MELBOURNE - 14 March 2013: Financial scandals such as the manipulation of Libor by a number of global banks and the manipulation of payment protection insurance in the UK have been coming with something of a rush in recent years.  Many global financial institutions have found themselves investigated and sanctioned by agencies such as the US Department of Justice (DOJ) or the UK Financial Services Authority (FSA).  Some of the financial institutions who have encountered regulatory retribution include: Barclays; Goldman Sachs; JP Morgan; Lloyds; RBS; Standard Chartered; and UBS.  Bankers and stockbrokers also have found themselves placed in the dock of public opinion as part of widespread public outrage about perceived abuse of community trust and financial regulatory infrastructures. 

Typifying this outrage are the hundreds of thousands of angry investors who have been mis-sold payment protection insurance by UK banks.  The total number of customers mis-sold payment protection insurance is not yet finalised but is likely to be more than 1,000,000 and the total costs of compensation payment costs set aside by UK banks already exceeds £12 billion.[1]  Little wonder then that public opinion polls reveal that financial professionals rank fairly low in public esteem.  For example, a November 2012 poll of more than 1,000 adults by US pollster Gallup found that stockbrokers ranked 18 across a range of 22 professions in terms of perceived honesty and ethical conduct.  This placed them above advertising practitioners, Members of Congress and car salespeople, but below many others including insurance salespeople, lawyers and business executives.  Obviously, this is not conclusive in any way but it is an indicator of low public esteem.[2]

This contemporary disdain is not a new phenomenon, Bridbury notes that in the Middle Ages financiers were considered to be usurers and, ‘...universally deprecated and formally anathematised’.[3] However, one issue that seems to act as a touchpaper to contemporary flames of public outrage towards financial professionals is the scale of bonuses paid to many in the financial services sector, even after the carnage wrought by the Global Financial Crisis (GFC) in which global financial institutions have been widely viewed as the villains of the piece.[4]   That public outrage about what many viewed as obscene levels of remuneration for financial professionals manifested in support for a capping of the total amounts that could be paid to bankers.  For example in the UK opinion polls found that 76% of respondents supported a cap on bankers’ bonuses.[5]  In February 2013, that public moral outrage in the UK and elsewhere in Europe such as Greece, where violent protests against post-GFC austerity programs have become a commonplace occurrence,[6] morphed into a powerful legislative mechanism which has the potential to substantially reshape the incentives paradigm within national and international financial services.

On 28 February 2013, the European Parliament announced that it had provisionally agreed a deal to impose a cap on the remuneration that financial institutions in the European Union (EU) can pay.  The proposed basic salary: variable remuneration ratio would be 1:1.  This could rise to a maximum of 1:2 with shareholder approval, but would require the votes of at least 65% of the shareholders owning a minimum of half the shares.  Even if that shareholder approval is gained, then at least 25% of the variable remuneration must be paid in longer term deferred instruments with a minimum period of five years. Also, the risk posed by banks of over-leveraging would be reduced by requiring them to hold a minimum of 8% Tier 1 high quality capital and the proposed legislation would require banks to reveal profits made, taxes paid and subsidies received country by country.  These provisions would have to be implemented in the remuneration structures of banks headquartered in the EU and in the EU operations of non-EU headquartered banks.  The EU has announced that these provisions must be approved by Member States and the European Parliament which it expects to occur in the 15-18 April 2013 session.  Assuming that the legislation is approved, and the EU expects that it will be, Member States would have to include these rules in their national laws by 1 January 2014.[7]

The EU is yet to publish the detailed text of the legislation and it is not clear how national regulators will amend any existing rules.  The firms that are affected are likely to be those that fall within the scope of the Markets in Financial Instruments Directive (MiFID).[8]  Thus the current proposed arrangements regarding capping variable remuneration would not apply to other financial actors such as hedge funds and private equity that fall under the Alternative Investment Funds Managers Directive (AIFMD) which itself is required to be transposed in national laws by EU Member States before 22 July 2013.[9]  However, this situation may change in any EU political horse trading that may occur in the coming months if the bonus capping net is widened.

The proposed legislation may be the long-awaited game-changer in terms of incentive structures in finance, time will tell on that issue.  Assuming it is passed as proposed it is likely to generate pressure to reduce overall levels of pay to bankers and substantially increase base salaries.  It is not clear how the international competition implications may pan out and what this may mean regarding how financial organisations choose to domicile and structure their organisations, especially their trading divisions.  Certainly the UK Government mindful of protecting the competitive position of the City of London sought to dilute the reach of the proposed regime but was defeated by its fellow Member States in that endeavour.[10]  Other finance centres elsewhere may see these EU initiatives as a potential competitive advantage over London and other European financial centres.  Similarly there may or may not be significant repercussions for the career paths for individual financial professionals and the recruitment strategies of financial firms.  Michel Barnier the European Commissioner for Internal Markets and Services believes that the proposed reforms are a necessary and desirable brake on the excesses of bankers.[11]  In contrast some commentators believe that the proposed reforms largely miss their mark and will have little effect in practice.[12]    It is highly likely that the reforms will be passed by the European Parliament in a matter of weeks and in force in a matter of months, so we will not have to wait too long to see whether the EU bankers’ bonus cap fits market realities or not.