Growth shares, short contracts, employee owners: how banks will avoid the bonus cap
It's fewer than 48 hours since the EU's proposed bonus cap was finalized, and assorted methods of sidestepping the restrictions are already being floated. We've listed the key ones below. None are guaranteed of success - the UK Financial Services Authority Remuneration Code states that, "A firm must ensure that variable remuneration is not paid through vehicles or methods that facilitate avoidance of the code," meaning that anything not in the spirit of the rules risks breaching FSA rules. Implementation of the bonus cap is likely to be subject to similar prohibitions.
Moreover, trying to avoid the caps risks heavier regulation in the future. The bonus caps --a maximum of 250 percent of base pay -- are a reaction to banks failing to rein in their bonuses enough in the first place, and some jurisdictions are making noise about imposing their own, lower caps. The Dutch government is considering capping bonuses at just 20% of salaries and there have been calls to ban bonuses altogether.
This is what banks, and bankers, could try to do in response.
1. Pay a high proportion of bonuses in long term deferred instruments
The UK successfully negotiated a relaxation of the bonus cap in which compensation that is deferred for five years or more will be treated more leniently. While a spokeswoman for the European Parliament said the 250 percent cap is absolute, some lawyers said there may be room for negotiation as the portion that's deferred can be discounted using a net present value calculation.
The European Banking Authority will be setting the discount rate for long term deferred instruments over the next few weeks. The UK will be lobbying for a high discount. If it's successful, a very high proportion of 2014 bonuses could yet be deferred until 2019 or beyond.
2. Work for an organisation that flies below the radar
Lawyers said that there is nothing in the current commentary surrounding the bonus cap to indicate where it will apply. However, precedent might suggest that only the largest firms will be affected. In the UK, only the largest institutions are subject to the FSA's most stringent rules on bonuses. If the EU cap applies in a similar manner, small banks, brokerage firms, corporate finance boutiques and asset management firms may be exempt. Last year banks negotiated a special dispensation to exclude their asset management arms from some UK bonus rules, suggesting there may yet be some hope for banks' asset managers who are fearful of being hit by the cap..
3. Ask for your salary to be paid in escrow
This was the FT's idea from yesterday. The FT suggested that star bankers who have historically received large bonuses will have those bonuses reclassified as salary. However, rather than being able to access the increased salary automatically, the increase would be held in an escrow account from which it would be clawed back if targets weren't met.
Lawyers told us this could work, but that it would risk falling foul of avoidance rules.
4. Short term increase in salaries
When Goldman Sachs increased salaries for its investment bankers in London in 2009, it included a clause in its contracts stating that they would be reduced after 24 months. Speaking off the record (for fear of being seen to encourage avoidance), lawyers said similar clauses are likely if banks increase salaries in response to the cap on bonuses.
"People have been enquiring about increasing salaries for a year or two," one lawyer said.
5. Payment via restricted covenant
Another option under consideration is reportedly paying bankers for signing restricted covenants. Such covenants would state, for example, that the signatories would be unable to do certain things (work for competitors) within a specified time period. "A bank would effectively say to an employee that it wanted the individual to enter a new restricted covenant, and would offer a payment to compensate for that," said one lawyer.
The downside to this method of sidestepping the cap would that it could only be used once or twice.
6. Increased allowances
Lawyers also suggest that banks might increase employees' allowances. Housing allowances would be the most obvious delivery mechanism. However, lawyers say this also carries the risk of falling foul of avoidance legislation. "If you start giving someone a £200k housing allowance, it will look a lot like a bonus," said one.
7. Growth shares and SIVs
So-called 'growth shares' are probably the most interesting and viable plan being discussed among London's lawyers.
Under this scheme, a bank would create a new class of share in a company which had a very low initial value and a very high value upon vesting. Although the shares are clearly part of 'variable remuneration' and therefore captured by the cap, their initial value is so low that the cap can be easily adhered to. The downside is that it would be necessary to create a new class of share, which could be an issue for listed companies, lawyers said.
John Carney, senior editor at CNBC, suggests an alternative method of sidestepping the cap: "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."
8. Create employee owners
The bonus cap applies only to employees and not to 'employee owners.' For this reason, anyone working for a limited liability partnership would be unaffected London lawyers said. Could banks create separate structures where employees are somehow reclassified as owners? Lawyers say it's unlikely.
However, there is a way that banks could offer generous one-off payments. "The UK government has created a category of employees called 'employee owners'," said one lawyer. "Under this scheme, employees sign away some of their employment rights in return for a stake in the company. A bank could give away £500k of shares and say it was making someone an employee owner," he said. This would be a method of delivering a one-off payment to bankers. However, 'employee owners' under the UK government's definition would still be employees as defined by the EU and therefore still susceptible to the bonus cap.
9. Short term contracts
Short term contracts also offer a simple method of sidestepping the cap. In theory, banks could simply offer employees annual employ contracts with salaries reviewed at the end of each year (similar to point 4). However, lawyers say this may not work. "If a bank has changed someone's salary every year for three or four years, it's going to start looking like a bonus and will fall foul of anti-avoidance legislation," said one.
10. Avoid becoming code staff
It's likely that the EU's bonus cap will apply only to so-called code staff or regulated staff (see the definition here) said Alex Beidas, a lawyer at Linklaters in London.
From this point of view, individuals may seek to avoid becoming code staff so that bonuses are not restricted. However, Peter Hahn, a banking specialist at Cass Business School, said the European Banking Authority is due to tighten its definition of code staff later this year and that more London-based bankers caught be caught as a result. "Banks in France have 700 or 800 code staff whereas banks like Barclays only have 300-400," said Hahn. "The definition of code staff may be much wider in future," he added.