Ten terrible things that will happen when the EU caps bank bonuses in 2014

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It seems to be happening and it seems to be harsh: the EU's proposed bonus cap is becoming real. There's a crucial 'trialogue' meeting between representatives of the European Commission, the European Parliament and the European Presidency on the subject this afternoon. If attendees can reach agreement, the European Parliament will vote on April 15th. If the European Parliament votes in favour in April, the new European Union bonus cap will come into place in EU countries on the first of January 2014.

Early next year, therefore, bankers in the City of London will have an almighty shock. As currently conceived, the cap states that bonuses must be restricted to 100% of salaries. If 75% of shareholders are in favour, the cap can be lifted and bonuses can be raised, but only to 200% of salaries, no more.

The UK is said to have been frantically circulating an informal paper suggesting various compromises (the cap should only apply to cash compensation and only to countries in the eurozone), without success. Lobbyists for the City of London seem to be losing hope. "We can't comment on the proposals, the negotiations are  at a very, very delicate stage," one told us.

"It looks like the cap will cover all variable pay at all banks in the European Union - US banks included," said Alexandra Beidas at law firm Linklaters. "The UK has been arguing that long term incentive awards should be exempt, but it hasn't succeeded."

If the EU's plan comes to pass, this is what we predict will happen on, or before, January 2014.

1. Salaries in London will double

"The proposals are not an actual cap," said the assistant of a British MEP in Brussels, speaking on condition of anonymity. "They will not stop an organisation paying beyond a certain level. They will just reduce the organisation's ability to pay bonuses. Salaries can be increased."

Salaries will increase most in London, because it is London that bankers earn the biggest bonuses. By comparison, bonuses equivalent to 100% or more of salaries are rare in Paris or Frankfurt.

Banks based in the European Union have already released figures showing their proportion of fixed to variable pay for their regulated employees, with those for 2011 showing that variable pay averaged more than 200% of fixed pay at UBS, more than 300% of fixed pay at Deutsche Bank and more than 400% of fixed pay at Barclays.

2. Banks in London will monitor their highly paid staff a lot more closely

Current salaries for bankers in London are listed here. If in future banks have to pay salaries as high as £700k+ to all their managing directors they will be much more careful to monitor staff and ensure they're getting value for money.

"If banks think their average trader or average M&A banker deserves to earn £1m, that's fine," said Sony Kapoor, managing director of Brussels-based think tank Re-Define, which has successfully campaigned for the bonus cap. "Banks will need to pay higher salaries and to monitor employees very closely to keep him/her in check."

Expect more control on hiring and more emphasis on key performance indicators (KPIs). Bankers who don't meet KPIs will be out.

3. Traders will leave for hedge funds 

The new EU bonus rules will not apply to hedge funds and probably never will, Kapoor said, because taxpayers won't have to step in to save a hedge fund gone wrong. Traders who want big bonuses will be free to leave banks and to join funds. This is already happening, but in future banks will be even more bereft of their best traders.

4. Bankers will leave for private equity funds

Private equity funds won't be affected by the EU bonus cap either. Expect the best junior M&A bankers to escape to the private equity industry where they can earn bonuses and carried interest. This is already an issue (Goldman Sachs complained about it last year). It will become more of one.

5. Traders and salespeople will leave for anywhere outside the EU 

Traders and salespeople typically earn the highest bonuses as a proportion of fixed pay and thus are most affected by the bonus cap. Consider the case of  Kareem Serageldin – the former global head of structured credit trading at Credit Suisse who was paid a total of $7,279,487, of which only $279,497 (£171k) was his base salary. Or there's Raphael Geys, the former head of fixed income sales at SocGen, who said he was owed a €12.5m bonus after doubling the revenues of his division, even though his basic salary was only £150k.

Because the EU rules will apply only to banks operating in the European Union, salespeople and traders like Geys and Serageldin are likely to try their luck in Hong Kong or New York. While the rest of the world can't accommodate some 20,000 people who may want to leave the City, the most mobile will leave.

6. Bankers' spending habits will change

If salaries rise and bonuses fall, bankers will start to spend money differently said Dr Eugenie Proto, an expert on spending habits at the University of Warwick in the UK. People who receive a bonus are more likely to spend it on large big ticket items like a house or a Ferrari, said Proto.

Expect fewer outright purchases of houses, fine wines and fast cars, and more commitment to school fees and long term mortgage payments, suggested Proto. Competition for private school places in London could increase. Ferrari dealerships could go out of business.

7. No one will want to be defined as a member of code staff 

Beidas at Linklaters said the new rules will likely apply only to 'code staff' as they are known in the UK, or to 'regulated staff' as they are known in Europe. You can see a definition of code staff here.  Any promotion that results in an employee being elevated to code staff status will be seen as a bad thing as it will mean bonus potential will be lowered.

8. Redundancy purges will become much more intense

If banking salaries are substantially increased to compensate for the cap on bonuses, banks will be much quicker to chop highly paid staff when revenues wane. In the past they could simply chop bonuses. Not any more.

9. Banks will be far more careful about hiring

If bankers' salaries double, banks will think long and hard about adding staff as revenues rise. In the past, they could flex the cost of these new staff in response to the business cycle simply by altering bonuses. Now the new bankers will be a fixed cost no matter what. And does it really make sense to add £1m in fixed costs when revenues might fall back again next year? Expect more hiring on short term contracts.

10. Banking will attract nice steady non-risk taking types 

Banking will become a lot less like a roller-coaster full of risk takers vying for gigantic bonuses and a lot more like a highly paid branch of the civil service. Maybe this is a good thing, however?

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