UK will find EU bank bonus cap hard to lift

Mon Mar 4, 2013 6:11am EST

* Stormy late-night talks seal globe's first cap on bank bonus

* Tide turned against Britain after it lost German backing

* Lawmaker Karas says bonus victory could snowball, catching hedge funds

By John O'Donnell

BRUSSELS, March 4 (Reuters) - Some of the lawmakers who achieved a European Union cap on bank bonuses wanted to celebrate the deal with champagne, such was the symbolism of tackling what they see as a root cause of the financial crisis.

In the end there was no toast to mark the agreement in the early hours of Feb 28, partly out of sensitivity towards London which sees in the new measures a threat to its place as a global financial centre.

Although the idea of a fixed ratio of bonus to salary was not new, the drive to make it happen was motivated by "a lot of anger" that an earlier rule introduced by the European Parliament to defer bonuses had not halted rising payouts, said Sharon Bowles, who as chair of the parliament's economic and monetary affairs committee was central to negotiations.

The concept had first been put forward by European Commissioner for Internal Markets and Services Michel Barnier at the beginning of 2012.

Even supporters of the deal had not predicted that the European Parliament would succeed in setting the basic cap at the same level as the base salary paid to bankers.

With Europe still struggling to overcome a financial crisis that began more than five years ago and banks still needing state support, there is little sympathy among European lawmakers for those who say that the new rules will drive the best bankers and traders to work for U.S. or Asian banks outside the EU.

"With the rules on banker bonuses, we will change the culture in management boards and on the trading floor, putting an end to short-sightedness for the mere sake of high pay," said Udo Bullmann, a German member of the European Parliament who fought for stricter rules at last week's meeting.

Britain's defeat on a financial reform breaks with an unwritten rule in Brussels, namely that EU legislation on financial services requires London's blessing because of the importance of banking to the British economy. The UK is home to some of the top earners in finance, and the industry accounts for about one tenth of the country's economy.

PACKING PUNCHES

The perceived threat to London has prompted senior figures in some of the biggest banks to engage directly with European lawmakers in an attempt to head off a curb on bonuses.

But the strong political undercurrent will make it hard for Britain's Finance Minister George Osborne to unpick the agreement, which is due to take effect next year, when he meets with his European counterparts in Brussels on Tuesday.

Osborne cannot block the deal from becoming European law as Britain's blessing is not required. But he is likely, at the very least, to underline his reservations and could argue for changes.

While he cannot count on the support of any other EU country to change bonus rules, if other parts of the wider bank capital agreement are challenged, Osborne could pounce on this opportunity to push for a softening of pay curbs.

One source familiar with Britain's position privately questioned the legality of the EU pay curbs, hinting at possible grounds for a legal challenge. But it is unclear whether Britain would favour such a confrontation.

"I don't believe that the majority of finance ministers will want to wage that battle so publicly because there are more punches to receive than to give in that battle," said Philippe Lamberts, a Green MEP who was one of those behind the push for the bonus cap.

The new rules, finalised at a chaotic and at times heated meeting of roughly 50 lawmakers and officials, will not apply to the majority of bank staff, who on average earn bonuses of up to 30 percent of salary.

It will instead target senior management and so-called "risk takers", such as traders, whose bonuses are many times their base salary.

Analysts estimate the law will affect around 300 to 500 people in each large bank or around 5,000 people in London, but that could rise significantly if regulators widen the definition of "risk takers".

European Parliament lawmakers demanded the cap in return for their approval for wider rules on bank capital, a key building block for a system of European Central Bank-led bank supervision due to start next year.

The determination of the parliament to introduce a bonus cap took many countries, including Britain, by surprise.

At last week's gathering, the exchanges became so heated that the talks came close collapse, with one lawmaker repeatedly threatening to leave the room, people who attended the talks said. The differences centred not only on the bonus limits but also on parliament's demand for greater reporting transparency for banks.

There were concessions, with weary lawmakers eventually agreeing to discount non-cash bonuses paid after five years, raising the effective ceiling on total bonus beyond two-times-salary. Bullmann, a German Social Democrat, fought to reduce the amount of bonus that can be discounted in this way during what participants said were at times stormy exchanges.

But as the clock moved closer to midnight and the parliament's translators prepared to finish their working shift, lawmakers rushed through a final draft of the legislation.

SNOWBALLING

In the build up to last week's negotiations, Britain had become increasingly isolated in its efforts to fend off restrictions on bonuses, Bowles said.

Although initially supported by Germany, officials in Berlin had become uneasy about the alliance with London because of the potential damage it could do to German Chancellor Angela Merkel, who faces national elections later this year.

"Maybe they thought that together (with Germany) that would be definitive," Bowles one of the parliament's most influential members, said. "As we got closer to German elections ... the whole dynamic changed."

Behind the scenes, others were also making clear the threat they thought a cap could pose not just to London but to Germany's financial centre Frankfurt.

Early last year, Anshu Jain, the co-chief executive of Germany's Deutsche Bank phoned Bowles to spell out his concerns.

Others including Standard Chartered chief executive Peter Sands and HSBC chairman Douglas Flint were also involved in the debate about pay and wider bank capital rules.

But the banks had little success in winning broad political support and no country, bar Britain, was willing to speak out against the European parliament's proposals.

Deutsche Bank, Standard Chartered and HSBC declined to comment.

The lack of opposition from countries to the European Parliament's radical reform took many there by surprise. And although many country officials privately had reservations about the law, said Bowles, they remained largely silent.

Britain's isolation may set a precedent.

"In the past, we didn't think Europe had anything to teach us," said one former British government official. "But British influence has diminished. If they don't have the Germans behind them, Britain is toast on a lot of these issues."

The parliament's focus is now set to turn to hedge funds and private equity firms, most of whom have chosen London as their base in Europe, Bullmann said.

They are not affected by the new rules on pay. But they could be subject to curbs under future legislation.

Othmar Karas, the Austrian lawmaker who negotiated the bank pay curbs said he hoped the rules on bonus would prompt similar reform in other areas of finance.

"It will have a snowball effect," he said.

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