United States: Comparison Of New EU Proposals On Proprietary Trading And Ring-Fencing Against US, UK, French And German Rules

The European Commission has published a legislative proposal that would prohibit certain large EU banks from engaging in selected types of risky proprietary trading. The proposal would also potentially require such banking groups to push out and ring-fence certain other high-risk trading activities. The UK, France and Germany have already adopted separate national ring-fencing legislation, while in the US the Volcker Rule, which bans proprietary trading, is now in final form. International banking groups will need to continue work on restructuring their businesses to comply with the overlapping and at times inconsistent sets of rules. This note summarises the key provisions of each measure.


The European Commission has published a draft regulation (the "Proposed Regulation") to prohibit certain large and systemically important banks from proprietary trading.1 The Proposed Regulation also gives national regulators in the EU various powers to require 'risky' trading activities (including market-making, securities underwriting, securitisation and complex derivatives) to become ring-fenced within those institutions into a separate legal entity from the retail bank. A retail bank is one that takes insured deposits under the Deposit Guarantee Scheme Directive.

The measures reflect and expand upon proposals originally included in the Liikanen Report.2 They go further than the Liikanen Report by imposing an outright ban on proprietary trading. If the Proposed Regulation is approved by June 2015, the ban on proprietary trading would apply from 1 January 2017 and the ring-fencing powers would come into effect from 1 July 2018.

In the US, the Volcker Rule imposes a general prohibition on banking entities and their affiliates from engaging in proprietary trading, subject to various exemptions.3 Some EU Member States have already enacted legislation providing for national bank ring-fencing requirements, and the intention in many cases was for these to be an alternative to a proprietary trading ban, as imposed by the Volcker Rule. In the UK, the Financial Services (Banking Reform) Act 2013 (the "UK Act"), which implements the reforms proposed by the Independent Commission on Banking, requires deposit-taking banking services to be ring-fenced from proprietary trading and other related activities.4 Recent French and German legislation also requires banks and banking groups to separate their proprietary trading and certain other high risk activities from their deposit-taking business.5 However, the Proposed Regulation is essentially a "Volcker Rule-lite," plus a form of ring-fencing (lite).

The Proposed Regulation includes an option for Member States to apply to the European Commission for a derogation decision to exempt a bank from the ring-fencing requirements of the Proposed Regulation if the bank is already subject to a national ring-fencing regime that meets similar standards. The decision applies to instances where national primary legislation had been adopted prior to 29 January 2014 (including secondary legislation subsequently adopted), which covers the UK, France and Germany. In the event that the technical standards mandated by the Proposed Regulation create further discrepancies between the pan-European regime and pre-existing national regimes, the use of derogation decisions may become increasingly desirable for European banks seeking to avoid multiple ring-fences. No statements have currently been made by any major European governments or regulators on their intention to rely on these derogation provisions and it is somewhat unclear whether they will be able to do so. The test for similarity appears to favour the UK and French reforms, though it is hard to believe the German would not be recognized also (perhaps with minor adjustment).

The UK Act requires regulators to review, within 12 months of the UK's ring-fencing requirement taking effect (currently expected in 2019), proprietary trading activities engaged in by all regulated financial institutions in the UK (and not just deposit-taking banks). The UK regulators are also required to review the UK's ring-fencing rules themselves within five years. It is therefore not yet clear whether the UK would rely on derogation decisions or instead seek to align its approach with that under the Proposed Regulation.

The table at the end of this note compares the Proposed Regulation with current requirements in the US, UK, France and Germany. While these regimes may, at first glance, appear similar, international banking groups will need to undertake detailed analysis to ensure they are appropriately structured to comply with each applicable requirement.


Proposed Regulation

The requirements of the Proposed Regulation will apply to "credit institutions" and "EU Parents." "Credit institutions" comprise, essentially, banks regulated in the EU. "EU Parents" include holding companies in the EU of groups that include credit institutions. The following organisations will be covered by the Proposed Regulation:

EU credit institutions and banking groups headquartered in the EU

  • any credit institution or EU Parent identified as being a global systemically important institution ("G-SII") under the EU's Capital Requirements Directive IV ("CRD IV") (and all their branches and subsidiaries wherever located) (the "G-SII test"); or
  • any EU credit institution or EU Parent with a credit institution established in the EU (and all their branches and subsidiaries, wherever located) where, for a period of three consecutive years, its total assets amount to at least €30 billion and it has trading activities amounting to at least €70 billion in combined value or 10% of its total assets (the "size test");

Credit institutions and banking groups outside the EU

  • the EU bank sub-group that meets one of the above tests, with all the branches of the EU entities and subsidiaries which drop down below the EU entities; and
  • an EU branch of a third country (e.g. US) bank provided that it meets the size test.

However, the European Commission would be entitled to determine that a third country regulatory regime is "equivalent" to the requirements under the Proposed Regulation, comprising both the proprietary trading ban and the ring-fencing requirement. For this test to be met, the third country's legal framework must be capable of recognizing structural measures provided for in the laws of other countries. The Commission FAQs on the Proposed Regulation imply that it is intended that the US is capable of being equivalent given various provisions of Bank Holding Company Act legislation which predate Volcker. Notably, the US regime is technically able to take into account the Proposed Regulation, though whether this ends up being the case in practice remains to be seen. Presumably the intent behind the Proposed Regulation is a grand negotiation on the topic between the EU and US. As in other recent EU legislation (e.g. EMIR), the equivalence determination is at the discretion of the European Commission.

Where the European Commission makes an equivalence determination, the Proposed Regulation will not apply to:

  • EU branches of that third country's credit institutions; or
  • third country subsidiaries of EU Parents.

Where there is no equivalence between the Proposed Regulation and the third country regime, a national regulator may exempt a third country subsidiary of an EU Parent from the structural split requirement provided that a resolution plan is agreed between the group level EU authority and the third country host authority and the resolution strategy has "no adverse effect on the financial stability of the member state where the EU Parent and other group entities are established."6 In other words, where (most likely) an effective multiple point of entry resolution strategy is implemented, a national regulator will have the power to exempt a third country subsidiary of an EU Parent.

Comparison with Jurisdictional Scope of the US Volcker Rule

The Volcker Rule similarly has some level of extraterritorial reach. In addition to domestic institutions, it applies to the banking operations of banking groups headquartered outside the United States, subject to certain key exemptions. The main exemption in this context is the "solely outside the United States" or "SOTUS" exemption. The SOTUS exemption is available where, in respect of a purchase or sale of a financial instrument for a trading book:

  • the banking entity headquartered outside the United States acts as principal outside the United States;
  • the entity and relevant personnel that make the trading decision are located outside the United States;
  • trading is not accounted for as principal in the United States;
  • a US affiliate does not provide financing for the trading; and
  • the trading is not conducted with or through any US entity, other than on an anonymous basis on a US exchange or through a US central counterparty, or in a transaction with the non-US operations of a US entity.7

Interaction of EU and US Regimes International Banking Groups

Unless and until the European Commission deems the US regime equivalent to the Proposed Regulation, there is the potential for substantial overlap and even conflict between the Proposed Regulation and the Volcker Rule.

Many large US-headquartered banking groups currently operate in the EU through branches. If the European Commission makes an equivalence determination with respect to the US, a US bank operating in the EU through a branch would not be subject to the Proposed Regulation. An EU subsidiary of a US bank would be subject to both the Proposed Regulation and the Volcker Rule unless an exemption applied under the US regime.

Given the difficulties of applying different proprietary trading standards in different countries, many banking institutions may well choose to comply with the more restrictive standards globally.


The Proposed Regulation prohibits in-scope entities from engaging in proprietary trading in financial instruments and commodities. Whereas the in-scope entities under the Proposed Regulation are limited to EU credit institutions having total assets of more than €30 billion, or who are already deemed to be "globally systemic," the Volcker Rule applies the prohibition on proprietary trading to a broader group of "banking entities," that includes any insured depository institution, its holding company, a bank headquartered outside the United States that is treated as a bank holding company under the International Banking Act of 1978, as amended, and any subsidiary or affiliate of any of these entities.

The Proposed Regulation also defines "proprietary trading" more narrowly compared to the UK Act and the Volcker Rule. Unlike the UK Act and the Volcker Rule, the definition does not start with reference to the EU activity of "dealing in investments as principal" or "engaging as principal," respectively. Instead, a new definition is proposed of using own capital or borrowed money to take positions in any type of transaction regarding a financial instrument or commodity for the sole purpose of making a profit for one's own account. Any purpose connected to actual or anticipated client activity or hedging the entity's risk as a result of actual or anticipated client activity would mean the trade falls outside the definition.

The Volcker Rule adopts a broader definition of proprietary trading, where any short-term principal trading (of securities, derivatives or futures contracts) by a banking entity that does not fall neatly within one of the enumerated exemptions (discussed further below) will be presumed to be prohibited proprietary trading for purposes of the Rule. The Volcker Rule also adopts a wider and more objective view by relying on the trading desk as the smallest discrete unit of organization to measure compliance with the Rule's restrictions and limitations. Proprietary trading under the Proposed Regulation is limited to activity conducted through the use of desks, units, divisions or individual traders specifically dedicated to such position taking and profit making, including through dedicated web-based proprietary trading platforms.

Presumably the final text of the Proposed Regulation will not allow self-made structures which feed client and proprietary trading into the same desk, thereby falling outside the definition. However, nevertheless, the intention appears to be to impose a version of the Volcker Rule that is narrower and less objective than that being imposed in the US, with the ring-fencing provisions being included as a fail-safe.

As a result of this narrow definition, hedging, market-making and underwriting activities would generally be outside the ban, albeit such activities may be subject to ring-fencing instead. Specifically, market-making, the issuance, investment and sponsorship activities linked to risky securitizations and the structuring, arranging and execution of complex derivatives are intended to subject to the structural separation requirement rather than the proprietary trading ban.

There is also a specific exemption for trading in debt issued by Member States. The Volcker Rule contains an exemption for trading in securities linked to the US sovereign debt, which was extended recently to cover certain kinds of non-US sovereign debt, so this exception is broadly equivalent to that in the US. There are also exemptions for cash management and trading in cash and cash equivalent instruments (defined as being of less than 397 day maturity with returns no greater than the rate of return of three-month high quality government bonds).

There is a prohibition on investment in alternative investment funds ("AIFs"), derivatives linked to AIFs or shares or units in an entity that invests in AIFs. Investments are permitted in closed-ended and unleveraged AIFs, EU venture capital funds, EU social entrepreneurship funds and EU long-term investment funds. Each of these must be established in the EU under the Alternative Investment Fund Managers Directive ("AIFMD"), or established elsewhere and marketed into the EU in accordance with the AIFMD.

There is also a prohibition on investing in entities that engage in proprietary trading.

The management of entities subject to the ban will be required to ensure compliance. Remuneration arrangements are required to contribute to the prevention of circumvention of the ban.


The European Commission has stated that it believes that legal separation of certain particularly risky financial activities within a large banking group is also crucial for a safe and efficient EU banking system. Under the Proposed Regulation, any such separation would be independent of an assessment of a bank's recovery and resolution plan which may call for additional separation if deemed necessary (under the current version of the proposed Bank Recovery and Resolution Directive, which is still subject to the EU legislative process).

National regulators will be obliged to review the trading activities of in-scope entities at least annually with a view to determining whether the trading business should be required to be split, and ring-fenced from, the retail bank. The review must include an assessment of certain metrics, which if exceeded result in a decision by that national regulator that the retail bank must not carry out trading activities. These metrics include relative trading book size (trading assets divided by total assets), leverage (trading assets divided by core Tier 1 capital), counterparty credit risk (fair value of derivatives divided by total trading assets), complexity (measured largely by reference to derivatives), profitability (trading income divided by total net income), associated market risk (difference between trading assets and liabilities in absolute value, divided by average of trading assets and trading liabilities), interconnectedness (based on CRD IV criteria), and finally credit and liquidity risk from commitments and guarantees.

Particular assessment is to be made of market-making given its risks and interconnectedness. Similar scrutiny is to be made of securitization, which is seen as giving risk to significant liquidity risk. The EBA will draft Regulatory Technical Standards ("RTSs") which will be endorsed by the European Commission. The Commission will specify the relevant limits of the metrics, how many metrics must be exceeded for the test for separation to be met, as well as the level of aggregate significant risk being measured.

If these metrics are met and the national regulator determines there is a risk to the financial stability of the retail bank or the EU financial system as a whole, the process for splitting off the trading businesses will be triggered unless the institution can demonstrate the lack of any such risk to the satisfaction of the national regulator. Further, the national regulator can order a split if it identifies a risk to the stability of the bank or the EU financial system regardless of the metrics being surpassed. The Commission will specify what sorts of securitization do not propose a threat to the financial stability of the core credit institution or the EU financial system as a whole.

If such trading activities are required to be separated, they would need to be assigned to a separate legal entity (a "trading entity") pursuant to an agreed separation plan. The retail bank will only be able to carry on trading in order prudently to manage its capital, liquidity and funding, for which it can only use interest rate, FX and credit derivatives eligible for CCP-clearing, unless the Commission adds to that list, in order to hedge overall balance sheet risk. The hedging must mitigate individual or aggregate positions. In addition, the bank may provide risk management services to clients.

Ring-fenced entities must have strong independent governance and address regulatory capital and large exposures on a functional sub-group basis.

Remuneration practices must be aimed at hedging being determined by reference to its effectiveness in reducing risk, not on profits.


The Proposed Regulation requires the disclosure of information to regulators in order to ensure that the calculation of assessments is possible as well as to facilitate the monitoring of compliance with the requirements. Further, transactions, document systems and processes must be registered with regulators to enable the regulators to monitor compliance.

There are provisions for the imposition of administrative sanctions against corporate entities and individuals (management) responsible for breaches. Member States are permitted also to apply criminal sanctions for breaches of the ban on proprietary trading and any manipulation of information on trading activities that is submitted to regulators.


At a high level there are arguably subtle differences of intent between the various key regimes. The European Commission's primary objective is to isolate risky trading activity and eliminate purely speculative trading. The UK Act primarily seeks to protect deposit-taking banks from risks generated by the investment banking part of the wider group where, ultimately, a taxpayer-funded bail-out might be required to prevent depositor runs. The Volcker Rule, in contrast, is motivated by philosophical concerns that banks should exist only to do customer business.

The Proposed Regulation's requirements are not as strict as, and are in some ways more flexible than, the UK Act and the Volcker Rule. The ban on proprietary trading is in principle narrower than the Volcker Rule, requiring fewer exceptions to be developed. The provisions will apply the ring-fence - but not a ban - to many trading and investment banking activities such as lending to venture capital and private equity funds, investment and sponsorship of risky securitisation, and the sale and trading of derivatives. The ability to ring-fence such trading activities, rather than an outright ban in relation to some aspects of these as per the Volcker Rule, provides greater flexibility for banks in the types of activities they can undertake. Further, under the Proposed Regulation, ring-fencing is not automatically mandatory, but is at the discretion of national regulators on a case-by-case basis, albeit subject to the harmonised metrics set by the EBA. This makes the ring-fencing provisions more flexible than the UK Act, which provides a mandatory ring-fence of all deposit-taking activity. However, as neither the EBA metrics nor the UK secondary legislation are finalised, developments will need to be monitored. Moreover, national derogations may be used instead of the regime under the Proposed Regulation.

Unless derogations are used, it is possible that the combined effect of the Proposed Regulation and the UK Act will be to require some of Europe's largest banks to construct two ring-fences: one around their retail arm (as required by the UK Act) and one around their trading activities (as set out in the Proposed Regulation), in addition to satisfying any additional ring-fencing requirements under French or German legislation. Non-US banks would also need to ensure compliance with the SOTUS and other applicable exemptions for their operations outside the US to ensure they remain outside the scope of the Volcker Rule. US banks will likely ensure compliance with the Volcker Rule as a first step before looking at the EU or UK regimes, given that the Volcker Rule is more burdensome than either of these two regimes in most respects.


The European Commission published a draft regulation on the reporting and transparency of securities financing transactions (the "SFT Regulation")8 on the same day as the Proposed Regulation. The SFT Regulation applies to repurchase transactions (as defined in the Capital Requirements Regulation ("CRR")),9 securities or commodities lending and borrowing, and any transaction having an equivalent economic effect and posing similar risks such as buy-sell back or sell-buy back transactions (collectively defined as securities financing transactions ("SFTs")). The SFT Regulation is aimed at increasing transparency in the shadow banking sector and squeezes the brakes on collateral velocity, a phenomenon prevalent in the shadow banking arena. The goal is to mitigate contagion and systemic risk contributed by shadow banking transactions but at the cost, perhaps, of increasing the scarcity of collateral at a time when there is increasing demand for high quality collateral.

The key requirements of the SFT Regulation are:

  • counterparties to SFTs will have to report such transactions to a registered trade repository and keep records of SFTs that they report. Counterparties for this purpose include EU financial counterparties and their branches (wherever located), non-financial counterparties (as defined in EMIR), non-EU counterparties (if the transaction is concluded in the course of operations of an EU branch) and central counterparties;
  • management companies of undertakings for collective investment in transferable securities ("UCITS"), UCITS investment companies and alternative investment fund managers will have to inform their investors on the use they make of SFTs as well as other financing structures and will have to include information on the SFTs they are authorized to use in pre-investment documents; and
  • counterparties will have to meet minimum conditions if they wish to rehypothecate financial instruments including obtaining written consent of the collateral provider, disclosure of the risks to the collateral provider (in particular the potential risks in the event of the default of the counterparty) and the transfer of the financial instruments received as collateral to an account in the name of the receiving counterparty. Counterparties for this purpose include EU financial counterparties and their branches (wherever located), non-financial counterparties (as defined in EMIR), non-EU counterparties (if the rehypothecation is concluded in the course of operations of an EU branch or an EU counterparty or an EU branch is the provider of the collateral).

It is expected that the SFT Regulation will enter into force by the end of 2015. The reporting requirement will apply 18 months after the SFT Regulation comes into force and the requirements relating to reporting by fund managers to investors will apply six months after the SFT Regulation enters into force.

To read this article in full, please click here.


1 The Proposed Regulation is available at: http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:52014PC0043:EN:NOT.

2 The Liikanen Report is available at: http://ec.europa.eu/internal_market/bank/docs/high-level_expert_group/report_en.pdf.

3 Previous client notes on the Volcker Rule are available here.

4 The UK Act is available at: http://www.legislation.gov.uk/ukpga/2013/33/contents/enacted/data.htm and our client note on the same is available here.

5 The Act on Ring-fencing and Recovery and Resolution Planning for Credit Institutions and Financial Groups is available at http://www.bundesrat.de/cln_330/SharedDocs/Drucksachen/2013/0301-400/378-13,templateId=raw,property=publicationFile.pdf/378-13.pdf. The Law of 26 July 2013 on the Separation and Regulation of Banking Activities (Law no. 2013-672) is available at http://www.legifrance.gouv.fr/affichTexte.do?cidTexte=JORFTEXT000027754539.

6 Proposed Regulation, Article 4(2).

7 79 Fed. Reg. 5535, at 5786 (Jan. 31, 2014).

8 The proposed SFT Regulation is available at http://ec.europa.eu/internal_market/finances/docs/shadow-banking/140129_proposal_en.pdf.

9 The CRR is available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2013:176:0001:0337:EN:PDF.

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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Barnabas W.B. Reynolds
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