Brussels, 29/01/2014 (Agence Europe) - On Wednesday 29 January, the European Commission suggested banning 30 big European banks from proprietary trading (investing using own resources or borrowing at low interest rates by making use of the implicit state guarantee for “too-big-for-fails” and then investing in markets).
EU Internal Market Commissioner Michel Barnier said that, after the in-depth reforms of the financial industry, it is now time to deal directly with the risks that European banks still pose when they are so big that their assets are bigger than the GDP of some member states, and are so complex and inter-connected that their failure has consequences for the entire economic system. He pointed out that €1.6 trillion of public money had been used to bail out the financial sector, in other words 13% of GDP.
It is hoped that the ban on proprietary trading will come into force in January 2017 for financial instruments and commodities (but not sovereign bonds), along with a ban on investing in speculative funds (except unleveraged funds). The bans are based on the Volker rule in the United States that will come on stream in April 2014, to ensure fair trading on either side of the Atlantic and to promote a convergence of rules around the world as part of the G20. Barnier said, however, that the EU rules set clearer limits than the Volker rule.
As recommended by the Liikanen Report (see EUROPE 10950), the ban will cover banks that exceed the following thresholds for three consecutive years: (a) the bank's total assets exceed €30 billion and (b) the bank's total trading assets and liabilities exceed €70 billion or 10 percent of their total assets. This would affect around 30 European banks and overseas subsidiaries and two or three non-EU banks registered in the EU. The Volker rule covers the entire US banking sector.
Before the crisis, proprietary trading represented 15% of bank assets, but this has now shrunk to between 2% and 4% of bank assets, but the Commission says there is a risk that proprietary trading, which generated no value-added for the economy, will pick up again as economic growth strengthens.
Hiving off other risky trading activities. In the draft regulation, the Commission suggests allowing national supervisory bodies to force a bank, under certain circumstances, to hive off risky trading (market making, complex derivatives & securitisations operations and underwriting, lending to venture capital and private equity) into distinct bodies (separate companies), unless, that is, the bank demonstrates that its business does not involve risk, added Barnier.
A national supervisory body - the ECB for the eurozone under banking union - assesses risky investment of this type in terms of volume, complexity, profitability, interconnection and counterparty risk. Following dialogue with the bank in question, the supervisory body may force some business to be hived off so that any losses would not impact on retail banking (savings and payments systems). The bank would then have to draw up a separation plan that would need to be endorsed by the supervisory body and the Commission hopes that the first separation decisions would be made in 2018.
France and Germany have criticised the legislation, which goes beyond the scope of the equivalent French and German laws. At the Ecofin Council on Tuesday, Barnier said that nobody can be surprised either by the fact that the proposal was presented or by the Commission's power of initiative. He said he had taken account of what member states have already done, but the time has come to have a coherent framework.
France and Germany also criticise the Commission for granting special treatment to the United Kingdom, whose banks already benefit from a derogation on the subsidiary aspect of the new EU rules. The Commission says that, if separation has already been done, then in some cases it makes more sense to give the Commission the power to verify whether the risky trading has indeed been hived off. Reacting to the draft legislation, a UK government spokesman said that, as the Commission has acknowledged, the UK government's Banking Reform Act already meets, and in some places exceeds, the proposed standards set out by the Commission.
Wanting to avoid investment banking being transferred to shadow banks, the Commission has published a draft regulation to increase transparency for some financial transactions, particularly those that look like loans, deposits repurchase agreements (or repos), securities lending and “rehypotecation”, explained Barnier.
All transactions on these securities should be registered in a central register in order to enable supervisory bodies to easily spot connections between banks and parallel banks and to shed light on bank financing. The registration requirements will apply to brokers, funds, insurance companies, pension companies and other non-financial companies. The rules will not apply to the European central bank system, the Bank for International Settlements and national debt management agencies. European authorities ESMA and EBA will have access to the register.
The regulation will boost transparency for investment funds, which will have to provide details about transactions. At present, information is rarely provided about securities lending or total return swaps.
Rehypotecation (the re-use of collateral) will only be allowed if certain criteria are met. Clients or stakeholders will have to give their assent and acknowledge the risks involved. Rehypotecation will require written agreement after the collateral has been transferred to the body making use of it for its own ends. This measure will apply to all financial entities registered in the EU or bodies using collateral provided by a body in the EU. Barnier said these measures would deal with concerns brought to light by the collapse of Lehman Brothers because the collateral lent out far too often and securities changing hands in such a way that nobody really knows who they belong to.