UK regulators exempt small banks from bonus cap

UK regulators will not apply the European Union's cap on banker bonuses to smaller lenders as they pose fewer risks to the financial system. Under EU rules, all bonuses should be no larger than fixed pay but can rise to twice that amount with shareholder approval; London has the largest number of bankers hit by the cap which extends to asset managers in a banking group. The Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) have told the European Banking Authority (EBA) that they disagree with a blanket application of the bonus cap rule on all firms, interpreting the EU law as allowing for flexibility in relation to size and complexity of a lender. However, it should be noted that the EBA referred on Monday back to an announcement it made last year stating that the cap should be applied to all without exemptions; furthermore, the European Commission has powers to take a member state to court for not complying to the EU rules.

More than 1,000 fund managers, hedge funds, brokers and smaller banks will be exempt from the EU’s bonus cap after the Bank of England said it had concluded they did not fall within the scope of the rules.

The cap limits bonuses to one times salary – or twice if shareholders approve – and is opposed by the Bank, which argues that it pushes up fixed pay and makes it harder to claw back bonuses when things go wrong.

The Bank has told the European Banking Authority, which oversees European banking regulation, that is does not intend to broaden coverage of the cap beyond 100 or so City firms because it does not believe the others are big enough to need to comply.

The bonus cap was introduced two years ago in response to the financial crisis when it was argued huge bonuses had encouraged managers to take risks that put the stability of the entire banking system in jeopardy.

The move to limit the cap to the biggest banks in the UK has been prompted by guidelines issued by the EBA at the end of last year, when it pointed out that countries across the EU were making their own exemptions to the rules, including the UK.

A spokesperson for the European commission – which can take action against countries breaching directives – said it would look at the information provided by the EBA. “At this stage it is too early to talk about whether or not to launch infringement proceedings. The commission needs to first carefully look into and assess the detailed information provided by EBA.”

As it announced it had told the EBA that it was continuing with its decision to exempt firms, the Bank said: “Since the introduction of the bonus cap, a number of firms have markedly increased fixed pay as a percentage of total pay, while total pay remained stable during the same period.”

In its joint statement with the Financial Conduct Authority, the Bank said that UK regulators “believe that the shift to fixed remuneration makes it more difficult for firms to adjust variable remuneration to reflect their financial health, and limits deferral arrangements that put remuneration at risk should financial or conduct risks subsequently come to light”.

The EBA has supported some changes to the rules, such as amending the EU directive to exclude small firms and employees who are paid bonuses that are small compared with their salary, along with requiring bonuses to be deferred over a number of years.

The EBA has also delayed the final guidelines on implementation of the rules across the EU by a year to January 2017 to allow time for changes to be made. The remuneration rules are currently being reviewed by the European commission.

Andrew Bailey, deputy governor of the Bank of England, said he had discussed the issue with his European counterparts. “The Prudential Regulation Authority [regulator] attaches a great deal of importance to the principle of applying policies in a proportionate manner consistent with the legal provisions,” he said.

“We have followed the principle of proportionality, which in practice means that smaller firms which pose less risk to the safety and soundness of the financial system face lower regulatory requirements. This is a sensible outcome.”