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Europe's banks could be heading for another showdown over pay. The European Union's misguided bonus cap has forced them back to the drawing board when designing compensation policies. Institutions like HSBC Holdings PLC are now sounding out investors about the least damaging way of complying with the rules. Though higher salaries are likely, shareholders could demand tougher conditions for variable pay in return.
The EU plan, which comes into force next year, could upset the fragile ceasefire over banker pay. Most bonuses are now paid in stock and deferred for several years so that they can be clawed back if performance slumps. Shareholders, meanwhile, have been pressurizing banks to scale back total compensation. But the EU plan specifically targets bonus size, by limiting payouts to 100 per cent of salary for employees earning a total of more than €500,000 ($685,319).
The cap is particularly tricky for global banks headquartered in the European Union, as they face restrictions in Asia and the Americas that do not apply to local rivals. HSBC, which earns 80 per cent of its pre-tax profit outside the EU, recently warned the cap "could have a highly damaging impact on our competitive position."
To see why, look at HSBC's senior pay last year. The bank's 191 senior executives and "code staff" – deemed by regulators as needing extra supervision – took home a combined $145-million (U.S.) in salary and $384-million in variable pay. A strict cap would have required HSBC to slash bonuses by almost two-thirds. Even a cap at 200 per cent of salary – permitted by the EU rules if shareholders approve – would have lowered variable pay by a quarter.
The simple way of holding pay at pre-cap levels is to raise salaries and shrink bonuses. But shareholders will rightly object that higher salaries reduce the incentive for bankers to perform, and cannot be easily cut in a downturn.
The tradeoff may be to place greater restrictions on the variable component. HSBC's top 62 executives already receive bonuses in shares which are deferred for five years and cannot be sold until they retire. The bank could extend that policy to more of the roughly 3,500 bank employees affected by the EU cap. Bankers would have more comfort over a larger portion of their pay, while building up a performance-related pot to take later in their career. If that saves HSBC another showdown on pay, other European banks may follow suit.