According to press reports last week, the Chancellor, Kwasi Kwarteng, is considering scrapping the cap on variable remuneration that applies to dual-regulated firms’ material risk takers. The cap was introduced in 2014 as part of a suite of EU rules aimed at deterring excessive risk taking by more closely aligning reward with risk. At that time the UK opposed the introduction of the cap. The then Chancellor, George Osborne, argued that it would drive talent out of the EU (including the UK at that time) and inflate basic pay, making it harder for firms to trim costs in lean years.
Details are scarce, but it has been reported that the move is designed to boost the UK’s global competitiveness, making it a more attractive destination for top global talent. The reports also state that Kwarteng is considering the move as part of “Big Bang 2.0”, which will introduce a wider package of City reforms, most of which are contained in the Financial Services and Markets Bill, which is working its way through Parliament.
The cap has been deeply unpopular with the investment banking sector, and in particular with US and Asian investment banks operating in London, who found themselves unable to align London pay practices with those in other global centres such as New York or Tokyo. Whilst the theory behind the bonus cap was generally considered to be sound, many considered it to be an ineffective blunt instrument – not least because the industry reacted by adopting ‘role-based allowances’ to mitigate the impact of the rules. Many (including the Bank of England) maintain that the rules on deferral, clawback and malus are far more effective tools for the promotion of risk-aligned behaviours within the sector.
What Would Be Involved?
At the moment, the Dual-Regulated Firms Remuneration Code (SYSC 19D) (“Code”) states that in normal circumstances variable remuneration should not exceed 100% of fixed remuneration. However, this cap can be extended to 200% if shareholder consent is obtained. In practice, many large banks have already obtained such approval. A lifting of the cap would require the Code to be amended. Firms would then need to consider whether further shareholder approval is required to remove the existing cap. Perhaps more complex will be the requirement for firms to unpick convoluted pay structures, including role-based allowances, and renegotiate terms and conditions with their most senior employees.
There are clear advantages to the removal of the bonus cap. For some time, the cap has been controversial and unpopular, not least with global financial institutions operating in a number of key global hubs, including London. Removing the bonus cap would enable those firms to create a more level playing field by enabling London-based bankers’ incentive compensation to be aligned with their colleagues in the US and Asia. This could in turn promote internal mobility between global hubs such as London and New York, and more generally promote London’s reputation as a key financial centre. Removal of the cap could also provide banks with additional flexibility by shifting the reward focus onto discretionary bonuses, which are inherently more flexible vehicles for recognising strong performance.
Of course, the removal of the bankers’ bonus cap will be extremely unpopular within some social and political corners and, in times of austerity, could backfire. Whilst our view is that the bonus cap has been a blunt and ineffective instrument in ensuring risk-aligned behaviours, the public sentiment (and opposition narrative) could focus less on the Brexit advantages of deregulation and more on a fear of a return to the days of irresponsible and disproportionate ‘fat cat’ bonuses. Whilst the global financial crisis was almost 15 years ago, the UK financial services sector is still very much rebuilding its brand by focusing on strong cultures and customer-centric and purpose lead drivers and outcomes. As such it will be hugely important for the optics of any bonus cap removal to be carefully managed.
We may know more later this week. Kwarteng is due to announce a mini-budget on Friday 23 September to help the country as it faces soaring energy bills. It may be that a decision to scrap the bonus cap will be announced as part of this mini-budget, or it could be announced as part of a wider package later on. In any event any move would be subject to much consultation and we will be providing updates as and when the situation develops.