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UK banks face 'multiple ring fences', says expert, as EU sets out proposed structural reforms

Out-Law News | 31 Jan 2014 | 11:33 am | 2 min. read

The EU's largest and most complex banks could be forced by national regulators to separate certain 'risky' trading activities from their core deposit-taking functions in the event of a threat to financial stability under proposals announced by the European Commission.

The draft structural reforms proposed by the Commission would also ban those banks from so-called 'proprietary' trading, or making trades using their own capital. This proposal would be accompanied by measures to increase transparency in the 'shadow' banking sector as announced in September 2013, in order to prevent these banks from diverting such trading to less-regulated subsidiaries.

Banking reform expert Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com, said that the proposed measures were distinct from the 'ring fence' between UK banks' retail and investment activities, due to be implemented as part of the Banking Reform Act by 2019. For this reason, affected institutions must now consider their compliance strategies carefully, he said.

"The proposals will only impact on globally systemically important banks, meaning that of the UK banks HSBC, Barclays, Lloyds, RBS and Standard Chartered will need to comply," he said. "They now face a double compliance burden alongside the Vickers proposals: multiple ring fencing requirements with the EU requiring the separation of certain trading activities from deposit-taking and the UK's requirement to ring-fence what is essentially retail banking activities from the wider bank."

"With this announcement, the affected UK banks will now be reviewing their operational strategies being developed to comply with Vickers and on a tighter timetable. There may be some synergies under both approaches but the substantive differences will make it more of a steeplechase jump than a hurdle for these UK banks," he said.

The Commission's proposals are subject to negotiation with and approval by the European Parliament and member states. However, the proposed ban on proprietary trading is scheduled to be applied from 1 January 2017, while regulators would be given the power to order the separation of trading activities from 1 January 2018.

The draft regulation proposed by the Commission (65-page / 311KB PDF) would apply to those banks deemed to be of globally systemic importance: generally those with over €30 billion in total assets, and trading activity that either totals €70bn or represents 10% of total assets. It is expected that this would cover only 30 of the estimated 8,000 banks operating in the EU, but that those 30 banks would account for around 65% of total EU banking assets.

The proposals are based on the recommendations of a working group led by Bank of Finland Governor Erkki Liikanen, presented to the Commission in October 2012. However they do not go so far as to impose the mandatory separation of banks' trading and retail activities, as recommended by that report. Instead, national supervisors would be required to enforce separation where activities such as market making, investment and sponsorship of complex securitised products and over-the-counter derivatives exceeded certain thresholds and risks. They would also be given the power to require certain trading activities to be separated if it deems that activity to pose a risk to the financial stability either of that bank or the EU.

The ban on proprietary trading is based on the US Volker rule, but would only apply to the largest banks and any entities that form part of that bank's corporate group. The ban would prevent a bank from trading financial instruments, physical commodities and hedge fund investments with its own money rather than its customers' money, so as to make a profit for itself. Although the Commission said that such trading was already less common following the economic crisis, it is "generally highly risky" and "alien to the traditional role of banks as intermediaries between borrowers and capital suppliers".

Internal Market Commissioner Michel Barnier described the proposals as the "final cogs in the wheel" to complete the regulatory overhaul of the EU banking system.

"This legislation deals with the small number of very large banks which otherwise might still be too-big-to-fail, too-costly-to-save, too-complex to resolve," he said. "The proposed measures will further strengthen financial stability and ensure taxpayers don't end up paying for the mistakes of banks."