Electrify the Vickers Ringfence Says Commission

On 21 December 2012, the Parliamentary Commission on Banking Standards published its first report, in which it gives consideration to the draft Financial Services (Banking Reform) Bill and associated proposals which give effect to the conclusions detailed in the Vickers’ report.

Whilst the Commission supports the introduction of ring-fencing, its Chairman Andrew Tyrie MP, stated that the proposals “fall well short of what is required”.  The Commission recommends “electrification” of the ring-fence by given regulators the power to forcibly separate any bank found guilty of trying to circumvent the rules.  In addition, the Commission proposes that the Financial Services and Markets Act 2000 should include a legal duty on boards of directors to preserve the integrity of the ring-fence.

Better news is found in the Commission’s conclusion that there is a case in principle for permitting the sale of simple derivatives to small businesses from within the ring-fence.  However, such permission would need to be subject to conditions and agreement on a satisfactory definition of “simple derivatives”.  Less welcome will be the news that the Commission will investigate further as to whether a ban on proprietary trading – akin to a Volcker Rule – is appropriate.

The Phantom of Banking Union

This is a link to an excellent opinion piece in the FT on the recent announcement regarding EU banking union.

The first steps towards banking union announced last week were widely lauded as representing a significant in-principle agreement.  The truth is that this principle was agreed two years ago.  Unfortunately, what happened last week was a failure of the political process to deliver the results logically required by the economic reality in Europe.

FSB Press Release on RRP Consultation

On 18 December 2012, the Financial Stability Board (FSB) published a press release regarding responses received to its 2 November 2012 consultation on Recovery and Resolution Planning, together with links to the responses of the following institutions:

• Association of British Insurers
• Barclays
• BNP Paribas
• British Bankers’ Association
• Credit Suisse
• Deutsche Bank
• Federation Bancaire Francaise
• FirstRand Bank
• Global Financial Markets Association
• Institute of International Finance
• International Banking Federation
• Investment Management Association
• Polish Financial Supervision Authority
• Santander
• UBS

 

EBA Provides Opinion on Liikanen

Introduction

On 14 December 2012, the European Banking Authority (“EBA”) published its opinion on the recommendations of the High-level Expert Liikanen Group on reforming the structure of the EU banking sector.

The final report of the Liikanen Group was published on 2 October 2012 and made the following recommendations:

•  mandatory separation of proprietary trading and other high-risk trading activities to the extent exceeding a threshold;
• possible additional separation of activities conditional on an institution’s resolvability;
• possible amendments to the use of bail-in as a resolution tool;
• review of the capital requirements on trading assets and real estate loans; and
• strengthening banks’ governance and controls.

General Comments

In general, the EBA considers that the Liikanen proposals strike an appropriate balance between protecting the core features of the universal banking model and strengthening the resilience of the financial sector.  However, it believes that an impact assessment is required in order to properly be able to evaluate the potential benefits and cost of the proposals.

Aware that several Member States are considering structural change to national banking industries, the EBA emphasises the need to ensure consistency across the EU so as to protect the operation of the Single Market.  To this end, it states that clear criteria must be established in relation to such issues as:

• the situations where separation is mandatory;
• parameters that apply to exceptions such as the provision of “hedging services to non-banking clients”; and
• the provision of financial support between deposit banks and trading entities pursuant to the proposed bank recovery and resolution directive (the “RRD”).

Banks’ compliance with the proposals should also be subject to periodic review and macro-prudential monitoring to avoid structural arbitrage.  In addition, any structural changes must be consistent with existing legislation, such as the RRD and the large exposures regulation, but should not be viewed as a substitute for adequate supervision.

Bail-in

The EBA considers that there is a need to further develop the bail-in framework in the RRD in order to improve its legal and operational certainty and so avoid possible destabilising effects.  The EBA repeats its preference for a two-tier bail-in regime.  Under such a regime, bail-in would initially be applied to a targeted category of debt instruments.  This targeted approach would, it is hoped, avoid the risk that a wide ex ante bail-in regime turns out to be of limited value once resolution actually occurs.  Only if the targeted approach proved insufficient, would remaining creditors be bailed-in within a proper administrative resolution procedure.

In addition, banks would be required to issue and hold a minimum percentage of their liabilities as “bail-inable” debt.  It is anticipated that this would create a market in bail-in debt, encourage the standardisation of contracts and incentivise rating agencies to focus on the rating of bail-in instruments.  However, the EBA supports the proposal that such debt should be held outside of the banking system, suggesting that penal risk-weightings could be introduced in order to discourage acquisition of such securities by the banking sector.  It also welcomes the suggestion to use bail-in instruments in remuneration schemes for top management and as part of bonus schemes.

Insurance and the Question of “Too Big To Fail”

More from the FT, which provides an interesting update on the initiative to identify globally systemically important insurers.  Plans drawn up by the International Association of Insurance Supervisors are described as being “incoherent, impractical and simplistic” by the industry, which expresses particular concern about the intention to include variable annuities on the list of activities that are “non-insurance”, “non-traditional” or “semi-traditional” and hence subject to increased capital requirements.

Commission on Banking Standards Threatens Forced Bank Break-Ups

The FT reports this morning that the Parliamentary Commission on Banking Standards may recommend that UK banks which fail to comply with the Vickers proposals are subject to a complete separation of retail and investment banking activities.  It also seems increasingly likely that banks will be subject to frequent checks as to their compliance with the ringfencing requirements of Vickers.

RRD to be agreed by June 2013

On 14 December 2012, the European Council published its conclusions regarding the steps necessary to complete economic and monetary union (EMU).  These include:

• the need for the rapid adoption and implementation of the single supervisory mechanism (SSM);
• the agreement on the terms of the Recovery and Resolution Directive (RRD) and the Deposit Guarantee Schemes Directive by June 2013; and
• the rapid follow-up to the proposals of the Liikanen Group.

Ex Freshfields partner to review special administration regime for investment banks

On 13 December 2012, HM Treasury published a press release announcing that Peter Bloxham, a former Freshfields partner, has been appointed to review the special administration regime (“SAR”) for investment banks.

HM Treasury expects that an initial report will be published by the end of January 2013, with further recommendations and a fuller report being produced by the end of June 2013.  The review will be co-ordinated with the FSA’s own review of its Client Assets Rulebook, which is also expected to conclude by the end of June 2013.

First Steps Towards Banking Union Agreed…

…with respect to 200 banks.

As the FT reported today, eurozone finance ministers agreed a plan for a common bank supervisor in the early hours of this morning.  Beginning in early 2013, the ECB will take responsibility for the supervision of banks – but only those having assets of more than €30bn, or representing more than a fifth of a state’s national output.  In addition, there are no explicit provisions governing timeframes in which the ECB is to assume responsibility for the EU’s biggest banks.

The single supervisor is seen as the first, and easiest, step in the three-stage process which will lead towards EU banking union, the other stages being the creation of a EU-wide common deposit guarantee scheme and a single European recovery and resolution framework.  An inability to confidently take this first step does not bode well for the future.  If banking union is to mean anything is must surely create a level playing field, not the two-tier regime threatened by the current political fudge.

Insurers Less Systemically Important Than Banks Says Geneva Association

Introduction

On 11 December 2012, the Geneva Association, a think-tank for the insurance industry, published a cross-industry analysis comparing the 28 Global Systemically Important Banks (G-SIBs) to 28 of the world’s largest insurers on indicators of systemic risk.

The analysis studied 17 indicators that are regarded as being comparable between insurers and banks to provide an analysis of the size of each activity. The conclusions drawn were that:

Insurers are significantly smaller than banks

• The average bank’s assets are 3.9 times larger than the average insurer;
• The largest insurer would rank only 22^nd in the list of G-SIBSs by size.

Insurers write considerably less CDS than banks

• The average bank writes 158 times the value of gross notional Credit Default Swaps (CDS) than the average insurer;
• The lowest ranked banks on average have 12.5 times the CDS sold by the average insurer.

Insurers utilise substantially less short-term funding than banks

• Short-term funding as a percentage of total banks assets is 6.5 times higher than short-term funding as a percentage of insurer assets.

Insurers are less interconnected to other financial services providers than banks

• Banks carry 219 times more gross derivative exposure than the insurer average;
• The lowest ranked banks carrying 66 times more gross derivative exposure than the average insurer;
• At the measurement date, banks owed on average 68 times more than insurers in gross negative derivatives;
• Banks are owed 70 times more from derivatives counterparties through derivatives exposure than insurers.