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The writer is the author of several books on the City and Wall Street
The abolition of a bankers’ bonus cap in the UK last week sets up a classic “heads we win, tails we win” scenario for the financial services industry. But the error was the EU’s imposition of the cap, not the Bank of England’s repeal. What were the consequences of the original measure and what, if any, are the benefits of its withdrawal?
The cap was imposed in 2014 when post-financial crisis sentiment was still very raw. New European banking laws were generally in line with global standards, but into the package policymakers slipped a bonus cap that would apply to some bankers doing financial services business in Europe. Bonuses would be capped at 100 per cent of salary for material risk-takers and their managers, rising to 200 per cent with shareholder approval. No other major financial jurisdiction followed suit.
George Osborne and Mark Carney, respectively UK chancellor and Bank of England governor at the time, protested vehemently, arguing that the measure would increase risk by prompting banks to raise fixed costs to compensate for reduced variable pay. But the bonus cap played to Europe’s banking critics, and there it stayed.
In the years that followed, financial institutions increased salaries and introduced special “role-based” allowances for material risk-takers. The risk-takers were protected from bad years in which they might otherwise have been given low bonuses and institutions’ fixed costs went up. It was all entirely unnecessary since other post-crisis reforms, including bonus deferral and clawback, reduced the systemic risk of take-the-money-and-run trading, which was the intended target of the bonus cap.
When the UK left the EU in 2020, Brussels changed the terms of trade, making no concession to the financial services industry which the UK dominated. UK-based financial institutions now need European footprints to operate there, and a steady trickle of jobs and more than a trickle of trading business migrated to Paris, Amsterdam and Frankfurt. For a British economy in need of growth, any threat to a prime industry such as financial services had to be taken seriously.
In 2022, chancellor Jeremy Hunt introduced a package of reforms intended to make the City a more attractive place to do business, including a Bank of England-led consultation on the bonus cap. There was an underwhelming total of just twelve responses to the consultation but nearly all were in favour of abolition, and the cap was duly scrapped last week.
The authorities believe it will improve the City’s global competitiveness and restore financial institutions’ flexibility to reduce fixed costs. I am not holding my breath on either front.
Let’s address competitiveness first. The bonus cap applied to British financial institutions doing business worldwide and foreign banks doing business in the UK. Following its scrapping, UK-domiciled global banks such as Barclays and HSBC, which previously paid some overseas-based staff high salaries to compensate for capped bonus packages, will be able to provide pay which is more in line with the local market.
The likes of Goldman Sachs and Morgan Stanley will be able to apply standard Wall Street practice to staff working in the UK, which will make London a slightly more convenient place to locate risk-takers than Europe — at least until the EU also scraps the bonus cap, as it surely will. But these are matters of administrative convenience, not competitive game changers.
Flexibility next. In theory, financial institutions can now negotiate down material risk-takers’ basic salaries in return for the promise of more performance-related pay. The new rules apply to the current financial year, a period in which trading businesses have been patchy and investment banking revenues flat. Credible demands for cap-busting bonuses should therefore be the exception rather than the rule and the answer to them should generally be “no”.
Clever management might even be able to negotiate lower salaries against the promise of higher bonuses in future. But star traders and bankers hold many of the cards in what many regard as their most important trade of the year. It is therefore likely that salaries that were doubled and even trebled to get round the cap will become baked-in, becoming the new base from which future uncapped bonuses are calculated.
Less than four months ago, Hunt and Bank of England governor Andrew Bailey called for pay restraint at the City’s Mansion House dinner. Regulators will doubtless be reinforcing this message as bank managements sit down to divvy up the year-end bonus pool.
There is no good time to reform a misguided (albeit well-intentioned) post-crisis measure that became a golden ticket for the lucky few. The authorities were right to tackle the problem and it is now up to the industry to behave responsibly in return.