Is the EU going too far by capping bankers' bonuses?

Steve Peers

Public opinion of bankers is currently quite low. Many people attribute the 2008 global financial crisis and the resulting European austerity measures to inadequate banking regulations and irresponsible actions by bankers. This sentiment has fueled a significant reformation of EU banking regulations, including transferring banking supervision to the European Central Bank, establishing new rules for bank bailouts, and creating provisions for criminal penalties against bankers engaged in market abuse. Additionally, EU law has implemented regulations to limit banker bonuses.

The United Kingdom, with the largest financial services sector in the EU, has expressed concerns about these new laws, opting out of some (market abuse rules, banking supervision rules, and parts of the bank bailout rules) and challenging others in the Court of Justice of the European Union (CJEU). Earlier this year, the UK’s challenge against the ban on ‘short-selling’ failed in the CJEU. A recent Advocate-General’s opinion suggests that the UK’s challenge to the restrictions on bankers’ bonuses is also unlikely to succeed.

These restrictions, part of the EU’s revised regulations on capital requirements and banking services authorization, are outlined in a 2013 Regulation and Directive. Essentially, they dictate that bankers’ bonuses generally cannot exceed their regular annual salary. An exception allows bonuses up to double the banker’s regular annual salary if bank shareholders approve through a specific procedure.

Advocate-General’s Opinion

The UK raised six primary objections to the bonus regulations: lack of EU authority to regulate pay; infringement of the principles of subsidiarity and proportionality; violation of legal certainty; unlawful delegation of power to the European Banking Authority; breach of EU data protection and privacy rules due to potential disclosure of bankers’ pay; and violation of customary international law principles due to the rules’ extraterritorial implications. Advocate-General Jaaskinen recommends rejecting all six objections.

The Advocate-General argues that Article 53 TFEU is the appropriate legal basis because it encompasses banking regulation broadly, not just the freedom of establishment for banks. The pay cap is not a ‘social policy’ measure, as it does not regulate bankers’ base salary, which forms the basis for calculating any bonus.

Second, data protection rules are not breached because the disclosure of bankers’ pay is discretionary, not obligatory. Member States requesting such disclosure would then be bound by EU data protection law.

Third, granting powers to the EU agency is legal because these powers do not pertain to the legislation’s core elements, and the European Banking Authority only recommends their adoption to the Commission, rather than enacting them directly. Fourth, the principle of legal certainty is not violated by applying the new regulations to existing employment contracts. Fifth, the principles of proportionality and subsidiarity are not infringed upon because a unified risk management system is more effectively achieved at the EU level, and EU institutions have considerable discretion in assessing the application of these principles. Lastly, the UK has not convincingly argued that customary international law prohibits the extraterritorial application of such limitations.

Comments

This case does not debate the merit of limiting bankers’ bonuses but rather whether the EU has the legal authority to do so. If the EU lacks this power, there’s nothing inherently preventing Member States from individually limiting bankers’ bonuses. The debate would then shift from the EU to the national level.

Some of the UK’s arguments are unconvincing. The international law argument lacks depth and persuasiveness. The legal certainty argument disregards that employment law regulations typically affect existing contracts, justified by the public interest principles intrinsic to employment law. Bonuses, by nature, are variable. Regarding data protection, the Opinion largely aligns with the CJEU’s precedent in EP v Council (family reunion): if EU law offers options for Member States, those options’ compatibility with human rights law should be evaluated when and if Member States exercise them. Previous case law on data protection and salary disclosure doesn’t establish an absolute prohibition on release (see Satamedia, for instance).

The UK’s remaining arguments are more compelling. While the EU’s banking agency doesn’t make the final decision on implementing the bonus cap, it does more than provide expert advice. The Commission must either act upon this advice or take no action, limiting its discretion in adopting delegated acts (refer to the complex decision-making system established by the Regulation that created the Banking Authority). This process is inherently flawed as it obscures accountability for the decision (and is too convoluted for transparency).

Concerning proportionality and subsidiarity, the past six years have undoubtedly shown that a decentralized system for managing banking risks was ineffective. While it’s hoped that EU-wide measures will be more successful, the subject matter necessitates an EU-wide response given the integration of European financial markets and the potential cross-border impact of bank failures. However, the UK isn’t challenging the entirety of the capital requirements rules, only the provisions regulating bankers’ bonuses. In fact, it’s not contesting provisions preventing bonuses for risky behavior, only those regulating bonuses regardless of bankers’ actions. The opinion should have addressed whether these specific provisions adhere to the subsidiarity principle. It’s doubtful they do.

This leads to the Opinion’s most significant flaw: the argument that the legal basis of freedom of establishment can regulate bankers’ bonuses. Understanding this requires a holistic view of the Treaty. It contains separate provisions on social policy, including a prohibition on EU regulation of pay (Article 153 TFEU). The general internal market power (Article 114 TFEU) explicitly states that it ‘shall not apply to’ measures ‘relating to the rights and interests of employed persons.’ The Treaty drafters clearly intended to provide lex specialis rules for pay regulation.

The CJEU’s case law has clarified the ban on EU pay regulation. In the Impact judgment, it ruled that the EU couldn’t regulate the level or components of pay but could establish non-discrimination rules regarding pay for different worker categories. Similarly, the working time directive mandates holiday pay but doesn’t regulate the level or components of an employee’s regular pay (which forms the basis for calculating holiday pay).

Following this precedent, the capital requirements legislation doesn’t determine the level of bankers’ pay on which bonuses are capped, but it does regulate the components of pay by dictating the proportion of variable pay. The Advocate-General’s reasoning implies that the EU could regulate certain aspects of workers’ pay in any area subject to special Treaty rules, rather than the general internal market legal basis. This means the EU could regulate aspects of pay for farmers, fishermen, transport workers, and those in other service industries.

It’s arguable that aspects of pay in these areas could be exceptionally regulated by EU law if essential to the regulatory framework, as in banking, if total pay could jeopardize a bank’s existence or if bonuses were linked to risky behavior. The legislation includes rules on these issues, but the UK hasn’t challenged them. Consequently, the opinion is unconvincing on the legal basis.

The financial crisis necessitates more effective banking regulations, and it wouldn’t be surprising if Member States addressed public anger over bank bailouts by limiting bankers’ income. However, resentment towards bankers’ pay, even if justified, doesn’t grant the EU powers that a reasonable interpretation of the Treaties suggests it lacks.

Postscript (November 21st): It’s important to remember that Advocate-Generals’ opinions are non-binding, a fact overlooked by several British journalists and politicians when the opinion was published. Regardless, the issue is now moot as the UK Chancellor decided to drop the legal challenge following the opinion’s publication. His official justification was to save taxpayers’ money, which is unconvincing given that most legal fees were likely already incurred and could be reimbursed if the UK won. A UK victory wasn’t implausible, considering the CJEU didn’t follow this Advocate-General’s views in a previous banking law case (concerning the short-selling ban), and the legal basis analysis is weak.

Barnard & Peers: chapter 14, chapter 19

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