Following yesterday’s Advocate General’s Opinion rejecting the UK’s challenge to the EU’s ‘capital requirements’ directive, George Osborne seems to have decided (with a speed which has surprised many) to make the best of a bad job by formally withdrawing from the fight. ‘Humiliating climb down’ (per Ed Balls) or a prudent decision ‘not to spend taxpayers’ money on a challenge now unlikely to succeed’ as Mr Osborne now presents it – either way, this is a decisive moment in the battle of the bankers’ bonus.
The relevant European provisions (amongst other things) impose a set ratio between fixed and variable remuneration (salary v bonus) for those employed in areas in which their duties impact on the risk profile of financial institutions – ‘material risk takers’. These individuals cannot be paid a bonus of more than 100% of their base salary, increasing to 200% if shareholders so approve. Further, financial institutions are required to disclose the applicable ratio as well as the number of individuals being remunerated in excess of a certain level, plus the total remuneration of all members of the senior executive (if so requested by the member state or a competent authority).
The UK government brought proceedings in the ECJ in September last year, challenging the validity of the bonus cap, on a number of technical and policy grounds. The Advocate General yesterday made it clear that in his view, the ECJ should reject all grounds of challenge and dismiss the action. Whilst not of course binding on the court, an Advocate General’s opinion is often followed (in around three quarters of cases) and is clearly of persuasive value. The decision was not unexpected, but the force of the arguments was perhaps more surprising. Despite early indications yesterday that the Treasury was considering its position in relation to next steps, it clearly reached a view pretty swiftly that there was little point in pursuing matters further given the clarity and force of the opinion. The challenge was withdrawn later the same day – thought the court will still go on to issue judgment, probably in the early spring of next year.
The Advocate General’s opinion in essence concluded:-
- The legislation limiting the ratio was valid;
- It did not equate to a cap on bonuses or fixing the level of pay because ‘there is no limit imposed on the basic salaries that the bonuses are pegged against’ (this has unsurprisingly gone down badly with the banking community – with the BBA saying “We believe this law runs counter to recent reforms and will make the system less robust by incentivising firms to increase fixed pay. It also puts European banks at a disadvantage when competing with firms in other parts of the world’);
- The government’s attempt to argue that the EU does not have the power to cap bonuses in any event also failed. The UK had argued that the legislation had been wrongly framed under Article 53 of the Lisbon Treaty. The Advocate General disagreed, saying that fixing a ratio of variable to fixed pay relates to the conditions of access to and activities of financial institutions in the internal market, and hence had been correctly enacted under Article 53 (which deals with freedom of establishment and freedom to provide services: the UK’s position being that the fixed ratio measures fell within the realm of social policy and as was such more properly within the remit of member states to determine);
- There was no data protection issue involved in the disclosure of total remuneration requirement, as the UK had argued. The Advocate General reminded the government the provisions do not require mandatory disclosure but confer discretionary powers on member states, the exercise of which would have to take relevant data protection legislation into account;
- An argument around the principle of legal certainty was also robustly rejected – the UK said that it was unfair for the provisions to apply to employment contracts which had come into effect before the Directive had force. The Advocate General’s clear view was that not least in view of the extent of the media coverage following the Directive’s publication in June 2013, firms had had every opportunity to take account of these provisions well in advance of their coming into effect;
- The attempt to argue that the provisions also offended against the principles of proportionality and subsidiarity also failed – the Advocate General held that the objective of creating one, uniform regulatory system of risk management could not conceivably have been better achieved by individual national governments than by the EU.
The overall effect of the Advocate General’s opinion, and the government’s response to it, is likely to be to confirm the trend towards a rise in base salaries within the sector. Attempts which had been made to address the narrowing of the options by the use of flexible role-based allowances have also recently been curbed, and the alternatives to a rise in fixed salary cost in an effort to retain and incentivise talent seem few and far between. The government is likely to remain of the view that the Advocate General’s opinion is contradictory since it removes the case for the fixed ratio by showing that in fact the Directive imposes no ‘cap’ on bonuses in the first place, because there is no limit on basic pay. But it seems by withdrawing the challenge to have accepted that there is limited mileage in pursuing that argument much further. We do, therefore, seem to be heading once again towards a climate of salary increases within the sector – which as many have noted may well not do much to reduce future instability. Bonuses are, after all, much easier to cut than salaries, if the going gets tough.
On that note, George Osborne and Mark Carney have both commented recently on the fact that ultimately systems may well be required to enable claw back not only of past bonus, but past salary (not currently subject to the malus and claw back rules applying to variable remuneration) - and that could well be the ultimate destination of this argument, raising all kinds of questions not least about contract and enforceability. Mr Osborne wrote to Mr Carney yesterday following the withdrawal of the challenge, suggesting (amongst other things) that he was ‘interested’ in ideas floated by the New York Federal Reserve regarding ‘performance bonds’ – to be forfeited should fines be imposed on a bank by a regulator. Such bonds would be treated as part of the fixed pay of senior bankers, hence ensuring that the executives rather than the shareholders bear the brunt of any fines. It appears that Mr Osborne is anxious for the Financial Stability Board to have charge of developing any such proposals in order to ensure co-ordinated international action rather than individual state regulation. Given that Mr Carney is chair of the FSB, it will be interesting to see how their thinking on this issue develops.