Europe’s equivalent to the US Volcker Rule, which bans deposit-taking banks from engaging in certain proprietary trading activities, also threatens to limit banks’ market making capabilities.
In the proposal on banking structural reform, published today, the European Commission (EC) outlined the steps it plans to take to limit proprietary trading activity, where banks use their own balance sheets to trade for profit. The policy is similar to the Volcker Rule, which forms part of the US Dodd-Frank act, but has some key differences.
The EC document states that the largest and most complex banks in the European Union will no longer be able to engage in proprietary trading of financial instruments and commodities. It said such activity is highly risky, while offering limited benefits to bank clients or the wider economy.
The most controversial aspect is a move to shift market-making activities into legally separate subsidiaries in some cases.
A statement from the Commission said the new rules will “grant supervisors the power and, in certain instances, the obligation to require the transfer of other high-risk trading activities (such as market making, complex derivatives and securitisation operations) to separate legal trading entities within the group”.
The Commission said the rule is designed to prevent banks from getting around the ban on prop trading by engaging in “hidden” trading activities, which could become too risky.
By contrast, the original Volcker Rule – finally signed off by US regulators in December – will enable banks to continue to engage in market making.
Industry representatives say the impact of the rules on market making will damage the European banking sector and render it uncompetitive with the rest of the world.
Simon Lewis, CEO of the Association for Financial Market in Europe, said: “Europe can ill afford a diminished financial system at a time when it seeks to diversify its funding sources and develop mechanisms in support of long-term financing”.
But the Commissioner for internal market and services, Michel Barnier, insisted the rules will strike a balance between protecting taxpayers and meeting the needs of business.
"The proposals are carefully calibrated to ensure a delicate balance between financial stability and creating the right conditions for lending to the real economy, particularly important for competitiveness and growth," he said.
The proposals are accompanied by plans for new transparency rules to increase oversight of the shadow banking sector, to ensure banks do not try to circumvent the rules by shifting activities to less regulated subsidiaries.
These proposals have been developed on the basis of the Liikanen Report, published in October 2012 by a high-level expert group set up by Commissioner for internal market and services Michel Barnier and headed by Finish central bank governor Erkki Likkanen.
Plans to ban prop trading have been drawn up in various jurisdictions globally since the financial crisis of 2008, where banks’ trading of complex financial instruments was criticised for leaving them holding excessive risk and highly leveraged balance sheets.
The Commission expects the rules will approved by the European Parliament and Council by June 2015, which would result in the ban on prop trading being implemented on 1 January 2017, while separation of other activities would need to be completed by 1 July 2018.