Bankers Can Easily Avoid the EU Bonus Cap

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So is the EU cap on banker bonuses going to devastate London's financial sector?

Almost certainly not. Investment bankers will just react to this the way they react to every rule imposed upon them: They'll innovate right around the rule.

The proposed rule would cap bonuses at twice a banker's salary. Since salaries are often a fraction of bonuses, this rule would seem to be set to slash banker compensation.

Of course, if the rule did work, there would be an enormous flight of talent out of European banks. JP Morgan Chase, Goldman Sachs and Citigroup would just poach all the top performers.

But it won't work because it's too easy to avoid. The Financial Times' Lex commentary service explained one way Thursday morning:

Your fixed, cash salary will be increased from €500,000 to €10m per year, roughly in line with your average total compensation for the past five years, to be paid monthly into an escrow account. By signing your contract you agree that from this escrow account a monthly net payment equivalent to €500k per year will be paid into your personal bank account.

At year-end, you are entitled to the balance of your cash salary in the escrow account subject to strict clawback provisions detailed in this contract. For example, if 100 per cent of your various targets are achieved you will receive €9.5m, on a sliding scale to zero based on the formula enclosed and consistent with Article 88 of European rules implementing Basel III. Whatever money remains in escrow at year end will transfer to the bank's general account.

In other words, you just increase the salary to the anticipated bonus, hold it in escrow until year's end, and then subject it to a clawback for underperformance.

Alternatively, you form a special purpose vehicle to which you sell the rights to half of the future profits from a trading desk. The traders on the desk earn shares in the vehicle as part of their regular salary. At the end of the year, the SPV dividends out its profits to the traders. As an added bonus, this might make the dividends subject to capital gains rather than income taxes. Also, doing this would allow a bank to reduce its publicly disclosed compensation expenses and appear to comply with the law.

The ways around the cap are probably infinite. This is a rule with no teeth.

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