Strong British Case in EU Clash over Banking Bonuses

Strong British Case in EU Clash over Banking Bonuses

The UK is taking legal action against the EU, the cause being disagreement over banking bonuses. It is another case among a flurry of legal actions against EU rules, such as the bans on short-selling of shares, the plan to tax financial transactions in some EU states and another plan that would require clearing houses that deal with large amounts of euro-denominated assets to be based within the single currency area.

It is hardly news that the City is discontent with regulatory constraints imposed by EU, but it may have surprised most to find that there was political backing for protecting pay freedom in finance. After all, public opinion probably disagrees with the City on the topic of bonuses – at least the size of them. Arguably, one of the few things that are less popular than excessive pay with the Brits is the EU. The Treasury argues that a cap on bankers’ bonuses will end up hurting stability by pushing up fixed salaries instead, thus isolating bankers from the consequences of their performance.

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 and not 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, not promote it.

The Treasury said, “Regulation of pay in this manner goes beyond what is permitted in the EU treaty. 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.”

Specifically, the government has compiled a list of 6 points, which are believed to prove that the cap is unfit for its purpose. By and large, the critique aims at highlighting how the cap is “rushed and untested”, involves “insufficient data protection” and is “wrongly applied outside the European Economic Area (EEA), and unlawfully delegating to the European Banking Authority (EBA), seeing as it concerns policy, not technicality”. What is here considered policy is the fact that the EBA has to decide on which staff to apply the bonus cap. The financial sector has lobbied against the caps, citing similar concerns as well as emphasizing the potential brain-drain from European banks to counterparts in US, Asia and elsewhere.

Would it in fact make banking more risky to regulate the bonus schemes, and is it within EU’s power to do so?

Incentivized bonus pay led to excessive risk taking in the years before the financial crisis. If the cap indeed entails an increase in fixed salaries, it seems likely that it would be even harder to cut pay in times of stress or claw back if a bank suffers financial headaches. According to British Bankers’ Association, increases in individuals’ fixed pay are already happening.

Othmar Karas, member of the Committee on Economic and Monetary Affairs, sees the British backlash as an attempt at blocking a necessary and overdue change in the culture within the finance sector. While bonuses are probably part of this culture, it is hardly the triggering factor in the financial crisis, and of all the aspects that could be regulated in finance, pay schemes seem less relevant than ensuring proper risk assessment of new financial products, transparency in financial advice, and independent rating agencies, preferably incentivized to rate products and institutions realistically. Arguably, capping bonuses may reduce the susceptibility of bankers being tempted by short-term, risky profits, but the causality is far from clear.

Aside from the questionable effectiveness, the UK may have a justified charge against the EU. Alexandria Carr, a lawyer at Mayer Brown, said EU treaties “expressly prohibit the EU regulating pay as part of social policy and so it could be argued that the remuneration provisions…infringe this.” However, bonus caps do not regulate total pay and build on “unchallenged remuneration provisions” contained in existing EU law. Thus, it looks like the British go to court with a fairly solid case, and the Court of Justice has indeed expressed a preliminary recommendation that London’s claim is upheld. It all depends on whether bonuses can be interpreted as part of pay or not.

Categories: Europe, Finance

About Author

Mikala Sorenson

Mikala Sorensen is an Economist with regional expertise in Europe. She holds a first class honours degree in Philosophy, Politics and Economics from the University of York and a Masters in Economics from the University of Copenhagen. Having interned at the Danish OECD-delegation in Paris and currently working at the Danish Ministry of Finance, she specialises in politics and macroeconomics. Analysis for GRI is an expression of her own views.