Brussels, 08/04/2015 (Agence Europe) - At the end of March, the Latvian Presidency of the Council of the EU unveiled a draft compromise summarising member states' views on the controversial plans to reform the banking sector (see EUROPE 11287).
Despite reservations expressed by a number of countries, the Latvian Presidency decided to maintain the scope of the European Commission's initial proposal, along with clarifications, in line with the preferences expressed by a majority of non-EU countries, explains the draft compromise that this newsletter has seen. The directive's rules will apply to all banks registered in the EU, and its subsidiaries in any location, any subsidiary of a non-EU bank that is registered in the EU and subsidiaries of a banking group from outside the EU, as long as the group has at least two subsidiaries in the EU.
The presidency has kept an approach whereby it will be for the competent authorities to divide up the banks in question into three categories ('tier 1, 2 and 3') on the basis of risk (see EUROPE 11241). It has introduced triggers for risk-weighted trading assets as a share of total assets. Riga feels that the creation of these categories will increase the predictability of any prudential decisions.
Scrapping of bank on proprietary trading. At the start of 2014, the European Commission suggested banning around thirty big European banks from carrying out proprietary trading, in other words investing their own funds in the market (see EUROPE 11007). The Latvian compromise scraps the ban, replacing it with a “mandatory separation” of proprietary trading, in other words the requirement to hive off proprietary trading into a separate legal body (a subsidiary). “What is new is that the core credit institution will be able to own or invest up to ten percent of its assets in alternative investment funds that are not substantially leveraged,” explains the presidency. It says that the ten percent cap “aims at limiting the impact of possible losses of hedge funds which the core credit institution could own or invest in.”
The Latvian deal says that market making will not be considered a priori as proprietary trading and therefore would not be subject to the requirement that a subsidiary be set up, unlike the Commission's initial proposal. This change takes account of the views of a number of member states, recently relayed to the European Parliament by the chair of the ECB's Single Supervision Board, Danièle Nouy (see EUROPE 11286).
Greater transparency. In order to boost transparency for proprietary trading, Latvia lays down reporting obligations for trading not considered a priori to be proprietary speculation (market making, coverage of special risks for the bank's central core, the hedging of liquidity, interest rate and exchange rate risks on the banking book, sale or purchase of securities for long-term investment aims). A bank would be required to prove that this activity is not proprietary trading, does not involve excessive risk and is necessary for it to carry out its main role of financing the real economy.
Every year, banks shall submit a compliance programme to the supervisory body giving details such as the type of trading activity carried out by each trading unit, rules to restrict trading to match the type of client and the size of the markets. Likewise for the internal structure set up to carry out trading and manage the related risks. Every quarter, banks shall communicate aggregate information, broken down into trading units.
The competent authorities will use this information to assess the risks involved, whether market making is excessively risky, for example, and will examine the need for the trading in the light of the real economy and the bank's ability to absorb any potential losses.
The Latvian Presidency suggests two ways of reducing the risks associated with trading that is not considered a priori to be proprietary trading, viz.: -1) introducing stronger capital requirements on (tier 2 core credit institutions) and introducing greater capital requirements or even the creation of subsidiaries for risky activity of banks in the riskiest category (tier 3); - 2) introducing stronger capital requirements or demanding the end of such trading for tier 2 banks. The European Banking Authority would always be consulted about the potential risk of a decision taken to ensure financial stability. (Mathieu Bion)