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STRASBOURG - The European Parliament agreed to what officials described as the world's strictest rules on bankers' bonuses, capping big cash awards across the European Union in time for 2010 payouts.
The new law, agreed upon Wednesday, will limit upfront cash to 30% of a banker's total bonus and to 20% in the case of very large bonuses. Between 40% to 60% of bonuses will have to be deferred for at least three years and can be clawed back if the recipient's investments perform badly. At least half will have to be paid in stock or "contingent capital," meaning it won't be paid if the bank hits difficulties.
The law represents the latest victory in a global regulatory push to rein in the bonuses that some critics see as helping stoke the financial crisis. Officials said the law is likely to be formally adopted at a meeting of EU finance ministers next week, allowing it to come into effect at all banks operating in the European Union before this year's bonus season
The rules "send a strong political message: There will be no return to business as usual," said Internal Market Commissioner Michel Barnier. "Banks will need to change radically their practices and the mentality that have led in many cases to excessive risk-taking and contributed to the financial crisis."
In the U.S., despite much discussion about banker bonuses, there have been no moves to explicitly limit cash bonuses. The Federal Reserve has new, broad authority to tell banks how they should pay their employees, but there are no hard caps or taxes on bonuses. More-explicit restrictions could emerge as regulators write specific regulations on banks.
The new rules effectively codify what has become common practice among banks, which have sought to fend off harsher regulations by limiting cash payouts and tying banker pay more closely to long-term performance of the companies. Critics say big cash bonuses were one cause of the financial crisis, because they encouraged bankers to take big risks amid the knowledge that they would get paid even if their investments soured in the future.
Still, the law doesn't put a cap on total pay, although European banking supervisors will set guidelines later this year on the maximum proportions of base salaries that may be awarded as bonuses. And an unintended consequence of the law is that it could lead to higher base salaries as banks look to attract talent with the promise of more guaranteed money.
European officials said the rules will apply to banks and investment firms and not hedge-fund managers - though they would apply to investment firms that manage hedge-fund assets. Members of the parliament are likely to attempt to introduce rules curbing payouts for hedge-fund managers in legislation due later this year.
The law also requires banks to hold a minimum amount of capital to ensure they are covering risk from their trading books and complex securitized investments, such as mortgage-backed securities. The aim is to avoid a repeat of losses like those seen during the financial crisis that escalated in late 2008. The capital requirements would take effect in 2012.
The law is telling banks "hold more capital, get your priorities right," said Arlene McCarthy, the parliament member who steered the legislation through the assembly. "We want banks to focus not on their own pay and perks, but more on lending and support to economic recovery," she added.
Forcing banks by law to stretch out bonuses over several years will be good news for European banks because it will limit competition among them, says Alex Kleanthous, a partner at Gannons, a London law firm. "It's like the smoking ban on airlines. They all wanted to have a smoking ban, but nobody wanted to be the first to do it," he said.
The banks' biggest concern would be if financial centers in other cities, such as New York or Singapore, had less restrictive laws - which could lure some top bankers away or prove more attractive to recruits, he says.
In the U.K., which is home to Europe's largest financial markets, officials said that the law would extend more broadly what had already been codified by British regulators. At least, the law will put London on level ground with other European cities, if not other financial centers, in terms of banker pay.
The U.K. stood largely alone in regulating compensation despite a commitment from the leaders of the Group of 20 big economies to keep remuneration in check. In a statement last September after they met in Pittsburgh, G-20 leaders agreed "to implement strong international compensation standards aimed at ending practices that lead to excessive risk-taking." Before parliament's move Wednesday, however, efforts to put in place global standards have largely stagnated.
In another vote Wednesday, the European Parliament emphasized its opposition to proposals from individual EU governments that want to keep significant national control over a planned overhaul of official supervision of the EU's financial sector.
With an overwhelming majority, it voted to give European supervisory agencies - due to be created at the start of next year - more powers over national banks, financial markets and insurance firms than many governments would tolerate.
The parliament also voted to locate new agencies to supervise banks, markets and the insurance business in Frankfurt alone, instead of in London, Brussels and Paris as EU governments had envisaged.
Some officials said the parliament's position that the agencies should be located in Frankfurt is likely to be negotiated away in talks among the parliament, governments and the European Commission. The talks are unlikely to be concluded before September or October, when the different approaches to financial-sector regulation may be resolved.