Less pain is not a gain when it comes to shrinking the investment banking industry
The French authorities have developed a reputation for hostility to the investment banking industry, so it was no surprise when the French parliament adopted measures to ring-fence proprietary trading activities in the middle of last month.
Yet the measures, which came into force on 27 July, are being welcomed as less obstructive than the Volcker Rule, and what has been proposed in the United Kingdom (via the report by Sir John Vickers) and the European Union as a whole (in the report by Erkki Liikanen, the governor of the Bank of Finland).
Such is the regulatory environment today, that fund managers and investment bankers are pleased when a measure hurts less than they had anticipated. This is akin to being trapped in an abusive relationship.
The French reform still requires banks to place into a separate subsidiary any securities and funds trading activities conducted for their own account. This is more generous than the Volcker Rule, which simply prohibited banks from engaging in proprietary trading at all, albeit on a definition (still to be finalised) which tried to exclude market-making, underwriting, hedging and trading.
But the French trading subsidiary will still have to come up with a new name, appoint entirely separate management, comply with banking regulations on a stand-alone basis, refuse insured deposits from customers, and accept additional capital from the parent bank with the approval of the Autorité de Contrôle Prudentiel et de Résolution (ACPR) – the banking regulator – only.
True, the changes still mean that the rest of a French bank can continue to sell hedging instruments to customers (at least in return for fees rather than piece of the action) and make markets (provided the bank quotes firm bid and offer prices at particular sizes), while the botched implementation of the Volcker Rule means it remains unclear on that point.
But a French reform that requires French banks to place their proprietary trading activities in dedicated non-banking affiliates, and separate them from commercial and retail banking activities, is still an adverse development for investment banks and their clients.
The fact that it is less bad than the Vickers Report - which recommended that United Kingdom banks place the structuring, arranging or executing of derivatives transactions as agent or principal, proprietary trading, and the originating, trading, lending, underwriting or making of markets in securities, into a separately capitalised, separately managed subsidiary un-indemnified by the parent bank, with which it can work only at arm’s length, and subject to a ceiling on its exposure of 25 per cent of its equity capital – is cold comfort.
For that matter, it is also less bad than the Liikanen report. That recommended transferring to a separate legal entity not only the proprietary trading activities but market-making and all other securities and derivatives trading activities of any bank where they made up at least 15 per cent of total assets. Only hedging instruments sold to non-banking clients (such as FX options) would continue to be sold by the parent bank.
Under Liikanen, the trading subsidiary would have to meet all the capital and liquidity requirements on a stand-alone basis, and would not be permitted to fund itself from insured deposits. The Liikanen report also indicated explicitly that it thought the capital requirements for trading businesses under Basel III ought to be increased.
So the restriction of the French reforms to proprietary trading is more generous than what is proposed in the United Kingdom or for the European Union as a whole. But, specific reforms aside, it is worth remembering what the end-objective of all these measures actually is.
From the Volcker Rule onwards, all reforms of this kind have had the same intention – to prevent investment bankers placing bets with depositors’ money – and, if implementation is proving prolonged and messy, it would be unwise to express relief that a given measure is not as restrictive as originally feared.
After all, the goal of the regulators remains unchanged: it is to shrink the investment banking industry.