EU Parliament: We Don’t Actually Expect Liikanen to Work…

…we just want smaller banks.

On 25 June 2013, the EU Parliament’s Economic and Monetary Affairs Committee (ECON) published a report containing a motion for a resolution on reforming the structure of the EU banking sector that it adopted on 18 June 2013.  The report is notable less for the actual wording of the resolution and more for some of the statements made in the recitals which seem to cast light on the underlying motivations driving the structural separation of banks.

Separation doesn’t work

Despite stating the belief that the Glass-Steagall Act “helped to provide a way out of the worst global financial crisis to have occurred [in the US] before the present crisis”, the EU Parliament concedes that “there is no evidence from the past that a separation model could contribute in a positive way to avoiding a future financial crisis or to diminishing the risk of it”.

Banks are too big

Within the motion the Parliament clearly states the position that:

  • individual banks should not be allowed to become so large – even within a single Member State – that their failure causes systemic risks; and
  • the size of a Member State’s banking sector should be limited in terms of:
    • size – the suggestion seems to be that the ratio of private sector loans to GDP should not exceed 100%;
    • complexity; and
    • interconnectedness.

The resolution gives a clue as to the ‘look and feel’ of these smaller banks, urging the EU Commission, inter alia, to:

  • encourage a return to the partnership model for investment banking so as to increase personal responsibility;
  • ensure that remuneration systems prioritise the use of bail-in bonds and shares rather than cash, commissions or value-based items; and
  • rationalise the scale of the activities of banking groups.

Paul Tucker Speech on Resolution

On 20 May 2013, Paul Tucker, Deputy Governor of Financial Stability at the Bank of England gave a speech entitled “Resolution and future of finance” at the INSOL International World Congress in the Hague.

Within the wider context of discussing solutions to the problem of “too big to fail”, the speech gives a useful summary of the ways in which both “single point of entry” and “multiple point of entry” resolution would operate in practice.  It also touches upon the interaction between resolution regimes and bank structural reform, noting the way in which bank ring-fencing, as will be implemented in the UK via the Financial Services (Banking Reform) Bill, represents a back-up strategy to resolution, under which essential payment services and insured deposits would be provided by a “super-resolvable” ring-fenced and separately capitalised bank.  This, it is believed, should make it easier for the UK authorities to “retreat to maintaining at least the most basic payments services” if a preferred strategy of top-down resolution of a whole group could not be executed.

Update on Banking Reform Bill

On 9 May 2013, the Financial Services (Banking Reform) Bill was reintroduced to Parliament, having been carried over to the 2013-14 session.  The text of the bill is the same as that originally published on 4 February 2013 (see this blog post for more detail).  The bill completed its committee stage on 18 April 2013 and will now proceed to the report stage, although the date upon which this is scheduled to take place is not yet known.

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.

Banking Reform Bill: HM Treasury publishes Amended Statutory Instrument

On 18 March 2013, HM Treasury published an amended version of draft Financial Services and Markets Act 2000 (Ring-fenced Bodies and Core Activities) Order (the “Ring-Fenced Bodies Order”).  The Ring-Fenced Bodies Order is one of the pieces of secondary legislation to be made under the Banking Reform Bill.

The main change from the original version of the Ring-Fenced Bodies Order, published on 8 March 2013, seems to relate to high net worth individuals (“HNWI”) and small and medium sized enterprises (“SME”).  As detailed in our previous blog post, deposits are exempt from the requirement to be held within a ring-fenced body if they are held on behalf of:

  • HNWI (i.e. individuals who have, on average over the previous year, held free and investible assets worth GBP 250,000 or more); and
  • SME which are also financial institutions.

Under the original order, HNWIs and SMEs could effectively self-certify their status as such.  Under the amended order it seems that the institution in question is now responsible for determining whether HNWI or SME status is indeed appropriate.

ECON Draft Report on Structural Reform of EU banking sector

On 13 March 2013, the EU Parliament’s Committee on Economic and Monetary Affairs (ECON) published a draft report on reforming the structure of the EU’s banking sector.

The report welcomed the Liikanen Group’s analysis and recommendations on banking reform, concluding that, while current proposals for reform of the EU banking sector are important, a more fundamental reform of the banking structure is essential.  Accordingly, it urges the EU Commission to draft a proposal for full and mandatory separation of banks’ retail and investment activities via ring-fencing around those activities that are vital for the real economy.  According to ECON, mandatory separation should result in:

  • separate legal entities;
  • separate sources of funding for the bank’s retail and investment entities;
  • the application of adequate, thorough and separate capital, leverage and liquidity rules to each entity (with higher capital requirements for the investment entity); and
  • net and gross large exposure limits for intra-group transactions between ring-fenced and non-ring-fenced activities.

 

“2013 is the year when we re-set our banking system…”

…said George Osborne in a speech to staff at JP Morgan in Bournemouth yesterday.  According to the Chancellor, the reset button comprises four main elements:

  • The transfer of responsibility for banking supervision from the FSA back to the Bank of England, which will have the “power to call time before the party gets out of control”;
  • The ringfencing of retail banking from investment banking;
  • Changing the culture and ethics of the banking industry; and
  • Giving customers more choice in their receipt of banking services.

Ringfencing

On the subject of ringfencing of retail banking, Mr Osborne confirmed that the Banking Reform Bill was published yesterday.  The bill is based on the recommendations of the Vickers Report and will require the creation of a ringfence around the retail arms of banks, enabling essential operations to continue in the event that the whole bank fails.  If a bank flouts the rules, the Bank of England and the Treasury will have the power to break it up altogether.  Mr Osborne expects the bill to be passed into law this time next year.  In addition, the Chancellor announced that:

  • A high street bank will be required to have different bosses from its investment bank;
  • A high street bank will manage its own risks, but not the risks of its investment bank; and
  • Investment banks will not be allowed to use retail savings in order to fund “risky investments”.

Increased Choice

On the subject of increased choice, the Chancellor announced that the Government would bring forward detailed proposals to open up payment systems, ensuring that new players in the market can access these systems in a “fair and transparent way”.  The implication is that responsibility for supervision of payment systems will be taken away from the Payments Council, a bank-led body.

Osborne Promises to Electrify the Ringfence

The FT reports that George Osborne will today make clear that any bank which attempts to circumvent the ringfencing rules, proposed as part of the Vickers Report and published today in the form of the Banking Reform Bill, faces the prospect of separation in full by the Bank of England.

Further Blow Dealt to Liikanen

The FT reports that the German finance ministry has proposed legislation dealing with banking reform that has been interpreted as a rejection of the concept of ringfencing as contemplated by the Liikanen report.  Instead, the draft bill would require banks to set up a separate unit for proprietary trading activities that accounted for either EUR 100 billion of assets or 20% of balance sheet.  If passed by the German parliament, the measures would likely come into force by mid-2015.

The draft bill largely mirrors French proposals, published in December 2012, to ringfence speculative trading activities.  However, it is in contrast to both the Vickers proposals in the UK (pursuant to which deposit taking activities would be ringfenced) and the Liikanen proposals (which require the ringfencing of all trading activities above a certain threshold).