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The European Union (EU) today (Wednesday) approved one of the toughest worldwide bank pay regulations to date, hoping to rein in risk-taking and prevent another widespread financial crisis. However, in doing so, it increased the likelihood that financial firms would set up shop in other countries with less stringent regulations.
The European Parliament voted overwhelmingly for the restrictions, in a 625-28 approval at the Strasbourg, France meeting.
"The banks have had two years since the 2008 financial crisis to do this and have failed to act, so now we will do the job for them," Arlene McCarthy, a member of the European Parliament and the sponsor of the bill, said in an e-mailed statement to Bloomberg. "We want banks to focus not on their own pay and perks, but more on lending and support to economic recovery."
The new legislation limits the amount of cash a banker can receive to 30% of their total bonus – 20% for some higher bonuses. Some or all of the remainder will be deferred for up to three years and held as contingent capital, which could decline in value – or be forfeited altogether – if the bank's financial performance is poor.
Large cash bonuses for financial executives are thought to have encouraged excessive the risk-taking that led to the global financial meltdown.
"The exercise here is to make sure that bonuses are not a one way bet, so that if you take risks and lose in a big way that will affect what you get," Nick Dent, an employment law partner at Barlow Lyde & Gilbert LLP who monitors financial compensation, told The New York Times.
Directors of banks that received public bailout funds will have to justify their bonuses and institutions will report the number of employees earning more than $1.3 million (1 million euros). If regulators determine a bank has not properly adjusted executive compensation, they can impose financial penalties or require the bank to shore up more capital to reflect its risk-taking level. The more money banks give their employees in bonuses, the less it has to lend into the economy, where the funds are more beneficial.
Banks also will have to hold a minimum amount of capital to cushion against market shocks. Those rules are set to take effect by 2012.
The new bonus structure is in line with global guidelines discussed by the Group of 20 nations. Britain, Germany and France already limited bank bonuses last year under political pressure to tighten the industry. Although some banks have already slashed pay, the rules are intended to prevent a return to excessive compensation once the economy improves and hiring in the banking sector becomes more competitive.
European leaders expect the reform to radically change the bonus culture at banks like Deutsche Bank (NYSE: DB), Barclays (NYSE: BCS) and Goldman Sachs Group (NYSE: GS). But just how far the rules will go remains to be seen as each country's government will decide which bank employees will be affected, and if traders will also be included.
The EU rules are much more detailed and stringent than regulation in the United States, which has issued pay guidelines for the biggest U.S. financial institutions, but has not specified bonus caps. The federal pay czar currently is preparing to release a review of compensation amounts at 180 U.S. financial companies.
Driving Out Finance Talent
While the EU has taken steps to crackdown on its banking industry, bankers worry that top finance talent will flee to countries without compensation regulation, like Switzerland, Singapore or Dubai.
A couple big EU financial names have already set up shop in Geneva to avoid the new regulation.
Alan Howard, one of the most successful hedge fund managers, moved to Geneva in June with Europe's largest hedge fund Brevan Howard Asset Management. A $19 billion fund manager founded by former JPMorgan Chase & Co. (NYSE: JPM) traders also moved to Switzerland from the United Kingdom earlier this year.
"We are receiving daily inquiries from companies and individuals thinking of relocating to the Geneva area," Larry Levene, found of a Switzerland-based property group, told Financial Times.
Switzerland for years has been a draw for companies because of its low taxes and stable government. In both 2007 and 2008, 500 companies moved to Switzerland, mostly to Geneva, Zug and Zurich.
"The general view is that many countries are in bad shape and companies are looking for a way out," Marcel Jouault, head of business promotion for Pfaffikon, told MarketWatch. "And Switzerland is the best [destination] of all."
If the United States keeps its rules less strict, it could also lure bankers away from the EU's across-the-board bonus caps.
The United States "[doesn't] think it can be a cookie cutter approach, the same approach for every firm, but it needs to be thoughtful and reflect the risk-taking appetite for each firm," Vicki Eliot, head of financial services consulting at Mercer Consulting, told The Times. "The European Parliament statement seems to be very rules-based in terms of what they are suggesting with specific numbers. It's a little bit concerning."
Hiring in the U.S. financial sector has picked up, and to nab the best-suited investment banking candidates firms are paying 30-40% more than employees' current salaries to entice them to switch companies. Some companies are offering pay packages up to $8 million, including bonuses that are not contingent upon a firm's performance.
"There are firms that don't have the ability to make a guarantee or are adamantly against guaranteeing compensation," Ross Baltic, a managing partner at recruiting firm Mercury Partners, told Business Week. "Instead, they're giving verbal guidance on what compensation may be. They're just not tying themselves down by putting something in writing."
News and Related Story Links:
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EU Toughens Bonus Rules With Limits on Cash Payouts
- The New York Times:
Cap on Bank Bonuses Clears Hurdle in Europe
- Money Morning:
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- Financial Times:
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- Business Week:
Firms Are Luring Bankers with Bonus Guarantees