“Responsibility for supervising the financial stability of the U.K. will always remain in the hands of the Bank of England,” he said in presenting the agreement to the House of Commons in February. But the BOE’s ability to make significant alterations to financial regulation may be limited whatever the outcome of the referendum.

If Britain leaves the EU, it would still expected to remain in line with regulators such as the Basel Committee on Banking Supervision that set global standards for the industry. The BOE’s Bailey has said there will be no “bonfire of regulations” upon a U.K. exit in part because it would be held to Basel standards.

Single Market

The Basel Committee doesn’t set remuneration rules, however. The EU’s bonus cap was part of the post-crisis backlash against bankers pocketing astronomical bonuses by loading up on risky assets and handing the bill to taxpayers when their bets blew up.

Yet after “Brexit,” the BOE would still have to contend with EU law if the U.K. government sought to maintain access to the single market.

Banks in the U.K. would probably lose the so-called passport that allows firms based in one country to operate in the others unless the government opted to join the European Economic Area, comprising the EU countries plus Iceland, Liechtenstein and Norway.

That, however, would entail adopting some EU legislation and allowing the free movement of people from the EEA into Britain. The campaign for “Brexit” has made taking back control of Britain’s borders a key part of their message.

‘No Possibility’

In the event the U.K. votes to leave, there is “no possibility” of retaining passporting rights, Gleeson said.

The next best thing would be for the U.K. to have rules in particular areas deemed equivalent to those in the EU, allowing British firms to sell services in the single market without penalty and while being supervised in the U.K. This may exclude the possibility of ditching the bonus cap.

Nicola Higgs, a regulation partner at Ashurst LLP in London, said that while the bonus cap may not prove a game-breaker in equivalence talks, she’s “pretty skeptical” that the U.K. “would drastically row back from the current European position” on remuneration at financial firms. “I certainly don’t think the U.K. regulators want to be seen as light-touch regulators,” she said. “They want to be seen as being as stringent as ever.”

Unintended Consequences

If Britain stays in the EU, it could pursue a removal of the bonus limit as part of the European Commission’s review of all financial-services legislation. Jonathan Hill, the commission’s British member who’s in charge of financial-services policy, has made clear that he’s prepared to fix rules that have had unintended consequences or impeded the push for jobs and growth.

What’s more, Hill told the U.K. Parliament’s Treasury Committee in March that a bonus cap can skew incentives by increasing fixed at the expensive of variable pay, a point often made by British policy makers. He reminded the committee that the cap wasn’t the commission’s idea to begin with, and that if he’d been in the job at the time, he wouldn’t have proposed one.

This doesn’t mean that the bonus cap would fall if the U.K. remained in the EU to push it. After all, British lawmakers in the European Parliament helped to put the limits in place, and many in the assembly would probably resist if it came under attack.

Right Balance

And the political divide on the bonus cap exists not only between the EU and the U.K., but within Britain itself, with the Conservatives siding with government and the Bank of England, and Labour insisting on the rule’s importance.

“It seems clear that the bonus cap has not had the desired effect and that a re-evaluation of this proposal by the Commission would be welcome,” said Syed Kamall, a Conservative member of the European Parliament. “I would hope that the Commission would take on board these views and act appropriately.”

On the other side of the aisle, Labour MEP Anneliese Dodds said the Commission “is rightly looking at the whole landscape of financial regulation to make sure that it has got the balance right. One thing I will be making sure that the Commission does in that process is to continue to prioritize financial stability and consumer protection. The bankers’ bonus cap has been an important part of that.”

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