EBA steps up bonus cap pressure on Dutch prop traders

The European Banking Authority (EBA) has stepped up pressure on Dutch regulators to enforce strict bank-like bonus caps on principal trading firms, even as the European Commission is poised to recommend exempting all European investment firms from the rules.

On December 6, the EBA officially closed an investigation into an exemption from the Capital Requirements Regulation used by proprietary trading firms in the Netherlands, after the Dutch central bank (DNB) announced it would impose CRR on the firms.

In its statement, the EBA also reminded the DNB to “pay due attention to the provisions concerning remuneration policies”. In particular, the EBA referenced article 141 of the fourth Capital Requirements Directive (CRD IV), which limits bonus payments for firms that need to undertake a capital restoration plan. Some Dutch prop traders are likely to need such a plan to strengthen their capital ratios once CRR is imposed from March 31, 2018.

“One would actually think this is EBA’s way of saying: ‘Even though the breach is gone, I am looking over your shoulder.’ It seems they will have a close look at both the capital regime and the remuneration regime,” says an industry source in Amsterdam.

CRD IV imposes a bonus cap of 100% of base salary for credit institutions, which can be increased to 200% with the approval of shareholders. In the Netherlands, however, the authorities gold-plated the EU rules with a bonus cap of just 20%. The exemption has protected the prop traders until now.

Principal trading firms claim the restrictions would be completely incompatible with their existing pay structure. At many firms, the staff themselves own a significant stake in the business. The DNB recognised this, and in its November 13 announcement of the switch to CRR, indicated it would not be enforcing the bonus cap for investment firms before December 31, 2019, and would consult with the Ministry of Finance and industry before then to decide on appropriate rules.

Risk.net understands the Dutch finance ministry recently hosted a meeting with industry participants focused on the Beloningsbeleid (remuneration policy), at which ministry staff indicated they would reach a decision by the end of the first quarter of 2018. Prop traders expect the finance ministry will not apply the 20% bonus cap gold-plating to their firms, but do not know what will happen with the restrictions contained in CRR itself.

Crucially, the UK Limited Activities investment firm regime under which most non-bank market-makers in London are operating allows them to ask supervisors to disapply much of the CRD IV remuneration regime. This means the Dutch pay regime for prop traders could end up being significantly stricter than the UK regime.

[The EC] seems to be copying the UK approach, which has a lot of proportionality and an obligation for the firm to show the regulator that their approach is appropriate; we support that

Industry source

Separately, the European Commission is currently reconsidering the entire prudential framework for investment firms, with a meeting on Wednesday (December 20) potentially set to adopt a proposed regulation and directive.

A leaked draft of the regulation seen by Risk.net would impose capital requirements mostly in line with those recommended by the EBA earlier this year. However, the EC draft would place no rigid restrictions on remuneration policies. Instead, it would only require firms to disclose information such as the ratio of variable to fixed pay and the number of staff earning more than €1 million ($1.2 milion) per year.

In a draft of the accompanying directive, also seen by Risk.net, firms are instructed to ensure: “The total variable remuneration does not limit the ability of the investment firm to strengthen its capital base.” This is more flexible than the wording of Article 141 in CRD IV, which explicitly prohibits anything that would “create an obligation to pay variable remuneration” at a time when the firm requires extra capital.

“[The EC] seems to be copying the UK approach, which has a lot of proportionality and an obligation for the firm to show the regulator that their approach is appropriate; we support that,” says a second industry source.

2020 target

The new prudential framework is expected to enter into force alongside the revised CRR for banks, potentially as early as 2020. If the final remuneration rules are in line with those contained in the leaked draft, this would mean any bonus restrictions imposed by the DNB at the EBA’s behest could be superseded by the new EU framework within a few months.

“There is this risk you get multiple, subsequent implementations of the rules. The Dutch authorities are looking at how to address the remuneration issue… because it is not clear cut what applying CRR really means. They are on a steep learning curve to see how other jurisdictions are doing this,” says the second industry source.

A discrepancy over the compliance date for capital restoration plans is being interpreted by Dutch prop traders as a further sign the EBA is in the driving seat. The EBA’s statement requested the DNB to submit details on the firms requiring capital restoration plans by April 30, 2018. However, the DNB had earlier asked firms to submit these plans only by May 12, and the affected non-bank market-makers are seeking clarification on which deadline will apply in practice.