Conference: The Banking Union and the Creation of Duties - Department of Law, Robert Schuman Centre for Advanced Studies, European University Institute By: Paul Davies, University of Oxford

1. ACTIVITY
RESTRICTIONS
Paul Davies
University of Oxford
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2. What are we talking about?
• Partitioning lines of business
• Either within groups containing a deposit taking bank
• Or by restricting range of activities open to such groups
• Latter is simpler in regulatory terms than the former
• All (!) latter requires is definition of the excluded line of
business
• Former requires that and regulation of intra-group
transactions and governance (latter costly)
• More ambitious than standard asset partitioning through
corporate law: risk, not just assets
• Asset partitioning relies on creditor monitoring of risk;
activity restrictions partition risk through rules
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3. Why do it?
• This strategy turns on a distinction between ‘core’ and
non-core banking activities
• Core activities associated with a high level of externalities
from their cessation
• E g loss of payments system, reduction in lending to
SMEs, loss of ‘store of value’ facility
• Cf underwriting, hedging, market making etc
• Three main potential benefits from ring-fencing
- reduced probability of failure of entity carrying on
core activities
- increased probability of orderly resolution of entity
carrying on core activities without taxpayer support
- reduced state subsidy to banking
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4. Reduced Probability of Failure
• Simple view: separation of ‘low risk, essential’ retail
banking from ‘high risk, inessential’ investment banking
promotes financial stability
• Rejected by Vickers (2013)
• Standard retail banking is risky
• Failure of fully separate investment bank can have an
adverse impact on retail banking (cf Lehman)
• Banking group which has both elements might have lower
volatility than each separately if risks are not correlated
• But there might be reduced probability of failure of the
investment bank: if ring fencing reduces probability of bail-
out of i.b., it incentivises better creditor monitoring of i.b.
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5. Improved Resolvability
• ‘Firebreak’: activity restrictions reduce contagion from i.b.
to r.b, so r.b. more likely to be saleable in group
insolvency (esp if subject to higher capital requirements)
• Activity restrictions give authorities a wide range of
choices in resolution because entities pre-separated
• “Structural reform is an element in the optimal regulatory
package at the heart of which must also be much greater
capacity by banks to absorb losses.” (Vickers, 2013)
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6. Is Group-wide Restriction Different?
• Assuming same level of activity restriction, group wide activity
restrictions
• Maximise the benefits of activity restriction,
• Add potential removal of conflicts of interest, but
• Do not reduce the costs
• Add a new cost: removal of ‘one stop’ banking
• Modern group-wide restrictions modest: proprietary trading –
limited social utility, easy to scale up quickly
• EU restriction more limited than Volker: main role as a
bargaining chip in extra-territorial disputes?
• “The structural measures in the proposed regulation are
intended to prepare the ground for the resolution and recovery
of financial institutions, with the two processes being
intrinsically linked.” (ECB)
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7. Disjunction in policy-making?
• “[In continental Europe] the legal framework for bank resolution
and for resolution planning has been adopted ahead of
structural reform projects” (Binder, 2014)
• In UK the opposite problem
• ICB set up by UK Govt in June 2010; Final Report Sept 2011
• Terms of reference:
“The Commission will make recommendations covering both:
• Structural measures to reform the banking system and
promote stability and competition, including the complex issue of
separating retail and investment banking functions; and
• Related non-structural measures to promote stability and
competition in banking for the benefit of consumers and
businesses.”
• Strengthened by Parliamentary Commission on Banking
Standards
• Legislation 2013
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8. 8

9. Meanwhile, back at the Bank of England
• FDIC/BoE Memorandum of Understanding on the
Resolution of G-SIBs, 2012
• Both countries express preference for Single Point of
Entry model of resolution
• Different mechanisms but same policy: US – transfer of
topco to bridge bank under OLA with non-transferred
creditors used to capitalise ultimate purchaser; UK – bail-
in creditors of failing topco to restore bank to viability as a
continuing entity
• How does SPE fit with ring-fencing of retail bank, ie an
apparent policy of ‘save the retail bank subsidiary’?
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10. The Speeches of Paul Tucker
• “In the UK, the government’s plan for ring-fencing provides the
basis for just such a back-up strategy [if SPOE does not work].
The introduction of ring-fenced domestic retail banks is,
therefore, consistent with the broader international agenda on
resolution.” (PT, Deputy Governor of BoE, 2013)
• “What I have described [non-operational holdco with extensive
TLAC] amounts to a major structural policy. Indeed, it is the big
structural reform in the banking field. On my view, Volcker,
Vickers and Liikanen are sub-plots. That doesn’t mean they
have no place in the restructuring of banking, but they are not
the core of it. Groups must have simpler legal, financial, and
organizational structures that positively enable orderly
resolution. That can make global banking a lot safer without
balkanizing it. It is down to regulators and resolution authorities
to deliver.” (PT, Independent Academic, 2014)
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11. Implications
• Structural reform should be concentrated at topco level
• Mandatory ring-fencing unnecessary for orderly resolution
• For MPE separation of retail bank can be planned for in
Resolution Plans or even imposed by regulators ad hoc
when RP inadequate
• Worse, it potentially hinders SPE
- US does not commit to BoE/FDIC MOU
- Imposes intermediate BHC, separately capitalised
• European Commission’s proposals fit better with SPOE
than Vickers (because subject to regulatory discretion)
• Vickers is the triumph of populism over efficient
regulation?
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12. Will the EU Save UK Banks?
• Hypothesis 1: UK obtains derogation from SMR. Nothing
changes (except sub-Volcker rule applied)
• Hypothesis 2: No derogation, UK in principle applies both
systems. Probably nothing changes: UK authorities likely
to find EU scheme unnecessary on grounds that domestic
scheme applies
• Hypothesis 3: No derogation, UK scheme held to be
inconsistent with SMR and repealed. UK banks breathe
sigh of relief
• Hypothesis 4: No derogation. UK scheme continues for
non-covered banks only. Indefensible result?
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