One of the few proposals to survive from Kwasi Kwarteng's Growth Plan in September 2022 is the abolition of the so-called bankers' bonus cap. We take a look at the consultation paper that has just been published.
Since the 2007/08 financial crisis, firms in the financial services sector have been subject to extensive reforms. A principle aim of those reforms was to align the remuneration practices in financial services firms across the EU by requiring those firms to ensure that their remuneration policies and practices are consistent with, and promote, sound and effective risk management.
Banks, building societies and investment firms regulated under the EU Capital Requirements Directive (CRD) have been subject to restrictions on the structure and timing of payments of variable remuneration (such as cash and share incentives and bonuses) to their staff since 2009. In 2014 those restrictions tightened as the largest and most systemically important CRD regulated firms became subject to the bonus cap. The bonus cap required those firms to ensure that the variable remuneration they paid to material risk takers (staff whose activities potentially expose the firm to risk) did not exceed 100% (or with shareholder approval 200%) of their fixed remuneration (i.e. salary, routine allowance and benefits). From 2020 all CRD regulated firms – other than small and non-complex firms – were required to apply the bonus cap.
On 19th December 2022 the UK regulators – the Prudential Regulation Authority and the Financial Conduct Authority - published a joint consultation paper CP15/22 - Remuneration: Ratio between fixed and variable components of total remuneration ('bonus cap') Bank of England setting out their proposal to abolish the bonus cap. This will take effect for most firms from the 2024/25 performance year.
The introduction and extension of the bonus cap were controversial. The UK regulators in particular were concerned that the bonus cap would lead to an upward spiral of fixed remuneration resulting in a number of undesirable (albeit unintended) consequences. The consultation paper provides evidence of the increase in fixed remuneration as a result of the bonus cap which, in turn, has increased firms' fixed costs, reduced flexibility and adversely affected competitiveness. The UK regulators also highlight that the bonus cap has limited the overall effectiveness of the remuneration rules – the increase in fixed remuneration means that a smaller proportion of staff's total remuneration is performance linked.
The lifting of the bonus cap is also controversial, particularly during the current cost of living crisis. A key question is whether the removal of the cap will see a return to the excessive risk taking practices that resulted in the 2007/08 financial crisis.
This is unlikely. Firms will still be required to set an appropriate ratio between fixed and variable remuneration for key individuals to ensure that the level of fixed remuneration is sufficiently high to allow for the possibility of paying no variable remuneration if justified in the circumstances. The regulators accept that the ratios between different categories of staff could differ depending on their role and the potential for excessive risk taking. While variable remuneration will increase, that will mean that a greater proportion of total remuneration will be subject to the "payout process" rules. These rules require:
- the payment of variable remuneration to be deferred over a number of years;
- a substantial proportion of variable remuneration to be paid in non-cash instruments; and
- the application of malus and clawback in the event of a material downturn in the firm's financial performance, a material failure of the firm's risk management procedures or the staff member's serious misbehaviour or error.
The consultation closes for responses on 31 March 2023.
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