The bonfire of the inanities. UK Chancellor of the Exchequer Kwasi Kwarteng isn’t pulling any punches with his first moves in office. First, he unceremoniously fired the most senior civil servant in the Treasury. Now he is contemplating taking an axe to European Union regulations on financial services. But he is starting on the latter in a very odd way — wading into the politically sensitive area of banker pay and possibly scrapping the cap on bonuses (currently at double one’s salary) the EU introduced in 2014 in a belated response to the global financial crisis.
This looks like ideological vice-signaling for a microscopic number of beneficiaries. Focusing on salaries of the very wealthiest would certainly send a message that trickle-down economics is leading the new government’s pro-growth agenda.
The principle is sound: Governments shouldn’t be in the pay-capping business. No other sector has these restrictions, and the Bank of England has always made clear it was against the bonus cap. But the timing is absolutely terrible. Deciding to clean up an old piece of red tape now is tone-deaf amid a cost-of-living crisis and risks further aggravating the EU when tensions are already high.
Financial services contribute about an eighth of UK gross domestic product, yet the vital industry was singularly ignored during the Brexit negotiations. A new approach to the “jewel in the crown” as Prime Minister Liz Truss puts it, is long overdue, but coming in hot on bonus limits may prove counterproductive for the real prize the City of London hankers for — regulatory equivalence, or a level playing field, with the EU.
Dangling carrots on banker pay will butter few parsnips in Brussels, which is already sensitive about the prospect of the UK tearing up the rule book and creating a regulation-light “Singapore-on-Thames.” The vast majority of European banks keep to the one-times-salary bonus cap, as shareholders have to specifically approve lifting the limit to two times salary, which very few boards have decided to brave. Meanwhile, most UK banks went for the higher option over time.
If ditching the bonus rule is viewed as a blatant regulatory divergence, it could backfire spectacularly and ruin a much more important financial-services equivalence deal with the EU.
There are, of course, potential advantages in unwinding much of the MiFID II legislation that came into effect in 2014. (Brussels is even ditching some elements too.) If this is just one part of the UK’s Big Bang 2.0 package to improve the competitiveness of the City of London, then there may be broader merits, even if it’s tricky to pinpoint the specific benefits of relaxing pay rules. More details might be forthcoming at Kwarteng’s “fiscal event” planned for Friday.
As a standalone measure, however, losing bonus caps would hardly be a game-changer when it comes to overall compensation. It could alter how banks reward their rainmakers. But if that means reducing base salaries in favor of a greater weighting to variable bonuses, that could actually result in lower overall pay in lean years, which, er, we’re in right now as deal volumes shrink. There are potential consequences for higher-end London house prices, too, because if base salaries do fall, then wealthy bankers will have a much harder time securing those monster mortgages.
In recent years, banker salaries have also often been topped up by an additional allowance to get around the bonus cap. These did not come with pension or other benefit rights and can easily be reduced or removed. So vanishingly few bankers will suddenly get paid more. Although the extra tax from higher bonuses would be welcome, is it really worth it for the negative press? No wonder the past three Conservative prime ministers have avoided the issue.
Yet even if it raises questions about the government’s priorities, the case for removing the cap is strong. Far more effective measures to control excess risk-taking have been put in place, so there is no regulatory justification for the ceiling to stay. The Financial Conduct Authority will still be keeping a very firm eye on compensation.
Most importantly, losing the bonus cap would make it easier for the big US banks to rejig fixed salary costs and transfer employees to London. It should help stem the tide of top traders leaving for hedge funds. And it removes an impediment for UK-domiciled banks in compensating employees overseas in competitive pay markets like New York or Hong Kong (although local hire contracts are much more common across the industry now, to manage costs and get around issues such as bonus caps).
So the UK has much to gain from raising the global attractiveness of the City, especially as Covid restrictions in Asia have led to a raft of banker relocations. But rule changes have to focus on ensuring a better place to do business overall, so it can attract institutions, not just individuals.
The EU could fight back. The Netherlands has probably been the biggest net beneficiary of financial-services business transferring from the City into the EU, particularly in derivatives and IPO listings, but it remains hamstrung in attracting top talent by its maximum 20% of fixed pay bonus rule.
With just two years before another UK general election has to be called, tangible measures for the new pro-growth agenda are urgently required. Did someone mention Global Britain, aspiration nation and Brexit dividends? The klaxon alerts are deafening, as Liz Truss aims for a clear blue versus red divide between Tory tax-cutting and the opposition Labour party. But ditching bonus caps may be a political gift that writes itself straight into Labour election leaflets, as making life easier for bankers is not the sort of levelling up most voters envision.
Banker pay never gets less sensitive. Sometimes anachronistic rules, however misguided, are best left untouched. At least until the timing is right.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was chief markets strategist for Haitong Securities in London.
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