On one hand, there's good news about the progress of the EU's rules governing banking bonuses. On the other, it is too early to assume that this good news will prove more transitory hot air.

The EU's bonus regulations are having a difficult and prolonged birth. Wound up in the EU's proposed CRD 4 regulatory capital directive, they're supposed to  come into effect at the end of this year, along with complex rules on bank capital requirements. Disagreements between the European Parliament, the European Commission and the European Council are prolonging matters, however.

How the 100% bonus cap came about

The EU's attempt to curtail bonuses as a proportion of total compensation began in July 2011 when the European Commission set forth legislative proposals for CRD 4 including the provision that its institutions should, 'set the appropriate ratios between the fixed and the variable component of the total remuneration.'

The Commission submitted this proposal to the European Parliament. And the European Parliament ran with it. Philippe Lamberts, a Belgian Green MEP and member of the European Parliament's Economic and Monetary Affairs Committee, and Othmar Karas, an Austrian MEP who is the European Parliament's lead negotiator on the bonus project, are both strongly in favour of a stringent cap. Lambert is in favour of capping bonuses at 100% of salaries, while Karas has been willing to entertain a limit of 200%.  Last May, the EU Parliament voted through the proposal that bonuses should be restricted to 100% of salaries.

The EU Parliament's position on bonuses is strengthened by Michel Barnier, the EU commissioner responsible for the internal market and services. Barnier says he's in favour of a cap, but hasn't said how high or low it should be. It has also been strengthened by Wolfgang Schaeuble, the German finance minister, who said in August that he too would favour a cap of 100%.

Why the 100% bonus cap may not happen

However, EU law isn't set simply by the European Parliament. Once Parliament has adopted a position, it must approved by the European Council. And the European Council is proving more pragmatic and pushing for a weaker cap.

Hence, we have stalemate.

The outcome on the bonus cap will be the result of negotiations between the council and the parliament, one insider close to the issue tells us. "There is an ongoing discussion in the search for consensus," he informs us. "We need to agree on the architecture. The parliament want a strict cap. The question is what the council can accept and how much leeway can be built in for shareholders."

The Cypriot proposal 

In this context, Friday's suggestion by the Cypriots - who currently hold the EU presidency - seems promising. The Cypriots have suggested that bonuses should be capped at a generous five times salary when there is shareholder approval, and at 300% when there isn't. They also suggest that immediate un-deferred bonus payments should not exceed salaries.

This doesn't seem too bad. No bank paid average bonuses to its code staff that exceeded 5 x salaries last year. The closest to the limit was Barclays, at just over 4:1 - and Barclays has promised to reduce bonuses this year.

What chance does the Cypriot proposal have of sticking, however?

EU experts warn that this is not the end of the matter. The Cypriot proposal is just that: a proposal. It isn't binding. Lambert has already declared the Cypriot ideas "totally unacceptable."  Further negotiations are underway at this moment, with key players in the EU locked in meetings on the matter all today (Monday). Regulatory lawyers are EU insiders are split on whether a consensus can be reached. One insider told us to expect a final bonus decision in the next few days. Others said it could be a while.

“Compromises are suggested and discussed on a very frequent basis and until things have been signed on the dotted line, it’s difficult to draw conclusions about the shape of the proposals,” said Ben Kingsley, a regulatory partner at Slaughter & May.

The worst case scenario 

The worst case scenario is that a consensus is reached soon, that the resulting agreement does involve a punitive cap and that this cap is brought into force in time to affect the 2012 bonus round. As the chart below shows, last year's split between average salaries and average bonuses for code staff at key European banks suggests that capping bonuses at anything less than 4 x salaries would present a problem - especially at the top end, where the multiples are likely to be far higher.

"The final version of these EU rules is supposed to be ready by the 1st of January 2013," says Sam Whitaker, a counsel in the Executive Compensation & Employee Benefits practice in the London office of Shearman & Sterling. "If - and it's a big if - the FSA moved fast enough to introduce UK rules by 1 January, it's unclear whether such new rules would be retrospective and apply to bonuses awarded in Q1 2013 in respect of the 2012 performance year.  However, that possibility is certainly there, and banks should be planning accordingly" he says.

Bob Penn, a regulatory partner at Allen & Overy, says it's hard to see how the EU will be able to reach agreement on the whole of CRD 4 before the January deadline. But it's not unthinkable that the bonus element of CRD4 could be rushed through ahead of the rest of the package to come into effect for the 2012 bonus round, Penn says.

If the EU does pass a punitive bonus cap in time for 2012 bonuses, banks will be unable to retrospectively hike salaries to compensate for smaller bonus payments. This would be against FSA remuneration guidelines, lawyers say.