EUROPE'S DEBT CRISIS HAS CAUSED A number of ruptures in
the once-mighty single market. Investors have pulled money out
of hard-hit peripheral countries and fled to the blocs
northern core; the European money market has fragmented along
national lines, making it harder for banks in the periphery to
fund themselves; and regulators are demanding that financial
institutions hold larger capital buffers in each country.
Now the European Union is bracing for the rise of a new
series of barriers this time inside the
regions leading banks. An advisory group led by Finnish
central bank governor Erkki Liikanen last month recommended
that major banks be required to place their proprietary trading
and market-making activities into separately managed and
capitalized subsidiaries. The proposal aims to insulate the
banks deposit-taking and lending operations from their
riskier market activities and reduce the potential need for
future bailouts like those many governments extended during the
global financial crisis of 2008 and 09.
The Liikanen report echoes the findings last year of the
U.K.s Independent Commission on Banking, with a twist.
The U.K. panel, headed by Sir John Vickers, an economist and
head of All Souls College, University of Oxford, recommended
that British banks be required to ring fence their
deposit-taking businesses in separate subsidiaries to protect
them from the risks of investment banking. But however the
fence is constructed by walling off market activities or
walling off retail banking the practical effect is
likely to be similar in terms of added costs and managerial
complexity for Europes big universal banks, analysts say.
But unlike the so-called Volcker rule in the U.S., which will
ban banks from trading for themselves and investing heavily in
private equity, the segmentation proposed by European
regulators will allow banks to continue their full range of
Yet for all its popularity in Europe, ring fencing is
proving very difficult to implement. Liikanens proposal
is only a few weeks old, and its not yet clear whether
Michel Barnier, the EU commissioner for internal market and
services, will introduce legislation to adopt it. The U.K. has
embraced the concept for more than a year, but regulators and
politicians are months away, at best, from adopting legislation
that would put it into practice.
The Vickers commission studied the industry for a year
before proposing its ring-fencing solution in September 2011.
The government of Prime Minister David Cameron endorsed the
commission report immediately, released a white paper in June
outlining how it intended to adopt ring fencing and published
draft legislation last month, but the bill is moving slowly
through Parliament, and lawmakers and regulators are struggling
to define essential features of the new regime. Im
still not clear as to what ring fencing will actually
mean, says Ian Gordon, a banking analyst at Investec
Securities in London. There are more questions than
answers at this stage.
What isnt in doubt is the determination to impose
tighter regulations on banks. The Libor scandal that erupted in
June after Barclays paid $455 million to settle charges that it
tried to manipulate the benchmark interbank rate has unleashed
demands for tougher constraints on banks. In July, Cameron
appointed the ten-person Parliamentary Commission on Banking
Standards to investigate conflicts of interest and issues of
culture and professional standards in banking as
well as advise on the best way to implement the Vickers
commissions ring-fencing proposal.
At hearings last month parliamentarians said they were
determined to stamp out the cross-contamination of
culture that investment banking divisions can cause
inside big banking groups and indicated that a ring fence alone
might not be sufficient. Several members spoke favorably of the
Volcker rule and indicated they might favor an outright ban on
certain activities. We have an open mind, says Andy
Love, a Labour Party member of the commission.
The Libor scandal helped convince the Liikanen panel that
the EU needed to impose structural barriers on the industry to
protect deposit-taking activities from banks riskier
market operations. Although Barnier hasnt yet committed
the European Commission to adopting a ring-fence rule, some
officials believe the pressure for EU legislation will be
overwhelming, if only to head off the creation of differing
national rules. In France, François Hollande promised to
introduce measures to separate banks riskier market
activities during his recent successful presidential campaign,
and officials have vowed to present legislation before the end
of this year.
The Liikanen group recommended that banks be required to
separate their proprietary trading and market-making activities
in cases where those businesses have assets of more than
100 billion ($129 billion) or exceed a range of
15 to 25 percent of the groups balance sheet. Jon Peace,
a banking analyst at Nomura Securities Co. in London, estimates
that the rule would affect 19 banks, including Germanys
Deutsche Bank, Frances BNP Paribas and
Société Générale, Italys
Intesa Sanpaolo and Spains Banco Santander.
In the U.K. the Vickers commission proposal called for the
ring fencing of all systemically important retail
banks, which effectively means the countrys Big Five:
Barclays, HSBC Holdings, Lloyds Banking Group, Royal Bank of
Scotland Group and Santander UK. Those companies would have to
make their retail operations legally and operationally
independent from their parent banking groups and provide them
with their own capital backing, according to the draft bill.
The proposed legislation provides little detail about how the
new arrangement would work, though. Many of the blanks are
supposed to be filled in later by Treasury officials in
so-called secondary legislation, just as the Dodd-Frank Wall
Street Reform and Consumer Protection Act requires U.S.
regulators to write scores of detailed rules.
Essentially, the only concrete proposal is that retail
deposits cannot be on the same side of the ring fence as prop
trading, Mark Garnier, a Conservative member of the
commission, tells Institutional Investor.
The draft bill appears to leave a lot of detail to be
determined in secondary legislation, commission chairman
Andrew Tyrie said in the House of Commons last month. We
will press vigorously to find out what that is going to
The draft bill says core activities must be
placed within a separate company, and it refers to
excluded activities that must be moved outside the
ring fence. But the bill specifies only one example of a core
activity the taking of deposits and identifies
only one excluded activity: dealing in investments as
principal, or prop trading. The Treasury must decide
where other activities should go.
The bill will also give the Treasury and regulators
considerable discretion in devising the rules governing the
relationships between ring-fenced entities and other companies
within the same group. The draft legislation spells out only
certain basic principles, such as the need to restrict the
number of shares a ring-fenced company can own in other
companies, and that contracts with other companies in the group
must be done on arms length terms.
Corporate governance issues raised by ring fencing
havent been addressed yet, either in the U.K. or at the
EU level. In an appearance before the parliamentary commission
last month, Liikanen was asked by Lord Turnbull, a commission
member who sits on the board of U.K. insurer Prudential,
How does the group exert its discipline on a
[ring-fenced] subsidiary? The central bank governor
offered little in the way of an answer. Work remains to
be done, he said. We have not solved every
The vagueness of the U.K. draft bill is encouraging
commission members to consider broader changes to banking
regulation. Labour parliamentarian Love says outrage over the
Libor scandal could push the commission to take a tougher
stance toward the banks. Theres been something of a
reassessment because of recent events, and there is more
evidence to look at, he notes.
Love says its too early to say what the commission
will recommend when it makes its final report, which is due by
the end of the year, but it is notable that commission members
were positive in their questioning of former Federal Reserve
Board chairman Paul Volcker when he appeared before the panel
last month. Volcker asserted that a ring fence would be
difficult to sustain because two subsidiaries of
the same group could not be entirely independent of each other.
Complete separation would be more logical, he said.
Commission chairman Tyrie described Volckers testimony
as extremely impressive. At a British Bankers
Association conference the same day as Volckers
appearance, Tyrie said the commission would consider whether to
add fresh constraints on banks including a deeper
separation between retail banking and trading activities
as a result of the Libor affair.
The talk of tighter restrictions is hardly surprising. Since
the crisis the U.K. has arguably seen stronger public
condemnation of banks than the U.S. Chancellor of the Exchequer
George Osborne ripped into big banks after the Barclays Libor
settlement, telling the House of Commons that through
2005, 2006 and 2007 we see evidence of systematic greed at the
expense of financial integrity, and they knew what they were
doing. The ring-fencing proposal by the Vickers
commission was something of a compromise between the status quo
of universal banking and a strict separation of retail and
investment banking along the lines of the old Glass-Steagall
Act, enforced in the U.S. until 1998. Sir Mervyn King, governor
of the Bank of England, said a year ago that he preferred a
modern-day Glass-Steagall law for British banks.