The EU bonus cap is unlikely to significantly shift European trading banks’ cost structure, Fitch Ratings says. Instead, the realignment of their businesses with changes in the broader regulatory landscape and revenue prospects will be the key factor in shaping the cost base.
Bafin’s results last week on its 2013 review of bankers’ bonuses for 15 German banks highlight the limited progress that banks have made to restrict the bonuses of top managers to their base salaries ahead of the new rules effective this year. The audit found deficiencies at most banks, with only four applying the fixed salary cap. Of the remaining banks, four awarded bonuses more than double base salary – the maximum allowed under the new rules with shareholder approval.
The finding that many German banks were not properly identifying “material risk-takers” highlights the challenges in interpreting and applying the pay restrictions. Inconsistent application of risk criteria could result in some banks getting around the bonus cap. Media reports also suggest some trading banks have bumped up fixed salaries, and are considering additional share awards and allowances that do not count as salary or bonuses in their European operations.
It is unlikely therefore that total compensation costs and benefits will fall significantly as a result of the bonus cap. Compensation costs of five large European global trading and universal trading banks were 41% of net revenues on average for the first nine months of 2013, and we do not expect the new rules that come into effect this year to substantially reduce this ratio.
The final proposal from the European Banking Authority on identifying “material risk-takers” published in December 2013 was relaxed to allow some bankers to be excluded from the bonus cap. Staff earning over EUR500,000 could be excluded if the national regulator is notified; those earning over EUR750,000 could be excluded if regulatory approval is obtained beforehand: and EUR1m plus earners could be excluded with EBA approval. This could allow trading banks to avoid the bonus restriction for some staff. Maintaining some flexibility with compensation is important as they compete for expertise with their US-based peers and in light of their volatile revenue. This could lead to jurisdictional differences in the implementation of the bonus cap.
However, the greater impact on overall compensation costs in the long term is likely to stem from the ever-increasing focus on costs, and exiting low-margin businesses. Evolving regulations around risk-weighted assets, leverage and liquidity are determining which operations will continue to achieve appropriate returns in a more punitive economic environment, and trading banks are withdrawing from selected businesses as a result.
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