Inflexible views on flexible pay

In just 36 hours last week, a crack widened into a chasm between two key regulators on the issue of bankers’ pay. Closing that gap is going to take a very long time.

The public brawl between the European Banking Authority and the Bank of England’s Prudential Regulation Authority has happened because of a fundamental difference of philosophy, which, in turn, stems from a different definition of what problem needs solving.

The issue is, of course, allowances – the mechanism that banks have used to circumvent – yes, let’s be honest about it – the new European cap on bonuses. The European Banking Authority ruled last week that the vast majority of the payouts, which were supposed to sit somewhere between variable and fixed pay, should be considered as the former rather than the latter and were, therefore, not in line with Capital Requirements Directive, the document that contains the bonus rules.

Its position was an unpleasant surprise for the industry, which has employed armies of consultants, lawyers and HR staff for months crafting the allowance system. While the EBA’s guidance isn’t legally binding on firms, and further remuneration guidelines are expected at a later date, the EBA expects national regulators to listen to its views and make them a reality in their own country.
A day after the EBA made its pronouncement, however, Andrew Bailey, the chief of the Bank of England’s Prudential Regulation Authority, pretty much blew a raspberry at the EBA. Public disagreement between regulators is very rare – the public slap is an indication of how fiercely the PRA feels on the issue.

‘The wrong policy’

Speaking at Mansion House, he described the bonus cap as “the wrong policy”, saying that debate around it was “misguided”.

He added: “They are not a good solution. I will not win friends in some places for saying this but it dismays me to see a debate which is at times so divorced from the heart of the matter, which is setting appropriate incentives by putting a meaningful amount of pay at risk.”
And there is the rub. The PRA wants banks’ cost base to decline if the bank falls on hard times. And it wants bankers to feel like they have a stake in their company’s health and not be like civil servants whose pay isn’t affected by success and failure. The PRA doesn’t like the bonus cap and considers allowances, as Bailey puts it, “a response to a bad policy”.

The European Commission thinks bonus-hungry bankers helped trigger the financial crash. It wants the whole bonus culture constrained. It thinks allowances are simply bonuses rebranded. It thinks they make banks more risky.

Indeed, the EBA itself alludes to the argument for cost-flexibility in its report. This argument is dismissed, in what some consider to be a direct attack on the UK’s position.

The report reads: “These allowances are also at least indirectly linked to performance as they are intended to retain cost-flexibility. Such allowances do not promote sound and effective risk management and are not in line with Articles 74 and 92(2)(a) of the CRD.”
The UK government is already challenging the bonus cap in the European Court of Justice. This, plus the latest disagreement, means most believe the UK PRA will push back on the EBA’s ruling and ignore the December 31 deadline set out in its report. That is likely to further enrage those in Europe who think the UK is allowing banks to dodge the bonus cap.

There’s a lot of inflexibility on both sides on the issue of flexible pay. Expect the argument to run to the bitter end.