THE DIRECTIVE EXPLAINED
Q.WHAT IS THE LAW CALLED, AND WHAT ARE ITS KEY POINTS?
A.The European Union measures on bonuses are contained within the third draft of the Capital Requirements Directive. As well as curbing pay practices at banks and hedge funds, the law requires higher capital buffers to be held against proprietary trading positions.
Q.WHERE DOES THE DRIVE FOR TIGHTER RULES COME FROM?
A.The aim in both bonus and capital rules is to reduce unnecessary risk-taking by bankers and traders. Labour MEP Arlene McCarthy said the rules would “transform the bonus culture and end incentives for excessive risk-taking”. In theory, the financial meltdown of 2008 – when many banks around the world had to be rescued by governments – is the genesis of the crackdown, but in practice MEPs openly admit they have wanted to bring in such changes for some time.
Q.WHAT ARE THE DETAILS OF THE BONUS REGULATIONS?
A.Only 30 per cent of an upfront bonus can be paid in cash, falling to 20 per cent for larger bonuses – to be determined by the European Union’s national bank supervisors. At least half a bonus has to be paid in a combination of shares and contingent capital, and at least 40 per cent of a bonus must be deferred for three to five years, rising to 60 per cent for a large bonus. The curbs will apply to senior managers and people designated as risk takers.
Q.WHY ARE HEDGE FUNDS INCLUDED IN THE PAY CURBS?
A.Although European lawmakers acknowledge alternative asset managers were not directly responsible for the onset of the credit crunch, they argue hedge funds benefited from the stabilisation of the financial system through taxpayer bailouts in 2008. Every hedge fund operating under the Markets in Financial?Instruments Directive is covered by the law just passed by the European Parliament. Those not covered will still be caught under the forthcoming Alternative Fund Managers Directive, which will have the same remuneration restrictions. National regulators will have discretion over ways in which the rules are applied to hedge funds, which is important as they are often structured differently to banks and may not be able to pay employees in shares or contingent capital.
Q.WHAT HAPPENS IF A FIRM BREAKS THE RULES?
A.National watchdogs such as the Financial Services Authority, or the Bank of England
in two years’ time, will be obliged to punish offenders. A typical deterrent would be forcing an institution to hold more capital on its balance sheet.
Q.WHAT ARE THE IMPLICATIONS FOR BRITISH BANKS?
A.British banks have moved faster than their counterparts anywhere in the world to bring in G20-approved guidelines on pay, deferring the bulk of awards over a period of several years and linking bonuses more closely to performance. As a result, the law has much tougher implications for French and German institutions which are now playing catch-up. However, lobby groups such as the British Bankers’ Association are concerned that firms could move en masse out of Europe because the region is introducing a regime far tougher than those of the US or Asia.
Q.WHEN DO THE MEASURES TAKE EFFECT?
A.The stricter guidelines on bonuses come into effect from next January, but will cover awards for 2010. The tougher capital requirements against trading positions will come in “no later than 31 December 2011”.