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Wednesday, January 29, 2014

The long lost Liikanen report returns – but it looks pretty different

Has the Liikanen report become the Barnier plan?
Update 30/01/14 11:45:

Some eagle eyed HM Treasury officials have flagged up that the recitals of the proposal (the preamble points before the articles of the regulation) do allow for the derogation to apply to secondary legislation as long as the key primary legislation has been passed. As we note below, this is the case with Vickers and the UK therefore certainly counts for the derogation. It is a bit strange that this isn't also spelt out in the article of the proposal but its inclusion is likely to be more that sufficient for the UK.


Okay, maybe long lost is an exaggeration, but it’s certainly been off the front line agenda for some time.

The time away from the spotlight has been used to significantly overhaul the European Commission’s flagship proposal on reforming the banking sector in the aftermath of the crisis.

Here’s the full proposal, out this morning, while here are the press release and Q&A.

While the proposal was always expected to be the offspring of the Liikanen report, in this case the apple has fallen quite far from the tree. The proposal is quite a change from the original report and as expected focuses more on a Volcker-style rule on proprietary trading rather than a significant separation of large banks. That said, the focus remains on separating off risky trading activities, meaning the main impact is a lessening of scope. We outline our thoughts below.

A reform overtaken by events?
While this was originally flagged as a key proposal, it has been a long time coming. In the meantime, a new single supervisor has been created, new plans on capital requirements, a new macro prudential framework, new plans on bank bail-ins and a new bank resolution scheme have all been substantially developed. The new framework for the financial sector has largely grown up without this proposal, and how exactly it will fit in – both in terms of timeline and structure – remains unclear.

An EU Volcker rule – the Barnier rule?
The key part of the new proposal is a ban on “proprietary trading in financial instruments and commodities, i.e. trading on own account for the sole purpose of making profit for the bank.” While this is well intentioned, it does come with some complications:
  • It has proved very difficult to identify what exactly classifies as proprietary trading, compared to necessary trading to manage risk and to act as a market-maker.
  • The current definition in the proposal is fairly narrow, and refers to activities specifically dedicated to making a profit for the bank itself. In other words, it looks as if it could be fairly easily side-stepped. It also exempts trading of government bonds and money market instruments for cash management.
Separation power – moving away from national control?
As we have noted before, the prospect of a supranational body ordering the break-up of a flagship national bank has the potential to be incredibly explosive. The banking union has brought this closer, but final decision on how to resolve a bank remains mostly national. This proposal would allow such a decision to be taken not just to resolve a bank, but also if its non-retail activity was impacting financial stability. However, it seems that the final say will now rest with the ‘competent authority’ (a definition which is never spelled out), which in the case of large eurozone banks would likely be the ECB as the SSM (Single Supervisory Mechanism).

Has the UK secured a derogation?
As expected, a clause has been included on a general derogation (not specific and only applying to the separation rule not the prop trading ban) which allows for the rules on separation to be superseded by any national rules which aim to achieve the same goals. While Vickers would certainly qualify on this front, the text specifies that the derogation can only apply to legislation adopted before 29/01/2014. Currently, all legislation relating to Vickers is not expected to be adopted in the UK until mid-2015. However, the key banking reform act (which includes the ring-fencing plans) was made into law in December.

For the most part then, it seems the UK has secured a derogation, which can be put down as a small but important win for the government. Plenty of other states have also secured scope for their national plans.There is clear encouragement in the wording for states who are yet to put a comprehensive system in place, to adopt the EU framework. That said, with lots of different national plans in place, one has to question how effective this system will really be.

A long way to go
As the points above suggest, this remains a controversial proposal and negotiations will be tricky. Little should happen this year, due to the European Parliament elections and the new Commission entering office. Assuming the next Commission picks up the same proposal (which is not guaranteed) the aim is to have the necessary legislative acts approved by January 2016, with the prop trading ban coming into force at the start of 2017 and the separation powers in mid-2018. As with some of the other regulations, it seems the EU response to the financial crisis will only be in place a decade after the crisis hit.

These are just some of the key points of contention upon first reading. There is much more to go in this process with the input of member states and the European Parliament likely to be very different, and sometimes even adversarial. There is also a lot of scope for the rules to be altered using delegated acts and technical standards – these will ultimately determine how the prop trading ban and separation rule work in practice.

So far, a large part of the banking sector (mostly smaller banks) will probably be happy. Larger banks will see it as an improvement, but will likely push for a further watering down. Questions can still be raised over whether costs will be passed onto consumers and whether it will really help limit risky activity, which can often be related to mundane retail bank activity. But then the idea is that other parts of the framework will also help limit this effects.  

In any case, the proposal is likely to once again fall away from the frontline and it could yet come back with a different face once again.


Jesper said...

Banks that are too big will still remain too big.

The ability to make bets were the risk-takers aren't actually taking any risk is still allowed. Bonus if the bet works and no bonus if the bet doesn't work out creates a situation where huge bets will be made. Malus has to be introduced but isn't.

Measures to improve governance? I'm guessing a few connected firms will make lots of money by consulting here. Then some Marxist valuation - the value of the consulting determined by the cost to produce the advise/process - and we'll see very expensive (and therefore supposedly good) governance measures put in place :-)

I'd love to see the information that lobbyists provided for the basis of this report.

Anonymous said...

Does the Liikanen Report demand that all entities (especially those with annual budgets of EUR130Bn) have their accounts audited on an annual basis? If not, why not?

And why has an entity that has not managed to audit its own accounts for the last c. 22 years now become the de facto financial regulator in Europe?

The EU has become a major threat to peace in Europe. Does the truth no longer matter?


Rik said...

The by far major challenge in the especially EZ bankingsector is the fact that half the sector is basically bust and dysfunctionally managed.
And basically nothing structural has been done to attack this issue. The only measures were simply 'buying time' ones.

Even worse the only real structural measures taken caused bankrupt states being chained to bankrupt banks and visa versa. Which has make a solution even more difficult as there are many more consequences.

The TBTF problem should be but it not by far the top priority at this moment. It was probably pre2007-2009, but things have changed.
In other words this is fighting yesterday's war.

Jesper says it most clearly: 'malus should be introduced'.
Which can be done much more effective and faster in other ways. Eg 'hang' the people that Fup and their chefs for failing to provide proper oversight. Eg by personal unlimited liability and high criminal penalties when going outside the mandates they have.
It is a wellknown fact that risktaking when people's own money is at stake is much less.
You won't solve everything, nothing does, but this can be done within a year could have been done before 2010.

Anonymous said...

I agree with introducing Malus.

But, to be fair, whatever the bankers have cost individual nations in Europe, the EU has cost far more.

By my reckoning, once this MananaZone crisis is over (in a decade or two if it doesn't collapse before then) it will have cost EUR3-4Trn.

Malus for one, Malus for all.

Let the EU lead by example and apply Malus to themselves first.


Rik said...


You usually donot solve problems by bringing other problems in.

Plus there is simply another platform these both discussions.
Banking within in the EU. EU itself at the politcal level above it.
It looks clear that via national presure change have to happen.
Hard to see that if one of the 2 applies it on themselves the other will follow. Both simply will have to be forced imho.

Anonymous said...

Rik - You usually do not solve problems by bringing other problems in.

Please tell that to the bunch of useless degenerates that run Europe. Mole hills turn into mountains and eventually destruction.

I am fully aware that it is the political level above that is responsible for bizarre judgments and law changes. It is this very level that is going to cause the next European war.

Politics and Finance do not mix - especially if it is EU-related.