European Parliament ushers in a new era for bankers' bonuses
07 July 2010
MEPs approved new rules on bonuses that will transform the bonus culture and end incentives for excessive risk-taking. They also cover areas such as stricter capital rules on bank trading activities and higher standards for re-securitisations.
MEPs on Wednesday approved some of the strictest rules in the world on bankers' bonuses. Caps will be imposed on upfront cash bonuses and at least half of any bonus will have to be paid in contingent capital and shares. MEPs also toughened rules on the capital reserves that banks must hold to guard against any risks from their trading activities and from their exposure to highly complex securities.
’Two years on from the global financial crisis, these tough new rules on bonuses will transform the bonus culture and end incentives for excessive risk-taking. A high-risk and short-term bonus culture wrought havoc with the global economy and taxpayers paid the price. Since banks have failed to reform we are now doing the job for them’, said MEP Arlene McCarthy (S&D, UK).
A different bonus culture
Upfront cash bonuses will be capped at 30% of the total bonus and to 20% for particularly large bonuses. Between 40 and 60% of any bonus must be deferred for at least three years and can be recovered if investments do not perform as expected. Moreover, at least 50% of the total bonus would be paid as ’contingent capital’ (funds to be called upon first in case of bank difficulties) and shares.
Bonuses will also have to be capped as a proportion of salary. Each bank will have to establish limits on bonuses related to salaries, on the basis of EU wide guidelines, to help bring down the overall disproportionate role played by bonuses in the financial sector.
Finally, bonus-like pensions will also be covered. Exceptional pension payments must be held back in instruments such as contingent capital that link their final value to the overall strength of the bank. This will avoid situations, similar to those experienced recently, in which some bankers retired with substantial pensions unaffected by the crisis their bank was facing.
Tougher treatment for bailed out banks
The law will introduce special measures for bailed out banks and it will restrain the overall amounts paid in bonuses, encouraging bankers to prioritise a stronger capital base and loans to the real economy rather than their own pay and perks. In particular, the rules provide that no bonuses should be paid to the directors of an institution unless this is duly justified.
Capital requirements for stable banks
Two other key issues covered by the new legislation are: stricter capital rules on bank trading activities and higher standards for re-securitisations. New capital rules for re-securitisations and the trading book will ensure banks properly cover the risks they are running on their trading activity, including for types of investments such as mortgage-backed securities that were central to the crisis. Studies show that the rules are expected to lead to banks having to hold three to four times more capital against their trading risk than they do at present.
Next steps
Following the plenary vote, Council will now rubber-stamp the deal, possibly on July 13. The rules on bonus provisions will then take effect in January 2011 and those on capital requirements provisions no later than December 31, 2011.
Pay principles for all listed companies
Separately, in a non-legislative resolution drafted by Saïd El Khadraoui (S&D, BE), Parliament calls for remuneration policy principles to be extended to cover all companies listed on stock exchanges. It proposes that listed companies be required to explain their remuneration policies if their directors' pay is deemed not to follow certain principles aimed at removing incentives to take excessive risk or to take decisions based on short-term considerations. The resolution also proposes that shareholders be given greater control over the directors of a listed company.
Finally, 'golden parachutes' handed to directors in cases of early termination should be limited to the equivalent of two years of the fixed component of the director's pay and severance pay should be banned in cases of non-performance or early departure, says the resolution, which was adopted by 594 votes to 24 with 35 abstentions.
