Drop a cap on bankers’ bonuses? UK is playing with fire

The bonfire of nonsense. Britain’s Chancellor of the Exchequer, Kwasi Kwarteng, is pulling no punches with his first steps into power. First, he bluntly fired the top Treasury official. He now plans to ax European Union financial services regulations. But he starts the latter in a very strange way – wading into the politically sensitive area of ​​bankers’ pay and possibly removing the bonus cap (currently at double the salary) that the EU introduced in 2014 in a belated response to the global financial crisis.

It looks like an ideological vice signal for a microscopic number of beneficiaries. Focusing on the salaries of the wealthiest would certainly send the message that trickle-down economics is driving the new government’s growth agenda.

The principle is sound: governments should not intervene in the area of ​​wage caps. No other sector has these restrictions, and the Bank of England has always made it clear that it is against the bonus cap. But the moment is absolutely terrible. Deciding to clean up an old piece of bureaucracy now is deaf in the midst of a cost of living crisis and risks further aggravating the EU when tensions are already high.

Financial services contribute around an eighth of the UK’s gross domestic product, but the vital industry was singularly ignored during Brexit negotiations. A new approach to the ‘crown jewel’, as Prime Minister Liz Truss puts it, is long overdue, but coming to bonus limits may prove counterproductive for the true prize the City of London aspires to – regulatory equivalence, or playing field level, with the EU.

Dangling carrots on bankers’ pay will butter few parsnips in Brussels, which is already sensitive to the prospect of the UK tearing up the rule book and creating a regulatory-light “Singapore-on-Thames”. The vast majority of European banks are sticking to the single bonus cap because shareholders must specifically approve lifting the limit to twice salary, which very few boards have decided to defy. Meanwhile, most UK banks have moved to the higher option over time.

If dropping the bonus rule is seen as a blatant regulatory discrepancy, it could backfire dramatically and ruin a much larger financial services equivalence agreement with the EU.

There are, of course, potential benefits to unwinding much of the MiFID II legislation that came into force in 2014. (Brussels is even abandoning some elements as well.) While this is only part of the Britain’s Big Bang 2.0 package to improve the City of London’s competitiveness, then there may be broader merits, although it is difficult to pinpoint the specific benefits of relaxing pay rules. More details could be released at Kwarteng’s “tax event” scheduled for Friday.

As a stand-alone measure, however, the loss of bonus caps would be little game-changer for overall compensation. It could change the way banks reward their rainmakers. But if that means reducing base salaries in favor of a greater weighting of variable bonuses, that could actually lead to lower overall pay in lean years, which, uh, we’re in right now as transaction volumes are decreasing. There are also potential consequences for high-end house prices in London, because if base salaries fall, wealthy bankers will have a much harder time getting those monster mortgages.

In recent years, bankers’ salaries have also often been supplemented with an additional allowance to circumvent the bonus cap. These were not accompanied by rights to pensions or other benefits and can easily be reduced or withdrawn. So very few bankers will suddenly be paid more. While the added tax of higher premiums is welcome, is it really worth it for the negative press? No wonder the last three Conservative prime ministers have avoided the issue.

Yet, while it raises questions about government priorities, the case for removing the cap is strong. Much more effective measures to control excessive risk taking have been put in place, so there is no regulatory justification for maintaining the cap. The Financial Conduct Authority will always keep a very close eye on compensation.

More importantly, the removal of the bonus cap would make it easier for major US banks to rearrange fixed salary costs and transfer employees to London. This should help stem the tide of top traders leaving for hedge funds. And it removes a hurdle for UK-domiciled banks in compensating overseas employees in competitive compensation markets like New York or Hong Kong (although local leases are much more common in the industry now, to manage costs and get around issues like bonus caps).

The UK therefore has much to gain from increasing the city’s global appeal, especially as Covid restrictions in Asia have led to a series of banker relocations. But rule changes must focus on ensuring a better place to do business overall, so it can attract institutions, not just individuals.

The EU could retaliate. The Netherlands has probably been the biggest net beneficiary of the transfer of financial services activities from the City to the EU, particularly in derivatives and IPOs, but it remains paralyzed to attract the best talent in due to their fixed compensation bonus rule of 20% maximum.

With just two years to go until a new general election is called in the UK, concrete action on the new growth agenda is urgently needed. Did anyone mention global Britain, the nation of aspiration and Brexit dividends? The horn alerts are deafening, as Liz Truss aims for a clear blue-red divide between the Tory’s tax cuts and the opposition Labour. But ditching bonus caps may be a political giveaway that writes straight into Labor election leaflets, because making life easier for bankers isn’t the kind of leveling most voters are considering.

The remuneration of bankers is never less sensitive. It is sometimes better not to touch anachronistic rules, however erroneous they may be. At least until the time is right.

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was Chief Market Strategist for Haitong Securities in London.

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