The European Parliament adopted at its plenary session on July 7th the new Directive restricting conditions for payment of bonuses in the banking sector. These rules cap upfront cash bonuses and establishes that at least half of any bonus will have to be paid in contingent capital and shares. The Directive also This new regulation also strengthens rules on bank capital reserves. MEPs also called for an in-depth reform on financial supervision in order to prevent future crises.

After the agreement reached by the European Parliament and the Council by the end of June 2010, MEPs have adopted on July 7th the Directive establishing the cap on banker's upfront cash bonuses as well as the rules regarding bank capital reserves. Rules regarding bonuses were adopted by 620 favourable votes to 27 with 35 abstentions, will be applicable after January 1st 2011.

A new culture on bank bonuses

The adopted text establishes that upfront cash bonuses will be capped at 30% of the total bonus and to 20% for particularly large bonuses, deferring between 40 and 60% of any bonus for at least three years to be recovered if investments do not perform as expected. Moreover at least 50% of the total bonus would be paid as "contingent capital" (funds to be called upon first in case of bank difficulties) and shares.

Bonuses will also have to be capped as a proportion of salary.  Each bank will have to establish limits on bonuses related to salaries, on the basis of EU wide guidelines, to help bring down the overall, disproportionate, role played by bonuses in the financial sector, and it also set that exceptional pension payments must be held back in instruments such as contingent capital that link their final value to the overall strength of the bank.

The law will introduce special measures for bailed out banks and it will restrain the overall amounts paid in bonuses, encouraging bankers to prioritise a stronger capital base and loans to the real economy rather than their own pay and perks.  In particular, the rules provide that no bonuses should be paid to the directors of an institution unless this is duly justified.

Capital requirements for stable banks

Two other key issues covered by the new legislation are:

• stricter capital rules on bank trading activities
• higher standards for re-securitisations

New capital rules for re-securitisations and the trading book will ensure banks properly cover the risks they are running on their trading activity, including for types of investments such as mortgage-backed securities that were central to the crisis.  Studies show that the rules are expected to lead to banks having to hold three to four times more capital against their trading risk than they do at present.

The rules on bonus provisions will then take effect in January 2011 and those on capital requirements provisions no later than 31 December 2011.

Reform on financial supervision

MEPs also sent a strong message to EU Member States that the only option for effective financial supervision is one based on a thorough reform of the current system. By adopting amendments to the legislation put forward by the Commission on financial supervision reform, but deferring the final vote on the legislative resolution, the EP has given its negotiators the backing of the full Parliament and has also left the door open for a few more weeks for an agreement to be reached at first reading with the Council after the summer break.

The declaration states that Parliament is willing to negotiate but is united in its view that the European authorities must be equipped with sufficient powers to prevent future crises and strengthen the single market.

Parliament voted to give a number of powers to the three European supervisory authorities (ESAs) which will be charged with controlling practices in the banking, securities and markets, and insurance sectors respectively. To ease interaction between the ESAs, Parliament is calling for them to be established in Frankfurt rather than having them spread around the EU.

The amendments adopted seek to ensure that the aim assigned by the Commission to the European Systemic Risk Board (ESRB), that of monitoring the build-up of risk in the EU economy, is carried out better, more clearly, and can thus be acted upon faster.