(The authors are Reuters Breakingviews columnists. The opinions
expressed are their own.)
By George Hay and Antony Currie
LONDON/NEW YORK, Feb 19 (Reuters Breakingviews) - Regulators
in Europe, the United Kingdom and the United States all agree on
the need to protect their lenders from the casino-like antics of
investment bankers. That’s no great surprise: who wouldn't want
to shield regular customers from the billions of pounds of
losses caused by rogue traders like Kweku Adoboli of UBS
UBSN.VX? But beyond this shared objective, there’s little
The United States kicked things off in 2010 with proposals
to prohibit deposit-taking firms from proprietary trading in
what was dubbed the "Volcker Rule" after the former Federal
Reserve chairman who created it. In the United Kingdom, a
commission headed by Sir John Vickers concluded that retail
deposit-taking institutions should be "ring-fenced" from
investment-banking arms, which should be legally separated with
their own capital and funding. More recently, a European
Commission working group chaired by Finnish central bank
Governor Erkki Liikanen recommended that Europe's banks should
firewall all trading assets, be they prop or market-making.
Why all the different ideas?
It’s partly politics: one of the reasons President Obama
embraced the Volcker Rule was to try to deflect criticism after
losing his supermajority in the senate. But the main factor is
that U.S. and European banks are structured differently.
A Vickers-style firewall between the safe and risky bits of
banks would not have cut the mustard in America: its lenders are
already carved into legally separate entities with restrictions
on intra-group exposures. Yet that didn't prevent
investment-banking shenanigans from landing the likes of Citi
(C.N) and Bank of America (BAC.N) in hot water.
UK and European universal banks, on the other hand, have
historically allowed deposit-taking retail activities and
investment banking to co-exist within the same legal entity.
Policymakers in all three regions worry that investment
banks get cheaper funding if they're tacked on to an entity that
creditors know will be bailed out. But the issue is especially
emotive in the United Kingdom, which is home to more than its
fair share of big banks. Rescuing them all in a crisis would
cripple British taxpayers.
Which plan is most conservative?
Tough one. Vickers is the only one to build a firewall
around the supposedly "safe" retail bit. But that's no guarantee
of success: witness the $6 billion-odd trading loss the
so-called London Whale caused at JPMorgan (JPM.N) when
supposedly hedging the bank's excess deposits. And if
Barclays’(BARC.L) investment bank collapsed, it’s a fair bet
that retail depositors would rush to pull their money out. UK
authorities might prefer to use taxpayer money to bail out the
trading arm than risk repeating the Lehman debacle.
Both Volcker and Liikanen judge proprietary trading to be
“risky” and market-making “safe”. But the losses caused by
Adoboli and the Whale were not prop trading. And the main reason
U.S. regulators have yet to finalise, let alone implement, the
Volcker Rule, is because it has proved exceptionally tricky to
define where market-making ends and prop trading begins. In
other words, putting only pure prop trading behind a firewall
will not remove all the risk from the system.
So what’s the point of firewalls, then?
Global capital and liquidity reforms from the Basel
Committee have already made banks safer – and have made prop
trading prohibitively expensive. However, banks are still too
big to fail. Solving this problem requires global progress on
resolution and recovery plans, which enable a failing bank to be
safely wound down. Firewalls are a useful first step in this
Will there be any nasty side effects?
There could be. Volcker bans prop trading with any U.S.
institution, even if the counterparty is outside the United
States. This extra-territorial bit of rule-making could
effectively extend the rule to non-U.S. banks. Volcker also
allows prop trading in American sovereign debt but not in that
of any other countries. As currently drafted, this would mean
that the likes of Citi or Bank of America Merrill Lynch might
withdraw from underwriting primary issuance of Canadian or UK
Vickers already penalises UK banks: forcing all their
market-making and prop trading outside the ring-fence will raise
funding costs. But Liikanen could heap further misery on UK
lenders. France and Germany, worried about the effect of
regulation on economic growth, are likely to adopt a kind of
“Liikanen-lite”, whereby they only firewall prop trading. This
means a U.S. manufacturer that sells to German consumers might
find hedging its dollar/euro currency risk pricier in London,
and decide to do so in Paris or Frankfurt instead. Finally, no
Asian jurisdiction is currently considering firewalls. That
means the region's banks will be less constrained at the same
time as their economies are growing faster than those in the
How much does any of this matter?
Right now, it’s too early to tell. Crucial details are still
up in the air. The size of the Vickers ring-fence will depend on
secondary legislation, the European Union has not yet given its
official response to Liikanen, and Volcker’s definition of what
will count as proprietary trading is still being debated. But
even if regulators stick to the current drafts, it’s hard to see
firewalls as the game-changer politicians might like to pretend
they are. Most of the other critical recent reforms – such as
the Basel capital and liquidity rules, and global resolution and
recovery schemes – will make global banks more alike.
Ultimately, different countries' structural reforms partly
reflect the fact that banking systems were different even before
the crisis. Regulators will - and probably can afford to - agree
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(Editing by Peter Thal Larsen and Sarah Bailey)
Keywords: BREAKINGVIEWS BANKS/FIREWALLS/
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