October 26th, 2017 by Nick Railton-Edwards
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The European Commission has quietly buried its TBTF ringfence proposal. At least to the financial community, the contents of Tuesday’s publication of the Commission Work Programme for 2018 were more notable for what they omitted. Under the aspirational subtitle “A Deeper and Fairer Economic and Monetary Union”, Annex III of the Programme contains nine financial reform priorities, none of which refer to ringfencing or structural reform. While retaining their implied too big to fail status, Europe’s largest banks are now also too big to separate.

The 2014 proposal “on structural measures improving the resilience of EU credit institutions” followed the 2011 Liikanen report. It included a wide raft of measures: potential separation of deposit and trading entities, capital/liquidity and funding constraints, large exposure maxima and product limitations. The proposal’s ban on proprietary trading was intended to take effect 1 January 2017, the power to separate trading and deposit-taking activities was to have been in place from 1 July 2018.  Combining elements from Vickers and Volker, the proposal faced concerted opposition from the systemically-important banks most likely to be affected. The proposal was significantly weakened by objections from the Council and the ECON committee.  With political progress stymied, pre-emptive national reforms in France and Germany effectively undermined the unified EU legislation. The French and German laws preserve the universal banking model, but are far from uniform. The French require proprietary trading to be conducted by a legally, operationally and economically separate entity, the trading subsidiary is prohibited from activities such as HFT and agricultural commodity derivatives. No such prohibitions exist under the German rules, which focus more on limiting the activities of the deposit-taking institution. Whatever the nuances of their individual approach, the national ringfences are far more accommodating to the continued stasis of EU TBTF banks than either Liikanen or the shelved proposal. Belgium’s own unchallengingly low ring fence came into force in April 2014, but will have little EU-wide effect due to Belgium’s fortunate lack of TBTF banks. Italy, the Netherlands and Luxembourg have no plans for structural banking reform. The Commission’s 23 November 2016 proposal to force non-EU banks to set up complex “intermediate holding companies”, still remains. The proposal imposes EU re-consolidation on all non-EU G-SIB’s and all EU branches or subsidiaries that together hold at least EUR 30 bn. in assets. Tuesday’s Work Programme omission confirms that the EU no longer plans to ring-fence its own largest banks, but the Commission still intends to effectively ring-fence non-EU entities.

The UK ring-fence, by contrast, is well on its way. The five banks with deposits over £25bn. are deep in preparation for the 1 January separation deadline, final Court hearings to approve the various transfer schemes are expected to take place in late February 2018. The Financial Services (Banking Reform) Act of 2013 combines separation, activity prohibitions, capital constraints and enhanced supervisory powers. In light of the lacklustre surviving EU national legislation and the rumoured FSOC decision to rewrite the Volcker rule, it seems likely that by 2019 the UK will have the only effective answer to the TBTF question. Of all the post-2008 remedies, structural reform is the most directly disruptive and arguably the most expensive (at least per entity- MiFID 2 wins the overall cost prize). EU officials have pointed to intervening legislation – national reforms, Capital Markets Union, enhanced reporting etc.- that have obviated the need for an EU-wide ring-fence. Although the cost of erecting and maintaining the UK ring-fence will be high, it is to be hoped that prudential regulation will pay dividends in stability and investment in the sector. Speaking purely as a taxpayer, it is clear which regime is preferable.

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