The current cap in place for bankers’ bonuses comes from a piece of 2014 legislation in the European Union. It states that employees of (more specifically) banks, building societies and investment firms are not able to receive bonuses more than 100% higher (or 200% higher with shareholder approval) than their base pay (their guaranteed salary based on their employment contracts).
The UK’s financial regulators were opposed to the rule when it was first introduced way back in 2014, since it was seen to limit the competitiveness of member states. First, it was feared that banking talent would relocate and choose to work elsewhere (for example in the US, where no such legislation exists – a number of US outfits in London who still run a US-style compensation model were particularly unhappy with the introduction of the cap). Second, the idea of the banks themselves relocating to outside of the City of London (so that they could have more flexibility in determining their own pay structures) was also a serious concern.
Now, the Prudential Regulation Authority (under the Bank of England) has released a report following a lengthy consultation earlier this year on the issue. Prime Minister Rishi Sunak is apparently committed to seeing through the proposed removal of the cap (a passion inherited from his predecessor Liz Truss, whose chancellor Kwasi Kwarteng was very open about his discomfort towards the rule).
The main reasons that the report provides for removing the cap include the fact that the cap ‘has been identified as a factor in limiting labour mobility’.
The Prudential Regulation Authority have explained that a higher percentage of a banker’s total pay packet coming from a base salary rather than bonuses has decreased the flexibility of banks to easily adjust salaries based on factors that any successful business needs to be able to respond to. This is because base salaries cannot be easily adjusted based on factors such as employee performance, whereas bonuses almost always are. In the interests of maintaining healthy British business, the regulator feels that the cap therefore needs to be scrapped.
The main opposition to lifting the cap has been drawn from arguments surrounding public outrage over the idea of bankers being able to earn more. Labour leader Keir Starmer stated last year that this proposal from the Conservatives meant ‘pay rises for bankers, pay cuts for district nurses’.
Paul Nowak, general secretary at a major trade union organising body, similarly suggested that, ‘at a time when millions up and down the country are struggling to make ends meet, this is an insult to working people’. These sentiments were a major reason for Boris Johnson avoiding the idea of removing the cap (especially during the cost-of-living crisis).
The idea that the removal of the cap will automatically lead to higher salaries for those in the banking industry is not entirely straightforward, however – as already noted, salaries barely decreased when the cap was introduced. This is because only the proportion of bonuses against base pay did, so the total pay packets were essentially the same.
Another commonly cited reason for keeping the bonus cap is the reason that the EU introduced it in the first place – the stability of big finance. Following the financial crisis in the late 2000s, the EU felt that bankers needed to be more careful in taking risks (a theme which is still ongoing today – see the collapse of SVB after failing to diversify properly).
One of the primary reasons why bankers were so willing to take risks were the huge bonuses on offer if those risks paid off, and so the bonus cap was born. UK regulators have responded to these issues by attempting to find a middle ground, removing a hard bonus cap while introducing legislation controlling how banking bonuses can be issued (for example, they may be able to be removed in cases of poor performance).
This story is of significant importance to the legal industry, since lawyers in practice areas such as employment will now need to advise their banking clients on these updated guidelines. Areas such as banking and finance law need to understand how this will impact their clients’ business models, and even in areas such as M&A (mergers and acquisitions), this could cause prospective buyers of businesses in the banking area to think differently about the numbers involved.
Aspiring lawyers (whether looking to become a solicitor or barrister) will need to understand these kinds of developments in order to demonstrate their commercial awareness skills at interviews for opportunities such as vacation schemes and pupillages.
Finally, it is useful for aspiring lawyers to think carefully and creatively about the ethical issues that stories like this can generate – and how factors such as public sentiment might actually end up impacting their clients.
Here’s our round-up of commercial questions to challenge you to think about the wider themes and implications associated with this topic:
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