The European Parliament has voted in favour of a proposal to introduce new rules (known as CRD IV) to put a cap on bankers' (who work for European banks anywhere in the world) bonuses. The new rules have attracted a good deal of attention from the banking community and media alike.

What are the new rules?

In relation to remuneration, the European Parliament has voted in favour of the following principles:

• Bonuses will be capped at not more than 1 times the employee's basic salary.
• This cap could be raised to 2 times the employee's salary but only with the approval of the shareholders.
• The higher bonus payment would require at least 66% of votes in favour, if more than 50% shareholders vote. If less than 50% of shareholders vote, the resolution would need 75% of votes in favour.
• To encourage more of a link between remuneration and long-term risk, 25% of any bonus exceeding 100% of salary must be deferred for at least five years (in the form of long-term deferred instruments (LTDIs)).

Who will be affected?

CRD IV will apply directly to European credit institutions and to investment firms (including the retail and investment banks).

The rules will not apply to all banking staff but only senior management, risk takers, staff engaged in control functions or any employee receiving total remuneration that takes them into the same pay bracket as senior management and risk takers.

Application in Asia

The Directive will have an extra-territorial impact in that it will apply to employees of subsidiaries of European companies operating outside the EU.

There is a concern that this could result in a violation of international trade agreements and the risk of legal challenge. As a concession to those firms who have been seeking an exemption for non-EU staff, the Commission will review the implications of the extra-territorial provisions in two years' time. In particular, it will consider whether this type of cap should continue to apply to any staff working effectively and physically in subsidiaries established outside the EU, where the parent institution is established within the EU.

Is it legal?

Article 153, section 5 of the Lisbon Treaty 2007 states that the European Parliament and the Council's ability to modify social policy "shall not apply to pay". However, the legislation has been passed as a measure to deal with systemic and macro-prudential risk i.e. not social policy. The European Parliament may also argue that the new rules do not regulate total pay, but merely the proportion of variable to fixed pay.

Next steps

The legislation was adopted by the Parliament on 16 April, following the conclusion of negotiations between the Council, the Parliament and the European Commission in March.

The Commission will review and report on the application of these provisions with the European Banking Authority, taking into account its impact on competitiveness and financial stability.

The final text remains subject to a detailed review of legal drafting and translation into other official EU languages, and formal adoption by the Council of Ministers, at which point we will be in a better position to review the detail.

The rules will then be implemented by the various EU member states. Although member states have to transpose the Directive into national law, the new rules are directly applicable, which means that they create law that takes immediate effect in all member states in the same way as a national instrument, without any further action on the part of the national authorities.

At present, the rules are due to come into effect on 1 January 2014, but this may be delayed if translation cannot be completed in time for publication in the Official Journal before 1 July 2013. In the meantime, firms should plan ahead on the basis that bonus caps will be in place from 1 January 2014.

Consequences and potential solutions

Once the text of the legislation has been finalised, it will become clearer what strategies may be adopted to minimise the impact of the measure.

It seems that the new rules will inevitably lead to companies offering higher salaries to enable them to structure a package which is attractive enough to retain talent. A key concern for the European banks operating in Asia will be that the caps on remuneration cause them to lose their top-performers to banks that do not have the same restrictions with pay.

Ideas being floated to counter these restrictions include:

• Increasing fixed pay.
• Withholding salary during the year dependent on performance (although this runs the risk of being treated as variable remuneration and therefore subject to the new rules).
• Re-structuring remuneration for valued senior individuals by offering ownership/shareholdings to allow the individuals to benefit from profits alongside shareholders.