European Union: Does Volcker + Vickers = Liikanen?

EU Proposal For A Regulation On Structural Measures Improving The Resilience Of
  1. On 29 January 2014 the European Commission published a proposal for a regulation of the European Parliament and of the Council "on structural measures improving the resilience of EU credit institutions"1. This proposed legislation is the EU's equivalent of Volcker2 and Vickers3. It was initiated by the Liikanen report4 published on 2 October 2012 but the legislative proposal departs in a number of ways from the report's conclusions. There are two significant departures: the legislative proposal contains a Volcker-style prohibition, which also departs from the individual EU Member States' approach, and, although the proposal contains provisions which mirror the Vickers 'ring-fencing' approach they are not, in direct contradiction to Liikanen's recommendation, mandatory.

Background

  1. Post financial crisis, various jurisdictions have started to overhaul bank regulation and supervision. Bank structural reform is part of that agenda and involves separating retail and commercial banking from wholesale and investment banking, as well as outright prohibitions. The objective is to protect core banking activities and depositors from the 'riskier' trading activities, which have been deemed as 'socially less important', by reducing the risk of contagion spreading from trading activities to traditional retail banking and protecting the deposits of individuals and small businesses in the case of bank failure. In addition, bank structural changes are intended to reduce complexity and so improve the resolvability of banking groups. The EU has been concerned about banks which it terms "too big to fail", "too big to save" and "too complex to manage, supervise and resolve". It has been concerned that failure of these banks would be detrimental to the financial system in the EU as a whole. The EU also believes that these banks have an unfair advantage over smaller banks: it believes that the presumption that they would be bailed out rather than be allowed to fail provides an implicit guarantee which impacts their funding costs and leads to moral hazard and excessive risk-taking. These concerns and beliefs have led to a variety of legislative proposals and legislation.
  2. Different jurisdictions have taken different approaches to bank structural reform. Reference has already been made to the UK and US legislation but France5 and Germany6 have also adopted legislation and the Belgian coalition government reached a political agreement in December 2013 on structural reform of its banking sector which it aims to finalise before elections in May 20147. One of the fundamental differences between the US and the approaches of the individual EU Member States has been the US preference for prohibition (or owner separation) as opposed to the EU Member States' preference for ring-fencing (or functional separation / subsidiarisation). This difference means that the activities which the US has prohibited cannot be carried out within a banking group at all whereas the activities on which the EU Member States have focused can be carried out within a distinct trading entity which is separate from the retail and commercial bank entity. The EU's legislative proposal, by including elements of both approaches, blurs this distinction and creates a third approach to bank structural reform which is consistent with neither the US approach nor the approaches of the individual EU Member States.
  3. The second significant difference in the approaches taken to date relates to the activities which the different jurisdictions have regulated. Broadly speaking, the US approach has prohibited proprietary trading, sponsoring private equity and hedge funds (known as "covered funds"), investing in covered funds and loans (known as "covered transactions") to covered funds with which the banking group is involved. Proprietary trading is defined widely but there are a number of helpful exclusions and exemptions which narrow the scope of the prohibition, including a number of exclusions and exemptions to reduce the extraterritorial impact on non-EU banks, although, of course, there are conditions with which compliance is necessary before reliance can be placed on the exclusions and exemptions. There are similar exclusions and exemptions relating to the prohibitions on sponsoring and investing in covered funds and on covered transactions with covered funds. The Volcker rule is examined in detail in our legal reports "Final Regulation Implementing the Volcker Rule"8 and "The Volcker Rule – Application to Securitization Transactions"9.
  4. The UK approach (Vickers) focuses on a wider range of investment and wholesale banking. By prohibiting deposit-taking entities from 'dealing in investments as principal'10, it requires most of the derivative and trading activity currently carried out by wholesale and investment banks to be carried out by a trading entity wholly separate from the retail bank. The French and German approach follow the ring-fencing approach of the UK but, like the US, have a narrower focus. Their approaches reflect the agreement reached by the two countries to push forward arrangements in the EU for the separation of "speculative activities" from deposit- related and customer-orientated activities. Thus the French legislation provides that proprietary trading and unsecured financing to alternative investment funds ("AIFs") above a certain threshold (the "speculative activities") must be carried out by a trading subsidiary separate from the retail banking entity. Similarly, the German legislation specifies certain high-risk activities (above a certain threshold in terms of overall trading activity), including proprietary trading, credit and guarantee business with certain AIFS (or equivalent funds which are high leveraged or engaged in short selling) and certain forms of trading in one's own name with the exception of market-making that must be ring-fenced and transferred to a separate trading entity.
  5. Finally and amongst those jurisdictions that have chosen the ring-fencing approach, there is some difference in the strength of the ring-fence or the degree of functional separation required. The UK requires the ring-fenced body ("RFB") to be legally, economically and operationally independent, to interact with the rest of the banking group on an arm's length basis and to have its own capital and liquidity resources. The Prudential Regulation Authority ("PRA") will make additional rules to ensure the integrity of the ring-fence and the independence of the RFB. The German legislation requires the RFB to be legally, economically and operationally independent, to interact with the rest of the banking group on an arm's length basis and to have its own capital and liquidity resources, but does not give any guidance on how this should be achieved or should interact with German corporate law.

Liikanen...but not as we knew it

  1. At the same time as individual jurisdictions were considering bank structural reform to deal with the issues summarised at paragraph 2 above, the EU was considering action, believing that inconsistent national legislation increases the possibility of distortions of capital movements and investment decisions, serves to make the structure and operation of cross-border banks more complex and increases fragmentation. In February 2012, the Commission established a High-level Expert Group to examine possible reforms to the structure of the EU's banking sector, appointing Erkki Liikanen, Governor of the Bank of Finland and a former member of the European Commission, as the chairman. The Group presented its final report to the Commission on 2 October 2012, the Commission examined the possible reform options and their implications and, on 29 January 2014, it adopted a proposal for a regulation on structural measures improving the resilience of EU credit institutions plus a proposal on transparency of securities financing transactions aimed at increasing transparency in the shadow banking sector. This note focuses on the former proposal.
  2. The UK government had considered adding a Volcker-style prohibition to the Vickers ring-fence established in the Banking Reform Act 2013 but rejected it because of concerns that defining proprietary trading as opposed to activities such as market-making was too problematic, the "technical challenges" that the US was experiencing in implementation and the fear that it would distract regulatory attention from the ring-fence. The EU, however, clearly did not share these concerns as their proposal departs from the approach taken by individual EU Member States and contains a Volcker-style prohibition, as well as provisions on ring-fencing. The main points of note are set out in the table below.

The main provisions of the EU proposal

Scope

  1. It is proposed that the Volcker-style rule will apply to:

    1. EU G-SIIs (and all their branches and subsidiaries regardless of their location); and
    2. banks that for 3 years have total assets of at least 30 billion euro and trading assets of 70 billion euro or 10% of total assets.
  2. The proposal does not make ring-fencing mandatory but requires national regulators to consider the possibility in relation to each individual deposit-taking bank (termed "core credit institution") depending upon its risk profile. There is a wide definition of core credit institution.
  3. The EU proposal intends to have extraterritorial effect and apply to non-EU subsidiaries of EU banks, as well as effectively to non-EU banking groups with EU branches, unless the Commission deems the relevant non-EU jurisdiction equivalent to the EU regime but, although the stated intention is to create a level playing field in the EU, these provisions raise questions of legality and enforcement. National regulators may exempt a non-EU subsidiary of an EU bank from the ring-fencing requirements of the EU proposal in the absence of an equivalence decision if the relevant national regulator is satisfied that the subsidiary's resolution strategy has no adverse effect on the financial stability of the Member State(s) where the parent and other group entities are established. There is no such additional exemption for EU branches of non-EU banks or in respect of the Volcker-style prohibition.

The rules

  1. The EU Volcker-style rule prohibits proprietary trading (which is said to be narrowly defined), investments in AIFs save for closed-ended and unleveraged AIFs and investments in other entities which themselves engage in proprietary trading or investment in AIFs. This rule is considered in more detail at paragraphs 9 - 19 below.
  2. Unlike Liikanen, the EU proposal does not make separation of trading activities from retail and commercial banking mandatory. Instead it provides that national regulators must consider separation of trading activities (which is very widely defined to include almost all activities save those related to retail and commercial banking) from retail and commercial banking depending on the risk each individual core credit institution presents. The assessment of risk will be carried out on the basis of metrics set out in further legislation drafted by the European Banking Authority ("EBA") and the Commission. Where the risk levels are exceeded and the national regulator determines that there is a threat to financial stability then the national regulator must impose a ring-fence on that particular bank, unless the bank can demonstrate that the regulator's conclusions are not justified. These provisions are considered in more detail at paragraphs 20 - 39 below.

Individual Member State derogations

  1. The Commission may grant individual deposit-taking banks within Member States (not individual Member States) a derogation from the ring-fencing requirements set out in the proposal where national legislation is equivalent to the EU legislation. At the time of writing, it appears that only the UK legislation is likely to meet the requirements of equivalence but that may depend on secondary legislation, which the UK has yet to adopt, which will provide the technical detail of the Vickers rule.

Timing

  1. On the basis that the final text of the Regulation is adopted by the European Parliament and Council by June 2015, it is proposed that the provisions will be phased in over a number of years: the Volcker-style prohibition will come into effect on 1 January 2017 and the provisions on ring-fencing will come into effect on 1 July 2018.

To read this Update in full, please click here.

Originally published 26 February 2014

Footnotes

1 See here http://ec.europa.eu/internal_market/bank/structural-reform/index_en.htm

2 As implemented in section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 which created a new section 13 of the US Bank Holding Company Act of 1956.

3 As implemented in section 4 of the Financial Services (Banking Reform) Act 2013 which inserts Part 9B (sections 142A – 142Z1) into the Financial Services and Markets Act 2000.

4 See here http://ec.europa.eu/internal_market/bank/docs/high-level_expert_group/report_en.pdf

5 French law no. 2013-672 of 26 July 2013 on the separation and regulation of banking activities.

6 Trennbankengesetz (German Bank Separation Law) which is included in Article 2 of the Gesetz zur Abschirmung von Risiken und zur Planung der Sanierung und Abwicklung von Kreditinstituten und Finanzgruppen (Law concerning Separation of Risks and Restructuring and Winding-Up of Credit Institutions and Financial Groups), BGBl. 2013 I Nr. 47, 3090. The law was announced on 7 August 2013 and Article 2 entered into force on 31 January 2014, although most of the rules in Article 2 are not applicable until 1 July 2015.

7 The text is not yet available but was approved in second reading on 14 February 2014 by the Belgian Federal Government.

8 See here http://www.mayerbrown.com/files/Publication/f95121f8-0c01-40f8-b14b-46379c2b118d/Presentation/PublicationAttachment/ddaf0395-d75d-4456-b143-6a026db6be71/Final-Regulation-Implementing-the-Volcker-Rule.pdf

9 See here http://www.mayerbrown.com/files/Publication/b2ff45c7-4252-4bb4-8bc0-899c2914b6a8/Presentation/PublicationAttachment/9b7da3f6-47a6-4da5-8dfb-05f7f0893a0f/UPDATE-VolckerRule-Application_131219.pdf

10 Dealing in investments as principal includes buying, selling, subscribing for or underwriting securities or contractually based investments.

Learn more about our Financial Services Regulatory & Enforcement and Banking & Finance practices.

Visit us at mayerbrown.com

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

© Copyright 2014. The Mayer Brown Practices. All rights reserved.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.