11 July 2013

AFME: Structural reform of the EU banking sector

AFME and ISDA believe that one‐size‐fits‐all structural reform does not address the problems that the Commission aims to address. This is because the Commission’s concerns are already being addressed in the current legislative proposals (CRD IV, MiFID/R, OTC derivatives regulation and the RRD) as well as through improvements in banking supervision. AFME and ISDA believe that sub‐optimal structural measures will be detrimental to the effectiveness of the current regulatory agenda. Extensive market – and regulatory – driven structural change is already underway, and this will result in more robust funding policies, lower leverage, elimination of excessive risk taking in trading activities and stronger governance.

A one‐size‐fits‐all structural reform, including specific controls on activities, risks producing suboptimal outcomes and ‘doubles up’ on the economic impact from additional capital, leverage and liquidity requirements. AFME and ISDA believe this proposal is unnecessary as the analysis on the financial crisis has uncovered no link between the losses experienced by banks and their particular business models or size. As the Liikanen report itself highlights, the crisis was caused by weaknesses in controls, lack of funding diversification, poor risk management and inadequate levels of capital and liquidity.

The industry supports a healthier model of a financial Single Market that corrects the pre‐crisis excesses while supporting more robust growth across the region. This involves diversification of funding sources, more effective risk‐transfer and distribution of originated credit to the end‐investors and increased diversity in local banking sectors. AFME and ISDA believe that regulatory policies, in order to promote resiliency of the financial system as a whole, should promote diversity in bank business models, allow banks to provide end‐users with both lending and capital markets intermediation services whilst also ensuring that there is additional safety against any local economic disturbances.

The rating methodologies of the big rating agencies are favourable to well capitalised banks with stable business models, revenues and funding sources. The proposed separation will cause the carved out trading entity to face severely reduced diversity of revenue streams, lower diversity of funding sources and business position ‐ and assuming material restrictions to group support ‐ the separation will lead to ratings downgrades of several notches, increasing the entity’s funding costs and collateral requirements from its counterparts, reflecting the fragility of a narrow model. Therefore, the actual impact of the separation, especially to the trading entity, goes well beyond the intended objective of eliminating any potential government support for trading activities to the extent that AFME and ISDA expect it to cause a significant withdrawal of capacity.

European businesses and sovereigns rely on banks with strong balance sheets and capital markets capacity to support their primary issuances and secondary market liquidity of the securities and maintain their access to cost efficient funding solutions. These clients require large scale hedging products to mitigate interest rate, credit and foreign exchange risks in for example government bond issuances.

Market making represents the main trading business undertaken by banks. Through the provision of liquidity to meet investor demand, market making plays an important role in helping to manage risk across the financial system. Market makers help to bridge the varying requirements – including time preferences, investment mandates and risk appetites – of investors (retail and institutional) and users of capital (corporates and consumers) ‐ which are often highly diverse.

In summary, structural separation of all of EU banks’ trading activities is likely to lead to major changes in the structure of European capital markets as well as banking sectors. In effect, it would establish substantial barriers to entry for EU based banks, force the withdrawal of smaller and mid‐sized service providers that depend on overall relationship based business model (to attract clients and to be able to provide the capital markets services at competitive prices) and restrict the ability of large banks to develop their business models to accommodate for changes in client and market requirements.

Regarding the thresholds for separation, the joint associations do not believe that thresholds based on accounting definitions, relying on publicly available data, will provide the right framework for identifying high‐risk activities that in order to avoid contagion should be separated ex ante from the deposit‐taking activities of a banking group. We disagree with the notion that size necessarily equals complexity and therefore we believe that any systemic issues that are purely due to the size of an institution are already addressed in the existing regulatory framework in G‐SIB and systemic capital buffers and leverage ratio.

Full consultation response

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