Future of the bonus cap

In October 2023, the UK made a significant decision: to abolish the bonus cap for bankers. Several leading banks, such as Goldman Sachs, Morgan Stanley and HSBC, are already planning to adjust their remuneration systems accordingly.

 

Background of the bonus cap

The bonus cap, which sets a maximum limit for bonus payments of 200% of the fixed salary, was introduced in all EU Member States a decade ago in the wake of the global financial crisis. The aim was to prevent excessive risk-taking and uncontrolled bonus payments and to promote a more stable and less risky financial system. With Brexit, the UK now has the freedom to adapt its own regulations.

 

Reasons for abolishing the bonus cap

The British government argues that abolishing the bonus cap is necessary to strengthen the competitiveness of the British financial sector. London has been one of the world's leading financial centres for a long time. Following the implementation of the bonus cap, international banks feared an outflow of talent. By reducing the bonus regulations, the government hopes to increase London's attractiveness as a financial centre and attract highly qualified specialists and international banks. Above all, the aim is to strengthen London as a financial centre in relation to Asia and the US, where there are no such regulations.

 

Initial adjustments

Goldman Sachs was one of the first banks to adjust its remuneration systems following the abolition of the bonus cap. The bank has announced it will significantly increase its employees' bonuses to make London a more attractive location and to retain talent. Other banks are also expected to follow so they don’t fall behind in the competition for the best employees.

 

Long-term effects

The long-term effects of the abolition of the bonus cap are difficult to assess. It’s possible it will actually help to increase the competitiveness of British banks and strengthen London as a financial centre. At the same time, it could lead to a renewed increase in risky business practices.

But removing the bonus cap doesn’t automatically mean unlimited bonuses. On the one hand, banks have to set an "appropriate" ratio between fixed and variable remuneration. On the other hand, other regulations for variable remuneration for subsequent risk adjustment, such as deferral and backtesting through malus and clawback, continue to apply. Finally, it’s doubtful whether there will be any noticeable increases in salaries. In addition, all international banks had compensated for possible losses as a result of the bonus cap through role-based allowances, which can now no longer be unilaterally reduced. To prevent salaries from shooting through the roof as a result of uncapped bonuses, the plan is to offer managers the opportunity to switch to the uncapped bonus system in return for waiving their allowances, according to reports in the market.

 

Influence on the discussion in the EU?

The developments in London will also have an impact on the discussion in the EU. The CEO of Deutsche Bank, Christian Sewing, already requested the abolition of the fixed cap last autumn, without wanting to remove the risk retention of variable payments. It will be decisive how the banks and the government find the balance between attractive remuneration structures and the need for a stable financial system without excessive risks. The coming months and years will show whether the abolition of the bonus cap can achieve the desired positive effects or whether new challenges and risks will arise.

In view of this, serious consideration should be given to cancelling the bonus cap in the EU. This is all the more true as, according to a study by the Leibniz Institute for Economic Research Halle from February 2023, the effectiveness of bonus caps must be called into doubt. The behaviour of bankers was examined three years before and after the implementation of the bonus cap and compared with that of bankers from countries without a cap. The study couldn’t determine a measurable influence of the cap on the risk profile of the transactions carried out.