Bankers to flee after Europe pay squeeze?

European banking watchdogs have proposed a much tougher crackdown than expected. James Moore reports

Their actions might have precipitated the worst recession for a generation – but the banking industry has little shame.

The worst of the financial crisis was barely over before bankers and their representatives were issuing threats to the politicians and watchdogs who spent billions on keeping their employers afloat.

Their message? Squeeze us too hard and we'll be off. But yesterday, just 24 hours after the European Commission made clear its support for new banking taxes – the Committee of European Banking Supervisors (Cebs) called the industry's bluff on pay. Its draft rules on bonuses are tougher than anyone had expected, After months of talk while the banking industry urged no action without international agreement (while skillfully playing countries off against each other), the Cebs members appear ready to draw a line in the sand.

The new rules say that as much as 60 per cent of top bankers' bonuses will have to be deferred for between three and five years. Half of the upfront proportion (and half the deferred portion) will also have to be paid not in cash but in shares. And there will also be a minimum "retention" period over which bankers will have to hold these shares. Which could be for years after the deferral.

And there is a nasty sting in the tail: tax (at 50 per cent for the top bankers) will be liable on the shares as soon as they are issued. But the "retention" period means bankers will not be able to sell shares to pay the tax, although in Britain there may be ways of getting around this.

Banks will also have to work with regulators to define a maximum multiple of salary that can be paid as bonuses to bankers who exercise a "significant influence function" or a "significant risk-taking role". In other words, traders and top managers, although the exact size of the multiple has not been set.

The rules apply to all EU-based banks – with critics already saying they will suffer huge competitive disadvantages in regions like Asia, whose banks don't need to comply. Banks with Asian operations say they are already suffering from the current (less stringent) UK rules.

The new rules would only apply to the EU subsidiaries of non-EU banks, but this creates a dilemma for them: they may have to work out differential pay policies for different parts of the banks as a result. Human resources departments hate the idea of this, not least because it creates two different classes of employees. Most banks spread the impact of the UK's one-off tax on bankers' bonuses to avoid penalising one group of employees for this reason.

Officials from Britain, by far the biggest financial centre in the EU, are thought to have been among a minority urging a rather less aggressive set of demands. To no avail.

Add it all up, and the watchdogs appear to have decided to call the bankers' bluff. Will the long threatened exodus follow?

The British Bankers' Association said in response to yesterday's draft document: "The question is whether we want to isolate the EU's financial services industry and watch the business develop elsewhere. What this is about is big international banks wondering whether London really is the obvious place to build their EMEA (Europe, Middle East & Africa) headquarters. It used to be an easy decision. Now, not so much."

Jon Terry, head of UK reward at PricewaterhouseCoopers, said talk of a mass exodus was probably overdone. But he said that the rules will still have an impact: "With business that does not need to be carried out in the EU, screen-based business for example, if the group structure will allow, then banks will probably locate it elsewhere if their structures will allow this. We may also see restructuring to make this possible."

Mr Terry added: "We are beginning to see some major players thinking really hard about this. What we are seeing so far is, with new business areas, or when they are expanding existing businesses, they are looking at doing it elsewhere."

Mr Terry said it isn't just bonus restrictions, but also Britain's 50 per cent top rate of tax that is motivating this. So while there may not be a mass exodus there could instead be a drip, drip of business away from London. A likely winner will be New York, which could win back much of the business it lost when it brought in the Sarbanes-Oxley corporate governance reforms, seen as onerous and unfair on foreign operators.

Other contenders would be Hong Kong and the fast growing Singapore. Switzerland, in the form of Geneva, may also gain business.

But should Britain really be bothered if the bankers go? Mr Terry said: "The financial industry provided 9 per cent of our GDP before the crisis and it is a big payer of tax. There will be real knock-on effects for the economy if we lose it."

However, Gavin Davies, from the left-wing think tank Compass, disagreed. He said: "We keep hearing this but there has been no exodus. New rules are being brought in to avoid another financial crisis. They are actually in banks' interests. The alternative is another crisis."

TUC general secretary, Brendan Barber, said: "If bankers acted on their threat to leave the country every time they were asked to contribute towards repairing the mess they caused, we'd see tumbleweed drifting across the Square Mile. The banks easily paid the £3.5bn bonus tax and are set to dish out a further £7bn on bonuses in the coming months."

Mr Barber said the consequences of not cracking down on the banks could be far more serious than "a few empty threats".

New York

Bonus rules are far lighter, could regain business lostfrom Sarbanes-Oxley reforms

Hong Kong

Asia's leading financial centre, and several banks are already there. No bonus rules at all

Geneva

Already a favourite of hedgefund managers, even if it will want to avoid a battle with the EU

Singapore

Coming up fast on the rails, like Hong Kong, can't see what all the bonus fuss is about