laughing all the way

Europe might cap banker bonuses, but they’re ready: Some ways around the rules

December 14, 2012
December 14, 2012

The European Union has announced early-stage proposals to cap bankers’ bonuses at double a worker’s salary. That will upset quite a few investment bankers and traders who are used to earning many multiples of their basic wage. It will probably also inspire lawyers to come up with creative ways to swerve the new rule.

Of course, if every bank in the world has to play by this rule, there will be no competitive advantage in looking for loopholes. Top earners will not have anywhere to flee apart from to other industries. But the EU rule may not cover Asian banks whose operations are outside the European Union—though that will not be known until the fine print of the proposed regulation is published.

“This may give EU banks a competitive disadvantage compared to banks headquartered and operating in the Far East,” says Nicholas Stretch, a London-based partner at law firm CMS Cameron McKenna.

None of this is a done deal. Simon Gorham, of law firm Taylor Wessing, says it is uncertain when the full proposal will come out. He adds that the European Parliament is unlikely to vote on it until March. This, he says, means that the rule may not be enforced until 2014 (meaning it would apply to bonuses earned in 2014 that bankers receive in early 2015). Still, based on what they know so far, here are the ways legal experts say banks and their star earners may seek to avoid the bonus cap:

1) Pay really, really high salaries. This is the most obvious and easiest approach banks could take to make sure their star earners stay well paid and do not flee to Singapore or China. Banks could even make salaries a bonus in themselves, by telling staff that if they do well in 2013, they will get a big pay rise in 2014. This is not ideal, however, as it creates a high fixed cost base which is undesirable for cyclical industries such as financial services. Banks “like the flexibility of bonuses,” says Paul Quain, a partner at GQ Employment law. With the option to pay low salaries and high bonuses, banks get to reduce their staff costs in bad years. Promising the top people high salaries is disadvantageous “if you want to close down an entire department, for example,” Quain says. In such cases, the bank may have to pay a year’s salary to all those made redundant, and that could include expensive former rainmakers.

2) Create a non-bank unit of the investment bank that handles the biggest deals and employs the highest earners. Banks might be able to restructure their businesses so that their investment banks’ most profitable divisions are spun out of the main entity but supplied with work on a referral basis. The way it would work in practice would be that if a company approached Big Bank X looking to list on the London Stock Exchange, the bank would say “would you consider using the services of Non Bank X? They are our IPO referral partners.” Non Bank X, of course, would be made up of the bank’s former IPO experts who threatened to leave unless they got huge bonuses.

Lawyers are divided on whether that would work.  Theoretically, “anything is possible in terms of restructuring how a section of a bank’s employees provide their services,” Gorham muses. But on the other hand, he says, investment banks prefer to have control over their top earners, for example the right to restrict them working for competitors for a number of years when they leave. If the top earners “are hived off, you relinquish control” Gorham says.

CMS Cameron McKenna’s Stretch adds that the London Financial Services Authority would likely frown upon such an arrangement. He says the UK’s Financial Services Authority would be “looking to prevent” investment bankers carrying on as before, but just within a slightly different framework, and that regulators across Europe do not accept any “artificial structures being set up to get around things.”

3) Pay big bonuses in the form of shares in the bank. Taylor Wessing’s Gorham says that: “one obvious example is to pay more by way of shares or equity stake.” He adds that, at the moment, the EU is” only talking about cash payments rather than other way that cash could be received. So until we have seen the real nitty gritty [of the new rules] we are working on the basis this is cash only. But it could be wider than just cash and cover shares or other equity arrangements.”

4) Bankers could set up their own businesses, such as so-called advisory boutiques, that the EU would not consider to be banks. There may be nothing to stop a group of the EU’s best mergers and acquisitions advisers, for example, setting up their own boutique and charging companies who want to deals directly for the advice. Stretch says that is possible because the EU’s main concern when it comes to restricting the bonuses banks pay is protecting the capital of a bank. “Pure M&A advice is not in itself the kind of activity that triggers” existing EU rules or the proposed bonus cap, Stretch argues. “You are not exposing the financial capital of a bank here, you are just giving advice.”

The main disadvantage here for any banker thinking of setting up an advisory boutique is that he or she would have to be incredibly good at their job. Companies choose M&A advisers for many reasons, but a common one is that they can offer the lending services of their bank, either to support the deal or in future.

“Pure banking advice is not always attractive. Large banks have big franchises and boutiques do not,” Stretch says.

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