EU Commission to Publish Liikanen Proposal on 29 January 2014

On 24 January 2014, the EU Commission published a press release confirming that, on 29 January 2014, it will publish a legislative proposal on EU bank structural reform designed to implement the findings of the Liikanen High Level Group.

It is thought that political agreement on the legislative proposals will not be reached before the end of 2015, with restrictions on proprietary trading likely to take effect from 2018.

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Liikanen Proposal by End of January?

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”.

EU Shies Away From Liikanen?

The FT is reporting this morning that the latest draft of the Liikanen proposals, which implement bank structural reform within the EU, will be significantly watered down.  According to the article, separation will no longer be mandatory and will be less restrictive than previously thought.  Wider discretion is also to be given to national competent authorities – not always a good thing – to decide whether certain trading activity constitute a “systemic risk”, based on metrics provided by the European Banking Authority.  However, there may be a sting in the tail, with the EU Commission apparently proposing an ‘EU Volcker-Lite’ ban on proprietary trading – but only for the EU’s 30 largest banks.

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.

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.

EU Commission Publishes Liikanen Consultation

Introduction

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:

Option

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:

Activities/Strength

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

 

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.