EU proposals to cap bankers' bonuses risk legal challenge, City partners warn

EU proposals to cap bankers’ bonuses could be in breach of European rules governing pay, paving the way for a potential legal challenge by banks, according to some City lawyers.

The reforms, which are set to come into effect next year, were this week backed by EU finance ministers despite opposition from Chancellor George Osborne, and would see bankers’ bonuses capped at the same level as their basic salary, or twice salary with shareholder approval.

In addition to arguing that the plans could be open to a legal challenge in the courts because they breach European regulations, City finance partners have also complained that they would prove a “self-defeating handicap” to the City of London’s position as a financial centre.

The cap is expected to come into force next year and, in its current form, could affect all bankers in the EU, as well as those employed by European banks living anywhere else in the world.

Critics say this would put the UK and other European institutions at a disadvantage to rivals from other jurisdictions such as the US.

Herbert Smith Freehills finance partner Clive Barnard (pictured) said: “It’s completely self-defeating to handicap the European banks in this way because they’re competing in a global marketplace.”

Another finance partner warned it could lead to some banks moving their operations from the UK to Asia and the US: “A lot of the business we do is international, but a lot of it is in London. And [if] London becomes a less attractive venue for business, it’s difficult to see that law firms would escape from that.”

Meanwhile, while no legal action has yet been launched, employment lawyers are already considering whether there are grounds to challenge the cap.

“This turns on whether the bonus cap is pay regulation, which is outside the EU’s remit,” said one magic circle employment partner.

“It is definitely arguable that this is pay regulation as the 1:1 ratio has the effect of limiting how much an individual can be paid. The difficulty with bringing any claim is the possible PR ramifications for banks making this argument.”

A legal opinion by Shearman & Sterling for one banking client published in the Financial Times this week shows some firms have already started advising bank clients that fixing the salary-bonus ratio contravenes European law, and possibly the constitutions of some member states.

However, Alex Beidas, a London-based employee incentive lawyer at Linklaters, questioned the basis of any legal challenge: “The European Commission has been very careful to structure this so it’s not an absolute cap, but a ratio between fixed and variable pay.”

She added it was too early to say how financial institutions might respond to the cap, although higher base salaries is one option likely to be considered by financial institutions.

Negotiations over the final details of the new regulations are set to begin next week, with the start date for the new regime now due to be pushed back from the previously proposed 1 January 2014 implementation date.