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Four days before Christmas 2015, a 173-page web document landed on my desk. It was filled with enormous and bewildering phrases like 'prudential consolidation', 'solvency buffers', and 'ex-post risk adjustment mechanisms', and it was poised to wreak havoc on Europe's major financial associations.
The document's confusing title reflected its origins, stemming from years of dialogue, research, and consultation on how to curb the excesses of global banking trade following the 2008 financial crisis. The instructions on sound remuneration policies under Articles 74(3) and 75(2) of Directive 2013/36/EU and disclosures under Article 450 of Regulation (ecu) No 575/2013 encompass 326 separate paragraphs of guidance, but had a stronger objective: to protect the bonus ceiling for EU bankers. Furthermore, it could draw attention to the internal operations of Europe's major banks, which had never had such a regulatory framework and were no more familiar with interference in how they paid their staff.
The cover was designed excessively above the financial center of East London, on the 46th floor of the rectangular 1 Canada, the tallest building in Canary Wharf, and the base of the ECU Banking Authority, a rulemaker for ECUs in a building that symbolized the financial deregulation of the Thatcher era and the unbridled boom of the industry following the Big Bang reforms. The document arrived here like an early Christmas chain for regulators and consulting firms across Europe, who would have to spend many of the following years understanding what on this planet any of them basically assumes for bankers and financial businesses.
In fact, most banks didn't have the slightest idea how to handle it. Managing payroll became the responsibility of a company's HR branch, no longer famous for employing the sharpest minds in the business, and they struggled to determine how to organize their current work around tons of newer suggestions. They ended up resorting to large consulting firms, like the one I worked for, and signing six contracts with them to figure out what it all meant on their behalf (we weren't that sure, but we took the funds and gave it our best shot).
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The cap set limits on the ratio of fixed to variable pay: a banker's bonus could not be more than double the measure of their profits. The cap applied best to “MRTs” or “fabric opportunity takers”: those who had a say in where massive elements of a financial institution's capital were applied. The logic shifted so that bankers had acquired larger bonuses by investing in increasingly risky courses of capital to achieve higher returns – a key factor in the hobbies that led to the financial collapse. A smaller bonus meant that “fabric opportunity takers” would avoid taking fabric risks, and banks would gently crawl to achieve moderate gains by investing in exceptionally strong assets without collapsing the economic climate.
The cap was met with strong opposition the moment financiers in London learned of it. George Osborne, then Chancellor, immediately took up the mantle and fought the European to discard it – or at least, to find some exemption for London. Osborne even went so far as to insinuate that the cap had become illegal. He complained of “poorly designed suggestions” that “are totally self-destructive” and “are increasing bankers” salaries now, without reducing them.” Osborne’s arguments were easily refuted by an advisor to the European Court of Justice, after which the Chancellor unexpectedly relented, and the new suggestions became law. Compliance with them can cost hundreds of thousands of pounds and many man-hours in restructuring the banks’ internal operations (along with my own efforts).,
Regardless of his potent rhetoric, Osbourne would later crusade for the UK to remain within the European Union until the 2016 Brexit referendum. Even after Britain voted to leave, successive Conservative governments – and successive chancellors – did not bother to unearth old arguments about banker bonuses. I wrote to the UK's financial functions regulator, the Prudential Regulatory Authority, in 2020 to see if there was any flow of change to the limit suggestions. The answer was a 'no' from the agency: the PRA would do nothing more to hinder London's chances of receiving 'equivalence' – a regulatory status granted by the EU that can ease restrictions on switching monetary services with Europe. Despite their desire,
(Simon Walker/HM Treasury)
Therefore, it was a surprise when, last month, with the war raging in Ukraine, inflation at a 40-year high, and recession on the horizon, Britain's newest chancellor realized that it had become excessive time to unearth historical arguments about the salaries of financial institutions.
But he did drag them out. Just a few days into his new job, Kwasi Kwarteng was on the dispatch field at the Commons residence and proclaimed that the lid had been flipped. “We want international banks to create jobs here, invest here and pay taxes here in London, not in Paris, no longer in Frankfurt, not in the Big Apple,” he shouted, to a somewhat distant audience.
“The entire bonus cap has been changed to increase the primary salaries of bankers or to boost ventures outside of Europe. It never limited total compensation, so we're not going to sit here and pretend otherwise. We're going to get rid of it.”
Kwarteng's opposition to the bonus cap aligns with a few distinct premises. First, the libertarian instinct to avoid interfering in how a boss chooses to manage his company. Second, the perception that legislation is burdensome: fewer suggestions lead to greater innovation and an extra-fast boom. Third: undoing the cap wouldn't change bankers' pay levels anyway.
One first argument, it may also have some scope. No other industry faces this kind of mountain of laws whenever it chooses to reward a staff member for doing a great job. In no other profession does a person have to consult a one hundred and seventy-page rulebook every time they conduct an efficiency evaluation. Of course, the intention of the rules is to anticipate risky decisions, but it is complicated to set up in case they contributed to that conclusion and therefore somewhat complicated to justify their existence.
Kwarteng may also have some weight in the second argument as well. The growth of European banks over the last decade compared to their American counterparts is negligible. Between 2008 and 2018, the 'return to justice', a key metric of a financial firm's success, became roughly twice as large in the US compared to Europe. The reasons for this are complicated, but European rules probably haven't helped close the gap. As outdated as the financial burdens of the rules are, there are the human burdens. A bank with a handful of people taking significant risks now requires an army of compliance officers to ensure their paychecks don't violate the law. Something about that seems a little insane. This'‘
Kwarteng is almost certainly appropriate in the third argument. The ECU never sets a maximum limit on how much anyone in the financial resources sector can earn – in that case, recognizing the communication of a 'bonus cap' is a misnomer. And the pay scales of financial institutions haven't changed much because of this. At Deutsche Bank, one of the largest banks in Europe, typical pay rates per employee in 2021 were about 25% higher than in 2009 – certainly, pay grades increased 10% 12 months a year in 2016, the first year the cap was introduced.
Therefore, there is a fairly robust case, at least in theory, for eliminating the banker bonus cap in its existing form. But the problem with the Kwarteng resolution is the timing. It is one factor to be so oblivious as to impose a cap on bank payouts when tens of millions in the UK have long been on strike, protesting a real fall in their wages – that is ultimately a political gamble. It is another matter, however, to reintroduce an incentive to take risks at a time when the economic climate is in such a precarious state – that is a huge financial gamble.
European regulators were also completely wrong after thinking that it was the bonuses that toppled the main domino effect, leading to the near collapse of the economic system. But now is the time to reconsider their views and verify this. It challenges common sense that Kwarteng sees the dangers as rewards.
In the current climate, deregulation of bank payments has not been widely recommended as a hedging lever to exit the recession – neither in the UK, nor in Europe, nor elsewhere. It is not, as far as I can tell, something that the banks themselves take seriously. It's a complete mistake.
Less than a month after announcing his so-called mini-funds, Kwarteng was dismissed. His successor, Jeremy Hunt, now has the chance to choose which components of the mini-finance policies will go with him. Reversing the abandonment of the banker bonus cap should still be quite high on the record.
