Britain has launched a legal challenge to the European Union's cap on bankers' bonuses which London fears will hurt its financial industry.
Finance minister George Osborne has long argued that Brussels has gone too far with reforms aimed at preventing a repeat of the financial crisis. But EU financial services chief Michel Barnier said the bonus cap was legal.
The EU law will limit a bonus to no more than a banker's fixed salary, or twice that level with shareholder approval.
The British Treasury said the EU cap had been rushed through without any assessment of its impact and would push up bankers' fixed pay, making the banks riskier rather than safer.
"Regulation of pay in this manner goes beyond what is permitted in the EU treaty," a Treasury spokesman said.
Britain has made changes to defer bonuses over several years to discourage short-term bets that could go bad.
Barnier, who will have to defend the bonus curb in Europe's top court, said the reform was based on solid legal ground and was necessary to bring stability to Europe's banking system.
"Above all, our intention has been to ensure that it is the shareholders who assume their responsibilities and play a determining role when it comes to the remuneration packages for risk-takers in banks," Barnier said in a statement.
The cap, the world's toughest curb on banker pay, was approved at a time of public anger at bankers after they were bailed out with taxpayer money in the financial crisis, ushering in years of austerity. It will take effect on bonuses awarded from 2014. Most of the bankers it will hit are based in London.
The City of London, home to much of the capital's financial services industry, says the cap risks helping other financial centres take on Europe.
Britain's Robin Hood Tax campaign, which wants the financial sector to pay more tax, said it was "beyond belief" that Osborne was battling for bankers' bonuses.
Arlene McCarthy, the EU lawmaker from Britain's opposition Labour Party who proposed the cap, accused Osborne of defending big city bonuses and privileges of an industry "that provided 40 percent of the Conservative Party's donations in 2012".
The Conservative-led government is trying to renegotiate powers back to London from the EU ahead of a referendum on Britain's EU membership in 2017.
Relations with Europe is a hot political topic in Britain where a surge in support for UKIP, the anti-EU UK Independence Party, could threaten David Cameron's hopes of a second term as prime minister.
Some banks are raising fixed pay to get round the cap and Britain argues this will make it harder for the financial sector to cut costs in times of stress. Bonuses can be clawed back if awarded for performance that proves to be illusory but this cannot be done with fixed pay, the Treasury said.
The legal challenge also argues that giving powers to the European Banking Authority, an EU watchdog, to decide whose bonus should be capped goes beyond its legal power.
Last week, an adviser to the European Court of Justice backed Britain's claim that another EU securities watchdog should not be able to impose bans on short-selling of shares on a member state.
The Treasury said the cap may infringe privacy and breaks the EU treaty by forcing individuals to disclose their pay.
Alexandria Carr, a regulatory lawyer at Mayer Brown, said EU treaties prohibit it regulating pay as part of social policy.
"The counter-argument, however, is that the provisions do not regulate total pay and are a risk-management tool which build upon the unchallenged remuneration provisions" in existing EU law, Carr added.
Britain is also challenging a plan to introduce a tax on financial transactions in some EU states and a legal challenge has been lodged against a European Central Bank policy of requiring clearing houses that handle large amounts of euro denominated securities to be based in the single currency area.
Capping bankers' bonuses in the EU has been on the European Commission's agenda since the onset of the financial crisis.
Under a deal struck by MEPs and EU member states in 2010, bonuses could be capped at 30% of their bankers' salaries, rising to as much as 20% for higher salary bands.
EU rules on compensation are enshrined in proposed amendments to the existing Capital Requirements Directive.