EU Commission Publishes Liikanen FAQs

On 7 June 2013, the European Commission published an FAQ document regarding its May 2013 consultation on the Structural Reform of the EU Banking Sector (the Liikanen Reforms) – see this blog post for more detail.  The FAQs have been drafted in response to requests for clarification about the data templates published as part of the May consultation and deal with the following issues:

  • The nature of the treatment afforded to confidential information submitted by respondents;
  • Scenario analysis, specifically:
    • the impact on the group’s balance sheet and P&L resulting from the enactment of CRDIV and the Bank Recovery and Resolution Directive;
    • whether the scenarios assume the existence of specific underlying corporate structures;
    • the extent to which a trading entity can be funded by deposits;
    • how netted derivatives are to be reported;
    • how “matched principal” trading, “provision of direct market access to customers” and hedging activity are to be treated in relation to market making;
    • how exposures to venture capital, private equity and hedge funds are to be defined; and
    • how short-term and long-term securities are to be distinguished.

Bail-in and the Central Clearing of Derivatives

Pursuant to Article 38(3) of the original EU Commission proposal for a EU Directive establishing a framework for the recovery and resolution of credit institutions and investment firms (the “RRD”), resolution authorities may exclude derivatives transactions from the scope of the Bail-in tool if that exclusion is “necessary or appropriate” to:

  • ensure the continuity of critical functions; and
  • avoid significant adverse effects on financial stability.

Much has already been written as to whether derivatives should be in- or out-of-scope as far as the Bail-in tool is concerned.  The practical difficulties of implementing bail-in in relation to portfolios of derivatives transactions is generally recognised.  In addition, whilst excluding derivatives from the scope of bail-in creates a clear regulatory arbitrage in the way in which deals can be structured between counterparties, this risk is mitigated by the fact that firms which are subject to the RRD will be required to maintain a minimum amount of bail-inable debt at all times.

In many ways, the greater risk lies not in whether derivatives themselves are in- or out- of scope, but in the fact that Member States are given discretion to choose whether they are or not.  The extent to which this is really consistent with the concept of a single market is unclear, and some commentators have questioned whether this aspect of the EU Commission draft would survive the EU trialogue process under which the EU Commission, EU Parliament and the Council of Ministers thrash out their differing opinions with respect to proposed legislation with a view to arriving at a compromise position.  However, this question was largely answered on 5 June 2013, when the EU Parliament’s Economic and Monetary Affairs Committee published a report which sets out the Parliament’s proposed amendments to the RRD, in anticipation of the beginning of the trilogue process.  Within the EU Parliament document, the concept of Member State discretion in determining whether derivative transactions are in- or out-of-scope for the purposes of the bail-in tool remains intact and so seems unlikely even to arise during the trilogue discussions.

Interestingly, the EU Parliament has taken matters a step further, suggesting a different amendment which would, if passed, require that cleared derivatives are treated as more senior than non-cleared derivatives in a bail-in situation.  In other words, non-cleared transactions stand to be bailed-in before cleared transactions.  This is understandable in the context of the drive towards central clearing.  However, it will potentially change the risk associated with counterparties which are subject to the RRD and are established in jurisdictions where derivatives are within the scope of the Bail-in tool.  It will also potentially impact on the price at which such trades are executed.  It remains to be seen just how this provision interacts with another exclusion from the scope of the Bail-in tool – that relating to secured liabilities.  It may be that only uncollateralised non-cleared transactions would be affected.  Moreover, in light of requirement to enact the BCBS/IOSCO “Margin requirements for non-centrally cleared derivatives” in Europe, there may not be much of this trading activity taking place in the future.  Of course, excluding secured derivatives from the scope of the bail-in regime would likely defeat the point of bailing in derivatives in the first place.  In this scenario the discretion afforded to Member States may be more illusory than real.  Either way, as we don’t currently have answers to any of these questions we’ll be monitoring how this conversation develops, so watch this space.

EU Commission to Have Power to Resolve EU Banks?

The FT is reporting that, under the terms of a discussion paper currently under review in Brussels in relation to the single resolution mechanism (SRM), the EU Commission would be given the power to resolve EU banking institutions directly, with member states merely implementing Commission decisions.  This is in contrast to the agreement reached last week between France and Germany that the SRM should be run by a “resolution board” made up of national authorities (which itself when further than the original Germany vision of the SRM as a “network” of national supervisors).  The Commission also wants the resolution authority to have a single bank resolution fund as well as the power to borrow, using the “assets of euro area banks” as a guarantee and backstop.

Legislation Update

On 3 June 2013, the EU Commission published an updated summary detailing the timetable for certain legislative proposals and non-legislative acts that it expects to adopt between 28 May 2013 and 31 December 2013.  Of most note are the following:



Current Adoption Date

Previous Adoption Date (per April/May summary)

Regulation on a single resolution authority and a single resolution fund within a Single Resolution Mechanism

July 2013

No reference

Directive/Regulation on the reform of the structure of EU banks (the Liikanen Reforms)

October 2013

Q3 2013

Framework for crisis management and resolution for financial institutions other than banks

November 2013

No reference


Bail-In by 2016?

On 21 May 2013, the European Parliament’s Economic and Monetary Affairs Committee (ECON) published a press release detailing its negotiating position with respect to certain elements of the proposed Recovery and Resolution Directive (RRD).

The negotiation position was approved by 39 votes to 6 and states that:

  • the “bail-in” scheme should be operational by January 2016 at the latest;
  • insured deposits (i.e. those below EUR 100,000) can never be subject to bail-in;
  • uninsured deposits (i.e. those above EUR 100,000), can only be subject to bail-in “as a last resort”;
  • funds from deposit guarantee schemes will not be capable of being diverted in order to help pay for bank resolution measures;
  • taxpayer money can only be used to guarantee liabilities or assets, take a stake in a failing bank or institute temporary public ownership and only after all capital has been written down to zero and taxpayer intervention is necessary in order to:
    • prevent “significant adverse effects on financial stability”; or
    • protect the public interest;
  • bank-financed resolution funds must be established at a national level and must have a capacity equal to 1.5% of the amount of deposits of the participating banks within 10 years of the entry into force of the RRD; and
  • resolution funds will not be obliged to lend to each other.

The press release notes that the EU Council must now adopt its negotiating position, after which trialogue discussions between the Council, the Commission and the Parliament will commence.

EU Commission Publishes Liikanen Consultation


On 16 May 2013, the EU Commission published “Reforming the structure of the EU banking sector”, a consultation paper which represents a follow-up to the recommendations made by the Liikanen High-Level Expert Group (the “HLEG”) in its report of October 2012.  The deadline for responses to the consultation is 3 July 2013.

The consultation paper only presents policy options with respect to the structural separation recommendations of the HLEG, noting that the HLEG’s other proposals have been at least partially addressed in other initiatives such as the Bank Resolution and Recovery Directive and the Capital Requirements Directive/Regulation, or will only become actionable after the completion of ongoing exercises such as the Basel Committee’s review of trading book capital requirements.  The Commission also accepts that structural reform will only affect a small subset of the approximately 8,000 EU banks.  In particular, most local and regional banks will be excluded as well as the banks that focus on customer related lending.  Moreover, separation requirements would not necessarily apply automatically to banks exceeding applicable thresholds but may be at the discretion of supervisors.

Policy Options

Against a “no action” baseline, the EU Commission is evaluating options grouped into three basic categories:

  • the scope of banks which should be subject to separation;
  • the scope of activities to be separated; and
  • the strength of separation.

Scope of banks subject to separation

Comments are requested on four options, all of which adopt differing definitions of “trading activity”, the separation criteria suggested by the HLEG:

  • using the original HLEG definition, under which assets ‘held for trading and available for sale’ are to be separated;
  • a narrower definition that excludes ‘available for sale’ assets;
  • a definition focused on gross volume of trading activity, which is likely to focus on proprietary trading and market-making activities; and
  • a definition focused on net volumes, designed to capture only those institutions which concentrate on proprietary trading.

Within each separation option, the Commission asks for responses as to the degree of supervisory discretion which should apply, with specific reference to the following sub-options:

  • ex-post separation determined by EU legislation but with the actual separation decision to be at the discretion of a supervisor;
  • ex-ante separation subject to supervisor discretion to exempt individual institutions or include additional firms in accordance with criteria and limits set out in EU legislation; and
  • ex-ante separation pursuant to which any bank with trading activities above the threshold would automatically be obliged to separate those activities.

The scope of activities to be separated

The Commission are considering three options which can be summarised as follows:

  • “Narrow” trading entity and “broad” deposit bank: under which, broadly, only proprietary trading and exposures to venture capital, private equity and hedge funds would be separated;
  • “Medium” trading entity and “medium” deposit bank: under which both proprietary trading and market making would be separated; or
  • “Broad” trading entity and “narrow” deposit bank: under which all wholesale and investment banking activities would be separated, including proprietary trading, market making, underwriting of securities, derivatives transactions and origination of securities.

Strength of separation

Three broad forms of separation, none of which are mutually exclusive, are considered:

  • accounting separation: the lightest form of separation (and considered unlikely to be sufficient by the Commission) under which a group would be required to make separate reports for each of its different business units but under which there would be no restrictions on intra-group legal and economic risks;
  • functional separation: under which some activities would need to be provided by separate functional subsidiaries with various sub-options available as to the degree of legal, economic, governance and operational separation which should apply; and
  • ownership separation: the strongest form of separation under which the services would have to be provided by different firms with no affiliations.

The three ‘strength of separation’ options proposed by the Commission can be summarised as follows:


Degree of Functional Separation

Degree of Ownership Separation 

Functional   separation with economic and governance links restricted according to current   rules (“Functional Separation 1”)
  • Separate legal entities required
  • Legal entities subject to capital, liquidity, leverage and large   exposure rules on an individual basis
  • Separate governance (unless waived) for each entity
Functional   separation with tighter restrictions on economic and governance links (“Functional   Separation 2”)
  • Separate legal entities required
  • Restrictions on ownership links between separated entities   within the group
  • Legal entities subject to capital, liquidity, leverage and large   exposure rules on an individual basis
  • Intra-group dealings to be at arms’ length
  • No waiver of large exposure restrictions in relation to intra-group   trades
  • Limits on intra-group guarantees from deposit taking entity to   trading entity
  • Limits on board directors acting for multiple entities within   the group
Ownership   separation  
  • Banks to divest themselves of certain activities

Overview of Options

The Commission provides the following matrix which summaries all of the possible permutations associated with each policy option:


Functional Separation 1 (current requirements) 

Functional Separation 2 (stricter requirements)

Ownership   Separation

Narrow Trading Entity/ Broad Deposit Bank

e.g. Proprietary trading +   exposures to venture capital/private equity/hedge funds

Option A

[approximate to   legislation in France and Germany]

Option B

[approximate to US   swaps push-out rule]

Option C

[approximate to US   Volcker rule]

Medium Trading Entity/ Medium Deposit Bank

e.g. proprietary trading +   market making

Option D

[approximate to   legislation in France or Germany if wider separation activated]

Option E

[Approximate to   HLEG recommendations]

Option F

Broad Trading Entity/ Narrow   Deposit Bank

e.g. all investment banking   activities

Option G

Option H

[approximate to US   Bank Holding Company Act and UK Banking Reform Bill]

Option I


Bail-in Begins to Take Shape


On 8 May 2013, the EU Council published a note regarding the “state of play” of on the proposed Recovery and Resolution Directive (RRD).

The design of the bail-in tool has been identified as a central issue with three main approaches (all of which adopt preferential treatment for insured depositors and provide for a broad scope of bail-in with a limited list of defined exclusions) being defined:

  • the Harmonised Approach;
  • the Discretionary Approach; and
  • the Mixed Approach.

Harmonised Approach

The Harmonised Approach defines a limited set of exclusions from bail-in.  Insured depositors would benefit from preference treatment (with Deposit Guarantee Schemes (“DGS”) substituting for insured depositors), meaning in practice that they would be unlikely to be bailed in as other classes of creditors would have to absorb losses first.  The only discretionary exclusion from the bail-in regime relates to derivatives.  It is designed to provide a high degree of harmonisation across Member States by promoting ex ante predictability and legal certainty to markets regarding the treatment of creditors.

A variation of the Harmonised Approach (which reflects the original Commission Proposal) would still see DGS substituting for insurance depositors but being bailed-in pari passu with all other all other senior unsecured creditors, rather than on a preference basis.  However, it is felt that, in these circumstances, the low size of DGS funds compared to insured depositors balances would mean that the DGS would not be able to cover the losses in the event of a bail-in of a large bank, potentially making the bail-in tool unusable.

The EU Council notes that many Member States feel that the Harmonised approach suffers from a lack of flexibility.  Specifically, there is a belief that the inability to exclude a creditor or class of creditors from the scope of bail-in may have adverse consequences in terms of financial stability.  In turn, this may damage the practical usefulness of bail-in as a tool with the result that resolution authorities have no option but to resort to using the resolution fund or taxpayer funded bail-outs.

Discretionary Approach

The Discretionary Approach attempts to address the flexibility deficiencies of the Harmonised Approach by providing resolution authorities with a degree of discretion on how the bail-in tool is used.  A number of alternative models are possible.  These include:

  • A small number of discretionary exclusions, e.g. relating to:
    • eligible deposits;
    • short term debt;
    • liabilities related to the participation in payment, clearing and settlement systems; and
    • OTC derivatives.
  • A general exclusion from bail-in of eligible deposits (over €100,000) of a natural person unless inclusion is necessary in order to absorb losses and where it does not raise financial stability risks; and
  • Providing a resolution authority with the discretion to exclude any liability from bail-in on a case by case basis (subject to strict criteria and perhaps limiting the actual exclusion to a percentage of the total pool of bail-inable liabilities).

What the Discretionary Approach gains in terms of flexibility, it loses in terms of harmonisation of the bail-in regime across Member States and providing legal uncertainty for investors and other unsecured creditors.  It is likely that the Discretionary Approach would also require an institution to hold a higher minimum amount of own funds and bail-inable liabilities in order to ensure it maintained sufficient and appropriate loss-absorbency capacity.

Mixed Approach

The Mixed Approach defines a limited set of exclusions, some mandatory and some discretionary, from the scope of the bail-in tool.  It seeks to provide a compromise solution to the issue of harmonisation.  The EU Commission believes that it makes the bail-in tool more credible, as it removes the risk that Resolution Authorities will not deploy the bail-in tool due to concerns about the impact on public confidence.

The Road to Liikanen

On 6 May 2013, the EU Commission published a roadmap regarding a proposal for a structural reform of EU banks (i.e. the Liikanen reforms).  This followed the publication, on 2 October 2012, of the final report of the High-level Group on reforming the structure of the EU banking sector, chaired by Erkki Liikanen, a summary of which can be found here.

The main issues being considered by the Commission are:

  • The definition of relevant activities to be separated from deposit-taking entities.  This could include:
    • proprietary trading;
    • market-making; and
    • securities underwriting.
  • The nature and extent of separation and governance of separated entities.  Available options include:
    • functional separation (also referred to as “ring-fencing” or “subsidiarisation”);
    • accounting separation; or
    • full ownership separation.
  • Thresholds and de minimis exemptions.  These are likely to be based on:
    • bank balance sheet size; or
    • share of trading activities.

Consideration will also be given to:

  • the treatment of derivatives business (as principal or as agent);
  • the treatment of non-EU assets; and
  • exposures to hedge funds and private equity funds.

A further public consultation will be launched in early May 2013 and a meeting of stakeholders is due to be held on 17 May 2013.  Thereafter, as per its recent update, the Commission intends to adopt a legislative proposal in Q3 2013, although it is not yet certain whether that proposal will take the form of a Directive, a Regulation, or a combination of the two.

The Road to Non-Bank Resolution

On 6 May 2013, the EU Commission published a roadmap regarding a framework for crisis management and resolution for financial institutions other than banks (i.e. central counterparties, central securities depositories, insurance and reinsurance firms, payment systems, investment funds and certain trading venues).  The roadmap follows the consultation paper published on 5 October 2012, a summary of which is available here.

Rather than adopt a broad framework approach in terms of applicable nonbank institutions and general tools for authorities to intervene, the Commission believes that more specific provisions and tools in relation to each sectors is more appropriate due to the different types of risk to which each sector is exposed and the differing consequences their failure would have.  The Commission makes clear that any regulation will be proportionate in nature and “only entities which are big, interconnected or central enough in the financial system to cause widespread disruption should they fail” are to be subject to the regulation.

As noted in this update, the EU Commission currently expects a legislative proposal in this area to be adopted in November 2013.

EU Legislation Update

On 7 May 2013, the EU Commission published an updated summary of the legislative proposals and non-legislative acts that it expects to adopt between 1 May 2013 and 31 December 2013.  Of particular note are the following:


Proposed Date of Adoption

Regulation on a single resolution authority and a single resolution   fund within a single resolution mechanism July 2013 (had previously been due to be adopted in Q4 2013)
Directive/regulation on the reform of the structure of EU banks (i.e. the Liikanen reforms) Q3 2013
Framework for crisis management and resolution for financial institutions other than banks November 2013
EMIR delegated regulation concerning procedural rules for fines on trade repositories October 2013 (had previously been due to be adopted in Q2 2013)
EMIR delegated regulation concerning fees to be charged to trade repositories May 2013