City fears exodus as tough curbs on bonuses are agreed

Europe-wide cap on payouts may see bankers heading for New York and Far East

The City of London could be hit by an exodus of workers to New York, Hong Kong and Singapore, experts have warned, after politicians agreed to cap bankers' bonuses across Europe.

Officials concluded weeks of talks by confirming plans to introduce the world's strictest pay curbs across the Continent. The provisional agreement means that from as early as next year, bank bonuses in the European Union should be limited to no more than base salary – or up to twice salary with the explicit approval of shareholders.

The rules will apply to all banks based in Europe, regardless of whether they are American, Asian, Russian or European, and to units of European banks based overseas.

Boris Johnson, Mayor of London, said the proposals were "a boost for Zurich, Singapore and New York" at London's expense. David Cameron also expressed concern about the proposed rules, saying that any new ones must allow international banks to keep "competing and succeeding while being located in the UK". The cap is a setback for the British Government, which had lobbied hard against it.

Jon Terry, remuneration partner at PwC, said: "Capping bonuses to the extent proposed is a major problem for European banks, and will create a huge wave of unintended consequences.

"The failure to grant an exclusion for employees outside the EU is a blow for the large EU banks, who will now need to compete with one arm tied behind their backs against non-EU banks in New York or Hong Kong. Coupled with a likely expansion of the definition of 'risk-takers' later in the year, these proposals could seriously undermine the competitiveness of EU banks outside the EU.

"The proposals mean banks are more likely to build new capabilities in New York, Hong Kong or Singapore instead of Europe. This will harm employment, not just of bankers but in the wider economy."

Ireland, which holds the rotating EU presidency and helped to negotiate the deal, will now present it to EU countries. The Irish Finance Minister, Michael Noonan, said he would ask his peers to back it at an EU ministers' meeting on 5 March in Brussels.

Hedge funds and private equity firms will be excluded from such curbs, although they face restrictions on pay later this year under separate EU laws. A bonus cap in the US is believed to be unlikely. Mark Littlewood, director general at the Institute of Economic Affairs, said: "This is an arbitrary move which will serve only to drive business and talent away from the UK. With a larger financial services sector than other member states, this policy will have a disproportionately damaging effect on the UK economy.

"Aside from undermining the competitiveness of the UK's financial sector, the introduction of caps would be highly dangerous. Increasing the fixed costs of banks would mean they would be unable to reduce their costs when things go wrong.

"Removing the ability to control risk is the worst possible strategy," Mr Littlewood added. "This is yet another example of the European Parliament trying to exercise its muscle without any rationale."