The European parliament has updated its BRRD procedure file, postponing the plenary consideration of the proposal to its 14-17th April session. The regulatory framework has been agreed, however the plenary vote is a very necessary formality. Any further delay would place this cornerstone of EU banking reform perilously close to the 22nd May EU election.
On 17 January 2014, the EU Commission published a press release confirming that it will make a proposal “in coming weeks” for the reform of the structure of banking in the EU. The proposal will be based on the findings of Liikanen Report, published in October 2012, and will apparently will be “the final piece of the puzzle to address “too big to fail” banks”.
On Monday, Bundesbank Vice President Sabine Lautenschläger spoke out in favour of a single resolution authority at a conference in Berlin, according to this article. She said an EU wide mechanism would be able to take a “bird’s eye view” of financial institutions allowing for an easier and quicker solution in crisis situations. Lautenschläger added that it does not make sense to oversee banks at the European level while leaving their resolution to national authorities, although accepted that this would require amendment to EU treaties.
Her comments are at odds with the German government which ideally seeks a network of national resolution authorities (although recently agreed to a “resolution board” made up of national authorities) and is resistant to any scheme that could empower an external agency to independently decide when to close a bank. German Deputy Finance Minister Thomas Steffen, speaking at the same conference, said that the EU Commission would have a centralised resolution authority proposal soon.
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.
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”)||
|Functional separation with tighter restrictions on economic and governance links (“Functional Separation 2”)||
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)
|Narrow Trading Entity/ Broad Deposit Bank
e.g. Proprietary trading + exposures to venture capital/private equity/hedge funds
[approximate to legislation in France and Germany]
[approximate to US swaps push-out rule]
[approximate to US Volcker rule]
|Medium Trading Entity/ Medium Deposit Bank
e.g. proprietary trading + market making
[approximate to legislation in France or Germany if wider separation activated]
[Approximate to HLEG recommendations]
|Broad Trading Entity/ Narrow Deposit Bank
e.g. all investment banking activities
[approximate to US Bank Holding Company Act and UK Banking Reform Bill]
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.
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.