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Does Volcker + Vickers = Liikanen? EU PROPOSAL for a REGULATION on STRUCTURAL MEASURES IMPROVING the RESILIENCE of EU CREDIT INSTITUTIONS

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Does Volcker + Vickers = Liikanen? EU PROPOSAL for a REGULATION on STRUCTURAL MEASURES IMPROVING the RESILIENCE of EU CREDIT INSTITUTIONS Article Does Volcker + Vickers = Liikanen? EU PROPOSAL FOR A REGULATION ON STRUCTURAL MEASURES IMPROVING THE RESILIENCE OF EU CREDIT INSTITUTIONS By Francois-Regis Gonon, David R. Sahr, Andreas Lange, Mark Compton, Charles-Albert Helleputte1 1) On 29 January 2014 the European Commission deemed as ‘socially less important’, by reducing published a proposal for a regulation of the the risk of contagion spreading from trading European Parliament and of the Council “on activities to traditional retail banking and structural measures improving the resilience of protecting the deposits of individuals and small EU credit institutions.”2 This proposed businesses in the case of bank failure. In legislation is the EU’s equivalent of Volcker3 and addition, bank structural changes are intended Vickers.4 It was initiated by the Liikanen report5 to reduce complexity and so improve the published on 2 October 2012 but the legislative resolvability of banking groups. The EU has proposal departs in a number of ways from the been concerned about banks which it terms “too report’s conclusions. There are two significant big to fail,” “too big to save” and “too complex to departures: the legislative proposal contains a manage, supervise and resolve.” It has been Volcker-style prohibition, which also departs concerned that failure of these banks would be from the individual EU Member States’ detrimental to the financial system in the EU as approach and, although the proposal contains a whole. The EU also believes that these banks provisions which mirror the Vickers ‘ring- have an unfair advantage over smaller banks: it fencing’ approach, they are not, in direct believes that the presumption that they would contradiction to Liikanen’s recommendation, be bailed out rather than be allowed to fail mandatory. provides an implicit guarantee which impacts their funding costs and leads to moral hazard Background and excessive risk-taking. These concerns and beliefs have led to a variety of legislative 2) Post financial crisis, various jurisdictions have started to overhaul bank regulation and proposals and legislation. supervision. Bank structural reform is part of 3) Different jurisdictions have taken different that agenda and involves separating retail and approaches to bank structural reform. Reference commercial banking from wholesale and has already been made to the UK and US investment banking, as well as outright legislation but France6 and Germany7 have also prohibitions. The objective is to protect core adopted legislation and the Belgian coalition banking activities and depositors from the government reached a political agreement in ‘riskier’ trading activities, which have been December 2013 on structural reform of its banking sector which it aims to finalise before Volcker Rule—Application to Securitization elections in May 2014.8 One of the fundamental Transactions.”10 differences between the US and the approaches 5) The UK approach (Vickers) focuses on a wider of the individual EU Member States has been the range of investment and wholesale banking. By US preference for prohibition (or owner prohibiting deposit-taking entities from ‘dealing separation) as opposed to the EU Member in investments as principal,’11 it requires most of States’ preference for ring-fencing (or functional the derivative and trading activity currently separation/subsidiarisation). This difference carried out by wholesale and investment banks means that the activities which the US has to be carried out by a trading entity wholly prohibited cannot be carried out within a separate from the retail bank. The French and banking group at all whereas the activities on German approach follow the ring-fencing which the EU Member States have focused can approach of the UK but, like the US, have a be carried out within a distinct trading entity narrower focus. Their approaches reflect the which is separate from the retail and commercial agreement reached by the two countries to push bank entity. The EU’s legislative proposal, by forward arrangements in the EU for the including elements of both approaches, blurs separation of “speculative activities” from this distinction and creates a third approach to deposit-related and customer-orientated bank structural reform which is consistent with activities. Thus the French legislation provides neither the US approach nor the approaches of that proprietary trading and unsecured the individual EU Member States. financing to alternative investment funds 4) The second significant difference in the (“AIFs”) above a certain threshold (the approaches taken to date relates to the activities “speculative activities”) must be carried out by a which the different jurisdictions have regulated. trading subsidiary separate from the retail Broadly speaking, the US approach has banking entity. Similarly, the German legislation prohibited proprietary trading, sponsoring specifies certain high-risk activities (above a private equity and hedge funds (known as certain threshold in terms of overall trading “covered funds”), investing in covered funds and activity), including proprietary trading, credit loans (known as “covered transactions”) to and guarantee business with certain AIFS (or covered funds with which the banking group is equivalent funds which are high-leveraged or involved. Proprietary trading is defined widely engaged in short selling) and certain forms of but there are a number of helpful exclusions and trading in one’s own name with the exception of exemptions which narrow the scope of the market-making that must be ring-fenced and prohibition, including a number of exclusions transferred to a separate trading entity. and exemptions to reduce the extraterritorial 6) Finally and amongst those jurisdictions that impact on non-EU banks, although, of course, have chosen the ring-fencing approach, there is there are conditions with which compliance is some difference in the strength of the ring-fence necessary before reliance can be placed on the or the degree of functional separation required. exclusions and exemptions. There are similar The UK requires the ring-fenced body (“RFB”) exclusions and exemptions relating to the to be legally, economically and operationally prohibitions on sponsoring and investing in independent, to interact with the rest of the covered funds and on covered transactions with banking group on an arm’s length basis and to covered funds. The Volcker rule is examined in have its own capital and liquidity resources. The detail in our legal reports “Final Regulation Prudential Regulation Authority (“PRA”) will Implementing the Volcker Rule”9 and “The make additional rules to ensure the integrity of the ring-fence and the independence of the RFB. 2 Mayer Brown | Does Volcker + Vickers = Liikanen? | Summer 2014 The German legislation requires the RFB to be from the ring-fence. The EU, however, clearly legally, economically and operationally did not share these concerns as their proposal independent, to interact with the rest of the departs from the approach taken by individual banking group on an arm’s length basis and to EU Member States and contains a Volcker-style have its own capital and liquidity resources, but prohibition, as well as provisions on ring- does not give any guidance on how this should fencing. The main points of note are set out in be achieved or should interact with German the table below. corporate law. The main provisions of the EU proposal: Liikanen...But Not As We Knew It Scope 7) At the same time as individual jurisdictions were a) It is proposed that the Volcker-style rule will considering bank structural reform to deal with apply to: the issues summarised at paragraph 2 above, the EU was considering action, believing that i) EU G-SIIs (and all their branches and inconsistent national legislation increases the subsidiaries regardless of their possibility of distortions of capital movements location); and and investment decisions, serves to make the ii) banks that for three years have total structure and operation of cross-border banks assets of at least 30 billion euro and more complex and increases fragmentation. In trading assets of 70 billion euro or 10% February 2012, the Commission established a of total assets. High-level Expert Group to examine possible reforms to the structure of the EU’s banking b) The proposal does not make ring-fencing sector, appointing Erkki Liikanen, Governor of mandatory but requires national regulators the Bank of Finland and a former member of the to consider the possibility in relation to each European Commission, as the chairman. The individual deposit-taking bank (termed Group presented its final report to the “core credit institution”) depending upon its Commission on 2 October 2012, the risk profile. There is a wide definition of Commission examined the possible reform core credit institution. options and their implications and, on 29 c) The EU proposal intends to have January 2014, it adopted a proposal for a extraterritorial effect and apply to non-EU regulation on structural measures improving the subsidiaries of EU banks, as well as resilience of EU credit institutions plus a effectively to non-EU banking groups with proposal on transparency of securities financing EU branches, unless the Commission deems transactions aimed at increasing transparency in the relevant non-EU jurisdiction equivalent the shadow banking sector. This note focuses on to the EU regime but, although the stated the former proposal. intention is to create a level playing field
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