Bankers plot response to bonus cap threat It is easy to guess the response of most bankers to the news that the EU is poised to impose a limit on bonus levels, potentially capping them at the same level as salaries. "This is batty," says one top UK bank executive. Non-EU banks will simply move their staff out. "This is mad," agrees one Swiss banker working in London, astounded. "Oh, Christ," says a third. For months now bankers have been so concerned about the issue that chief executives have been making direct appeals to politicians from Berlin to Brussels to moderate the plan - seemingly to little or no effect. Many pay consultants agree. "This poses a real problem for banking," says Douglas McWilliams, head of the Centre for Economics and Business Research. There is a reason why pay has traditionally been variable in investment banking. And that's because [revenue] is variable. This kind of change will just limit that flexibility. Whatever the intellectual logic of the plan, even bank lobbyists are now starting to admit in private that the European Parliament's plan for a limit on the ratio of bonuses to basic salary - perhaps as low as 1:1 - is probably unstoppable. Though there may be tweaks to the rules as they move through the European legislative process, bankers are now turning their attention away from resisting the inevitable and more towards how they would deal with the issue. The biggest banks are likely to have the biggest challenges, say analysts, in particular US groups such as Goldman Sachs and JPMorgan Chase, plus European banks with outsized investment banking operations such as Barclays and Deutsche Bank. The least affected are set to be French banks, which have traditionally paid smaller bonuses and higher salaries. "Second-tier banks may also be less hit by the new rules," says one London-based analyst. They have already had to increase salaries more aggressively in recent years to keep their best people. Making up the shortfalls Pay consultants and banks" remuneration experts have got their thinking caps on, as they seek to find alternatives to the traditional banker's bonus, write Patrick Jenkins and Alex Barker. Pensions One option likely to be considered by some banks is a shift towards more generous pension allowances, a model used by Spanish groups such as Santander. Alfredo Sáenz, chief executive, has accrued pensions benefits worth nearly €90m, while chairman Emilio Botín has a pot worth more than €25m. But experts warn that for UK-based bankers, this kind of approach will fall foul of new pension limits. Top chief executives used to be able to build up vast pension pots. But these days, anything beyond a £1.5m pot becomes prohibitively expensive in terms of tax charges. A more workable alternative, especially in markets such as the UK, could be a trend towards career-long holding periods for so-called long-term incentive plans, which today typically vest after only three years. Investors have pledged to push this model, used by Goldman Sachs and HSBC, over the coming months at other banks. Under the EU plan as currently envisaged, LTIPs would be caught by the definition of bonuses, but some banks hope that they will be able to persuade lawmakers to exempt deferred schemes like these, especially if vesting periods are lengthened considerably. Profit-sharing Douglas McWilliams at the Centre for Economics and Business Research is confident that new structures will be invented to avoid being caught by the rules. "I can't believe they can ban all forms of profit-sharing," he says. Shrink code staff Banks have considerable latitude to nominate staff they judge to carry significant influence, and would thereby be caught by the new rules. Currently banks in Europe have an average of 100-200 code staff apiece, though some have fewer than 100. One way to minimise the impact of the rules would be to minimise the number of code staff. But if smaller boutique banks are caught by the rules, they may be the hardest hit, consultants warn, because their partnership structures typically rely on small salaries and large potential bonuses distributed in the "eat-what-you-kill" tradition. Not all bankers will be affected. Though the precise scope of the plan is still being debated, it is likely to be limited to a few thousand so-called "code staff," senior bankers or traders with a significant influence on profits. Analysts and pay consultants say banks will confront the rule change in a variety of ways. With the rules set to cover EU banks" operations globally, and global banks" operations within the EU, another consequence is likely to be a shift of staff away from European financial centres, principally the City of London. Bankers say US groups will move global business heads who might currently be in London back to New York or to Hong Kong, while the changes will put further pressure on banks such as HSBC, Standard Chartered and Barclays to shift their headquarters outside Europe. "This is a massive arbitrage in favour of the US banks," says one European banker, who points out that many traders are also likely to leave the industry in favour of hedge funds. There will inevitably be an effort to circumvent the rules, too. "There will be a level of creativity," says one top UK banker. It's like tax avoidance. You exploit the loopholes. However the commonest response, some argue, is likely to be further salary inflation to rebalance the ratio, as happened two years ago as banks sought to offset the impact of having to defer large percentages of bonuses over several years, following another European rule change. That will reduce banks" flexibility in tough times, either crimping profits or forcing banks to lay off staff rather than simply trim bonuses. "You will have to get rid of people, not cut bonuses," says Simon Garrett, a director in the pay practice at consultancy Hay Group. Pay consultants Towers Watson are predicting fixed salaries to double in a number of business areas, exacerbating a trend seen since the financial crisis. In the institutional clients segments of global banks, salaries have already risen from 18 per cent of total pay pre-crisis to 44 per cent last year, research by Towers Watson shows. Tom Gosling, a partner at PwC, says the legislation would bring banks into conflict with their shareholders who want a high proportion of the most senior staff's pay to be variable and based on performance. Are investors going to accept fixed pay of €5m for a bank's CEO? I think this will be very difficult, but to remain globally competitive they may have to," he says. Simon Garrett at Hay Group agrees, saying that playing about with the ratio of bonuses to salary, rather than addressing the total pay pot, is spurious and could further inflame relations with investors. The fixed ratio misses the point completely. They should be looking at the balance of pay versus dividends or reinvestment in the business.