The boggart of “too big to fail” banks has been chasing European regulators for years, so another attempt to defeat it was introduced last week (23rd of November, 2016). The European Commission released a new package of banking legislation reforms aimed at curbing taxpayer bailouts while also making the regulation more growth-friendly.
One of the key novelties is TLAC[1] measure, which sets the minimum level of liabilities that can be easily converted into equity or written down in case of financial distress. This buffer of subordinate debt is supposed to replace bail-outs with bail-ins, giving regulators an easy way to boost a stricken bank’s capital position without tampering with taxpayers’ money. To meet the criteria banks will be forced to issue billions in new debt.
The reforms provoked fierce debate between national governments. Berlin’s stance over the TLAC is sharply at odds with that of Paris and Rome. Under the new legislation authorities should be able to set tougher rules only if they could demonstrate that the extra requirements were “justified, necessary and proportionate”. German lawmakers insist on preserving the freedom for supervisors to demand buffers that go beyond agreed international minimum standards. They are also unsatisfied with the approach chosen by the commission as it is too reliant on raising new debt, meaning it would take too long to reach targets. On the other hand, France and Italy fear that stricter regulation would result in European financial groups being put at a competitive disadvantage. France believes to be disproportionally hit, as its banking sector is highly consolidated, thus all four major groups must comply with the standards set for globally systemically important institutions only [MREL[2] at 18% of risk weighted assets and 6.75% of the leverage ratio exposure measure].
In the centre of attention, however, was a different proposition. While capital requirements have been a usual subject of reforms, the introduction of intermediate financial company provision caught many by surprise. If the new regulation is adopted, a non-EU bank that has significant operations within the EU will be required to establish an “intermediate parent undertaking”, in effect a holding company subject to EU capital requirements. This provision tries to tackle the issue of global banks being “international in life but national in death”. It is designed to ensure that the EU operations of the group are sufficiently capitalised that in the event of the failure of the foreign banking group there should be sufficient capital, available locally, to contribute to the absorption of losses of the European operations. If European Commission follows through on its proposals, US banks will be forced to tie up even larger amounts of capital and liquidity in addition to the resources that they already have in their European operations.
Some see these measures as a protectionist backlash against US toughness on European banks. In 2014, it introduced new rules for foreign lenders, requiring them to capitalize their US subsidiaries separately so that American regulators could essentially oversee them as separate entities. The oversight by various US regulators has been a heavy burden: EU‐based banks were fined a total of $32 billion between 2009 and 2015. The US Justice Department's intention to fine Deutsche Bank $14 billion and a recent push for tougher capital requirements under the international Basel framework appear to have pushed the Europeans over the limit.
EU moves could have larger than intended impact when Brexit is considered. If non-EU banks need to create a separately capitalised holding company in the Eurozone, London could look a less attractive headquarters for European operations. EU officials insist the reorientation of policy is unrelated to Brexit. But the shifting position highlights an underlying clash of interests that will make agreement more difficult.
Overall, the package contains few negative surprises for EU banking groups, though the requirement for intermediate financial holding companies will trouble many non-EU banking groups with significant EU operations. The reforms are yet to be approved by the European Parliament and the EU Council.
Katrina Matyukhina
[1] Total Loss Absorbing Capacity
[2] Minimum requirement for own funds and eligible liabilities
One of the key novelties is TLAC[1] measure, which sets the minimum level of liabilities that can be easily converted into equity or written down in case of financial distress. This buffer of subordinate debt is supposed to replace bail-outs with bail-ins, giving regulators an easy way to boost a stricken bank’s capital position without tampering with taxpayers’ money. To meet the criteria banks will be forced to issue billions in new debt.
The reforms provoked fierce debate between national governments. Berlin’s stance over the TLAC is sharply at odds with that of Paris and Rome. Under the new legislation authorities should be able to set tougher rules only if they could demonstrate that the extra requirements were “justified, necessary and proportionate”. German lawmakers insist on preserving the freedom for supervisors to demand buffers that go beyond agreed international minimum standards. They are also unsatisfied with the approach chosen by the commission as it is too reliant on raising new debt, meaning it would take too long to reach targets. On the other hand, France and Italy fear that stricter regulation would result in European financial groups being put at a competitive disadvantage. France believes to be disproportionally hit, as its banking sector is highly consolidated, thus all four major groups must comply with the standards set for globally systemically important institutions only [MREL[2] at 18% of risk weighted assets and 6.75% of the leverage ratio exposure measure].
In the centre of attention, however, was a different proposition. While capital requirements have been a usual subject of reforms, the introduction of intermediate financial company provision caught many by surprise. If the new regulation is adopted, a non-EU bank that has significant operations within the EU will be required to establish an “intermediate parent undertaking”, in effect a holding company subject to EU capital requirements. This provision tries to tackle the issue of global banks being “international in life but national in death”. It is designed to ensure that the EU operations of the group are sufficiently capitalised that in the event of the failure of the foreign banking group there should be sufficient capital, available locally, to contribute to the absorption of losses of the European operations. If European Commission follows through on its proposals, US banks will be forced to tie up even larger amounts of capital and liquidity in addition to the resources that they already have in their European operations.
Some see these measures as a protectionist backlash against US toughness on European banks. In 2014, it introduced new rules for foreign lenders, requiring them to capitalize their US subsidiaries separately so that American regulators could essentially oversee them as separate entities. The oversight by various US regulators has been a heavy burden: EU‐based banks were fined a total of $32 billion between 2009 and 2015. The US Justice Department's intention to fine Deutsche Bank $14 billion and a recent push for tougher capital requirements under the international Basel framework appear to have pushed the Europeans over the limit.
EU moves could have larger than intended impact when Brexit is considered. If non-EU banks need to create a separately capitalised holding company in the Eurozone, London could look a less attractive headquarters for European operations. EU officials insist the reorientation of policy is unrelated to Brexit. But the shifting position highlights an underlying clash of interests that will make agreement more difficult.
Overall, the package contains few negative surprises for EU banking groups, though the requirement for intermediate financial holding companies will trouble many non-EU banking groups with significant EU operations. The reforms are yet to be approved by the European Parliament and the EU Council.
Katrina Matyukhina
[1] Total Loss Absorbing Capacity
[2] Minimum requirement for own funds and eligible liabilities