European rules that cap variable pay that banks can pay staff make it more difficult for firms to use remuneration to control risk and performance, according to Mercer, the global consultancy.

European rules that cap variable pay that banks can pay staff make it more difficult for firms to use remuneration to control risk and performance, according to Mercer, the global consultancy.

As they try and stay competitive and attract – and keep – top-notch staff, banks are working around European Union pay regulations, Mercer’s Global Financial Services Executive Compensation Snapshot Survey said.

These "CED IV" rules set out by the European Banking Authority are designed, its framers hope, to prevent dangerous risk-taking behaviour for which bonus-linked pay has been blamed. Concerns about such remuneration practices intensified after the 2008 financial crash.

Governments in countries such as the UK have moved to control bonuses paid to bank staff, arguably a significant breach of freedom of contract, although governments might argue that as tax monies were used to bail out failed banks, such intervention is justified.

Large numbers of banks are increasing base salaries or using cash allowances as part of the pay mix. These allowances cannot be performance-based under the European Banking Authority’s definition of fixed compensation, Mercer said in a report based on analysis of 78 organisations, including 44 banks in 18 countries.

“High-performing employees expect remuneration comparable to their peers, but CRD IV restricts EU-headquartered banks in what they can pay in performance-related compensation. They’re looking at other methods of making up the shortfall to prevent staff walking into the arms of other less-regulated competitors, such as hedge funds,” Mark Quinn, head of talent at Mercer UK and a specialist in financial services remuneration, said.

“Cash allowances are a form of fixed compensation that do not generally require a corresponding increase in benefits costs as base salary increases do. However, both are forms of guaranteed cash with no variable link to performance which is far from satisfactory,” Quinn said.

Malus

Part of the report referred to the use of “malus” conditions in remuneration. The term describes a negative bonus for poor performance.

The Mercer report said there is “strong evidence” that banks are applying malus conditions, such as reducing or not paying deferred unvested awards when lower performance, non-compliance or misconduct occur. In 2012, some 62 per cent of banks applied malus with it being more prevalent amongst European banks (82 per cent) compared to North America (25 per cent).

In 2013, however, the proportion of North American banks that applied malus increased to 42 per cent. Almost half of banks said that malus was applied to individuals due to non-compliance or misconduct while almost one-third said that it was applied because of poor performance.

“The progress the banks have made in improving their pay practices over the last several years since the crisis is now being reversed to some extent with the impact of the CRD IV rules,” said Vicki Elliott, Mercer’s global financial services talent leader.

“To remain competitive, banks are shifting a significant portion of compensation into fixed, guaranteed pay which reduces their ability to pay for performance and also to defer as much compensation subject to malus over a multi-year performance period,” Elliott said.

In some cases banks don’t pay any upfront annual cash bonus at all because of increases in fixed pay and shift all variable compensation into multi-year deferral or long-term incentive arrangements.

Asked about the impact of new rules, 70 per cent of EU-based banks said they will request approval from shareholders or the parent company to extend the variable pay cap to 200 per cent of total fixed compensation.

Some 63 per cent of EU-based banks are implementing or planning to implement base salary increases while only 13 per cent of those based outside the EU will do so. Some 55 per cent of EU-based banks and 47 per cent of non-EU based banks are planning to increase cash allowances to compensate for the bonus cap for impacted risk-taking staff.

Some 20 per cent of organisations in the EU and several outside the bloc are enhancing their broader employee value proposition beyond pay elements.

In shifting variable compensation to fixed compensation, 27 per cent of EU-based banks said they plan to discount variable pay, something that no bank based outside the EU intends to do, Mercer said.