15th May 2014

Bonus clawback proposals have merit but need more work

Written by Simon Hills, Executive Director, Prudential Regulation and Risk

The banking industry fully supported the Parliamentary Commission on Banking Standards’ (PCBS) suggestion to introduce new rules to allow bonuses to be clawed back from bankers who have been prosecuted and found guilty of causing harm to customers or their bank.  It is clearly right that if someone was responsible for serious misconduct that only comes to light after they have banked their bonus that there should be a mechanism to take that bonus back off them.

So we absolutely agree with the principle that the Prudential Regulatory Authority (PRA) is trying to achieve with its latest consultation. But we have some real concerns and would like the regulator to take a further look at the proposals.

As we say in our response today, we worry that many junior workers will be affected who might not have had any knowledge or involvement with any wrongdoing and were not the original targets for politicians; that the rules are intended to be applied retrospectively and that clawback will have some unintended consequences.

First and foremost the PRA has substantially widened the scope.  The PCBS called for the regulator to look at whether bonuses that had already been paid – known as vested in the jargon – to people who had been the, “subject of successful enforcement action” could be clawed back.

The PRA now seems to want to include a much larger number of employees who may not have actually committed any crime or contributed to any wrongdoings.  For example, they want to be able to claim back bonuses already paid from employees merely if there is “reasonable evidence of employee misbehaviour or material error” or if their “firm or the relevant business unit suffers a material downturn”.

No-one objects to bankers who have been prosecuted for wrongdoing having action taken against them to claw back their bonuses from recent years.  Our concern is that the PRA has widened the net so far that people who just happen to work in the same team or the same building as someone who has done something wrong would also have to repay money awarded to them years before that they have probably already spent.

The PRA adds that firms should seek to retrospectively apply these rules to existing contracts. We oppose retrospectively applying new rules to past behaviours – it goes against fundamental tenets of our laws.  On a practical level it will be impossible to retrospectively change contracts unless employees agree to it.  This could lead to some employees being treated very differently from others and no doubt result in a large number of legal challenges, which is in no-one’s interests.

We also think the authorities need to give careful thought to the unintended consequences of their proposals.  Bonuses are already deferred by up to five years. Adding on a clause that would allow bonuses to be clawed back for six years after they have been paid would significantly reduce the value of that bonus in the eyes of most staff.  That could create an upward pressure on salaries – something that neither the banks nor the regulator want to see.

These rules will also put UK banks, and banks with large subsidiaries here, at a real disadvantage to banks from other countries when trying to compete for staff.  Regulators, politicians and the public will probably argue that is a necessary evil but this will have an impact on banks’ ability to hire the best people.

Clawback is a well-meaning measure. But for all the reasons outlined above, we would urge the PRA to think again about how it can best be implemented.

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