European Union: EU Bank Structural Reform | Commission Sets Out Ban On Prop Trading, Retail And Trading Split

Last Updated: 3 February 2014
Article by Clifford Smout and John Andrews

Most Read Contributor in UK, August 2017

Today marks the 'end of the beginning' for EU bank structural reform, after the Commission published its long-awaited proposal for a Regulation which would ban proprietary trading at the biggest banks in the EU and ring-fence some of their remaining trading activities.

The Regulation amalgamates various features of existing bank separation rules: a Volcker-type outright ban on proprietary trading and investments in alternative investment funds (AIFs), with the possibility of further ring-fencing of trading activities, and some decidedly Vickers-style limitations on intra-group relationships and governance.

It adds to the raft of rules that are forcing banks to reconsider their legal structures, from resolution planning, to market access requirements, and other structural initiatives such as US enhanced prudential standards for foreign banks and UK retail ring-fencing. It could therefore complicate the regulatory landscape for those firms covered by these proposals.

Below is a whistle-stop tour of the proposal – its scope, the ban on proprietary trading, ring-fencing requirements, interaction with existing national ring-fencing rules, and projected timelines.

Who needs to pay attention?

The Commission wants to apply the rules to the largest credit institutions operating in the EU, including branches of non-EU firms. This means those that are EU-based globally systemically important banks, or those with:

  1. €30 billion assets AND
  2. Trading activities exceeding €70 billion or 10% of assets

The Commission estimates that "around 30" banks would be covered by these criteria based on historical data. 

The proprietary trading ban would cover all groups operating in the EU which include an EU credit institution (as measured by their EU consolidated accounts) and to branches of credit institutions headquartered outside the EU which meet the criteria based on the EU activities of the branch.

Additional ring-fencing would then apply to a subset of these banks ('core credit institutions' – those accepting deposits eligible for an EU deposit guarantee scheme) following an assessment of their trading activities, as explained below.

The ban on proprietary trading and investments in funds

Banks caught by the rule would be prohibited from proprietary trading in financial instruments and commodities. However, the ban on proprietary trading is narrowly drawn – the prohibition is on transactions which have the "sole purpose" of making a profit for a bank's own account, "without any connection to actual or anticipated client activity," when these are made through desks, units, divisions or individuals which are "specifically dedicated" to taking such positions. This is a notably different approach to that of the US Volcker rule, which bans proprietary trading even when undertaken through units which are not necessarily dedicated to that activity.

Investing in AIFs for the sole purpose of making an own account profit is also prohibited – this includes having shares in AIFs, investing in derivatives or any other financial instrument the performance of which is linked to the shares of AIFs, or having shares in any entity which engages in proprietary trading or itself acquires shares in AIFs.

Additional ring-fencing of trading

A subset of banks within scope of the Regulation would be subject to additional ring-fencing of trading activities, largely at the discretion of their supervisor (note that for eurozone banks this will mean the European Central Bank (ECB), given the advent of the Single Supervisory Mechanism).

Supervisors would be required to assess deposit-taking banks' trading activities using a specified set of metrics (defined but not yet calibrated). Following such an assessment, the supervisor may require subsidiarisation of any trading activities that are deemed a threat to the financial stability of the bank or the financial system. The supervisor can also choose to require subsidiarisation even if the metrics are not exceeded. However, firms will have an opportunity to respond, and if they can demonstrate to the satisfaction of the supervisor that its conclusions "are not justified", then the bank would not have to proceed with ring-fencing. In either case, the supervisor would have to publicly disclose its conclusions and reasoning.

Anyone subject to additional separation requirements would then face a series of further structural and operational restrictions, including:

  • A requirement to be structured with two "homogeneous functional subgroups" – deposit-taking entities on one side, and trading entities on the other – with relationships at arm's length, restrictions on shared board memberships, and a requirement for each subgroup to issue its own debt (unless this conflicts with the group's resolution plan);
  • The deposit-taking entity would not be allowed to own shares in the trading entity;
  • Limitations on trading activities for risk management purposes, which is restricted to management of the balance sheet risk in relation to capital, liquidity and funding. Derivatives used for this purpose would be restricted to those on interest rates, foreign exchange and credit, and must be eligible for central clearing. Further, trades would need to "demonstrably" reduce "specific, identifiable risks."
  • Constraints on the provision of risk management services to customers, with the deposit taking entity permitted to sell only interest rate, foreign exchange, credit, emissions allowances and commodity derivatives, all of which must be eligible for central clearing, to non-financial clients, insurers, or pension funds. The "sole purpose" of the sale must be to enable customers to hedge risks in these categories and an as-yet-unquantified aggregate position limit as a proportion of regulatory capital would apply.
  • The deposit taker may not have exposures of more than 25% of its capital to each individual sub-group within the wider group structure; it may not have exposures to individual financial firms outside the group exceeding 25% of its capital; and it may not have aggregate exposures to financial firms exceeding 200% of its capital.

What about the Banking Reform Act?

Consistency with the UK's Banking Reform Act is very much in the minds of UK banks and policymakers. The ban on proprietary trading would be mandatory across all EU countries, including the UK, but the Commission isn't proposing that UK banks follow two sets of ring-fencing rules. Instead, the Commission would be able to grant derogation to individual member states who want to pursue their own versions of ring-fencing. But this won't be a free for all – derogations are subject to conditions, including that national law hasn't been declared "incompatible" with the Regulation. The Commission will also pay particular attention to the impact derogation would have on the eurozone Banking Union. Further, national exceptions from restrictions on trading would be limited to those for risk-mitigating activities, rather than – for instance – for market making, for which for the existing French and German regimes do make an exception.

Equivalence – non-EU firms

As mentioned, the proposal extends to EU branches of non-EU firms. But the Commission is willing to waive both the proprietary trading and ring-fencing requirements for such branches where the parent firm is subject to rules at home deemed equivalent by the Commission, and where the home country provides for similar recognition of EU rules. This would appear to be aimed at the US Volcker rule, which is creating headaches for EU banks, but which contains no such provisions for recognition of foreign rules. But it may prove important for banks from elsewhere – the Swiss legislature is due to review its 'too big to fail' rules in 2015, with discussion of bank separation a possibility, while the evolution of policy in the Asia-Pacific region also bears watching closely.


The Commission estimates adoption of the Regulation by June 2015, with the required additional delegated acts to be adopted by January 2016. On this timeline an initial list of covered and exempted banks would be published by July 2016, with the ban on proprietary trading effective from January 2017, and separation of trading activities by July 2018. But for this to be possible, the proposal has to make its way through the EU legislature, and its path may well be bumpy, not least of all because of the imminent change of the guard at the European Parliament and Commission.

In summary, we now know more about the Commission's intentions, but little about where policy will end up, or how it will ultimately affect individual banks, whether from the EU or elsewhere.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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