The EU directive (CRD IV) applying a "cap" came into force in July 2013 and limits the level of any bonuses awarded to bankers to the value of their normal 'fixed salary' remuneration or, with special shareholder approval, to a maximum of twice their salaries. The directive's ostensible purpose is to avoid bankers being incentivised to attain inappropriate short-term goals which expose banks, their shareholders and the wider economy to excessive financial risk. However, the UK Government has argued that the measure may have an overall negative impact, suggesting that the cap could lead to key talent leaving Europe and/or simply drive up basic pay, meaning banks are stuck with high fixed costs even in difficult years.
The UK applied to the European Court of Justice to overturn the key provisions of CRD IV, raising six legal grounds for their annulment. Yesterday the court's legal adviser, Advocate General Jääskinen, released his opinion on those arguments, concluding that none of them had any legal merit. The ECJ does not always follow its Advocate General's advice, but it does in around three quarters of cases, and in this particular case the government's submissions were largely given short shrift.
One argument which the Advocate General recognised as having potential value suggested that regulating bankers' pay represented interference in social policy issues, and in particular, the right of national governments to set domestic rules on pay levels. The Advocate General's analysis on this issue focused on the fact that the rules only fix the ratio of variable to fixed pay, and therefore do not in fact limit or regulate the actual level of pay. In abandoning the legal challenge today, this point has in turn been seized upon, somewhat ironically, by George Osborne. He uses it to highlight his continuing dissatisfaction with the EU rules, because they do not in fact impose any such limit. He stated:
"I’m not going to spend taxpayers’ money on a legal challenge now unlikely to succeed. The fact remains these are badly designed rules that are pushing up bankers’ pay, not reducing it. These rules may be legal but they are entirely self-defeating, so we need to find another way to end rewards for failure in our banks."
Mr Osborne is now apparently focused on seeking agreement on some form of global standard, to support bankers' remuneration being structured in a way which encourages appropriate risk taking. This may include measures such as those floated by senior bankers to put more of the nominally "fixed" component of their pay at risk if decisions are taken which have bad consequences in the long term. Any such approach is likely to continue to be at odds with the present EU rules if it effectively increases the variable pay component. And, in the meantime, the current use by banks of "allowances" to supplement pay is much more likely to be tackled as a breach of those rules.
The government's emphasis on the need for a single worldwide set of standards is nonetheless telling, and explains its real motive for challenging CRD IV. The underlying concern is that one set of rules for London and another more "liberal" set for New York or other financial centres will simply lead to business moving to the more favourable location. As the Advocate General's opinion indirectly highlights, there is no barrier to the UK Government imposing whatever appropriate further limits or controls on bankers' pay it considers appropriate. However, despite the rhetoric about bankers' pay, it will not contemplate any such measures if they might lead international banks and other financial institutions to set up shop elsewhere than London.