COMMISSION STAFF WORKING DOCUMENT EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT Accompanying the document PROPOSAL OF A REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on structural measures improving the resilience of EU credit institutions and the Proposal for a Regulation of the European Parliament and of the Council on reporting and transparency of securities financing transactions
Date: 2014-01-29
Institutions: European Commission
Subjects: administrative transparency, bank, banking system, credit institution, financial control, financial intervention, financial legislation, financial transaction, mortgage













EUR-Lex - 52014SC0031 - EN











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52014SC0031

COMMISSION STAFF WORKING DOCUMENT EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT Accompanying the document PROPOSAL OF A REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on structural measures improving the resilience of EU credit institutions and the Proposal for a Regulation of the European Parliament and of the Council on reporting and transparency of securities financing transactions /* SWD/2014/031  final */










1.                      
Introduction

Over the last decades, the size of the EU
financial system has increased rapidly, significantly outpacing GDP growth. EU
financial institutions, and banks in particular, have expanded in scale, scope
and complexity. This has led to the emergence of large financial 'one-stop
shops' combining within one entity or group the provision of a diverse set of
services. This process allowed banks both to provide a broader range of
services to their clients, as well as responding to the increasingly sophisticated
needs of their global clients. Notwithstanding these benefits, the
unprecedented and extraordinary state sector-wide support to banks following
the financial crisis has clearly illustrated the negative impact on financial
stability arising from an ever more global and integrated financial system with
ever larger financial service providers. 
As a response to the financial crisis, the
European Union (the "EU") and its Member States have engaged in a
fundamental overhaul of bank regulation and supervision. In the area of
banking, the EU has initiated a number of reforms to increase the resilience of
banks and to reduce the impact of potential bank failures.
Despite this broad-ranging reform agenda,
concerns remain that some banks remain too large and complex to manage,
monitor, and supervise in good times and still challenging to resolve in bad
times. Several countries have therefore either decided to reform the structure
of their banks or are considering such reforms. The European Parliament as well
as international institutions have further highlighted the role of structural
reforms in tackling problems of too-big-to-fail ("TBTF")[1] banks.
In this context, Commissioner Barnier set
up a High-level Expert Group ("HLEG") under the chairmanship of Erkki
Liikanen, governor of the Bank of Finland. Its mandate was to assess the need
for structural reform of the EU banking sector. The HLEG recommended the
mandatory separation of proprietary trading and other high-risk trading
activities into a separate legal entity within the banking group. 
This impact assessment assesses problems
related to the corporate structure of TBTF banks (chapter 2); identifies the
objectives of structural reform (chapter 3); identifies the range of options
considered for reforming the structure of banks (chapter 4) and assesses the
benefits and costs to society of those reform options (chapter 5). The main
findings are summarised below.

2.                      
Problem Definition

The EU has traditionally had a diverse
banking system. This is a source of strength. Even so, over time the market has
also evolved to produce a few large, complex, interconnected banking groups.
These banks typically combine retail and commercial banking activities and
wholesale and investment banking activities in one corporate entity or in a
combination of closely connected entities with limited restrictions on interactions.
Being deposit-taking banks, they are by nature exposed to potentially damaging
runs. To ensure depositor confidence a number of explicit public safety nets (such
as deposit insurance) and implicit safety nets (bail outs) de facto have been put
in place. However, in light of the public safety nets, the unrestricted
co-existence of activities contributes to a number of problems, including (i) impediments
to orderly resolution and recovery; (ii) moral hazard, excessive balance sheet
growth and excessive trading; (iii) conflicts of interests and transaction-oriented
bank culture; and (iv) distortions of competition. 
The EU has already initiated a number of
reforms to increase the resilience of banks and to reduce the probability and
impact of bank failure. These reforms include strengthening banks' solvency
(the capital requirements regulation and directive, CRR/CRDIV); strengthening
bank resolvability (the Bank Recovery and Resolution Directive, BRRD); better
guaranteeing deposits (revised Deposit Guarantee Schemes directive, DGS);
addressing the risks of derivatives and to improve market infrastructures
(European Market Infrastructure Regulation, EMIR, and related revisions to the
Markets in Financial Instruments Directive, MiFID). Additionally, in order to
break the negative feedback cycle between the sovereign and banking risks and to
restore confidence in the euro and the banking system, the European Commission
has called for further development of a Banking Union, including the single
rule book that will be applicable to all banks in the entire EU, the Single
Supervisory Mechanism (“SSM”) and the Single Resolution Mechanism (SRM), which will
be mandatory for members of the euro area but open to voluntary participation for
all other Member States.
Despite this broad-ranging reform agenda
many regulators, supervisors and academics continue to express concerns that
the largest banking groups remain too large and complex to manage, monitor, and
supervise in good times and possibly challenging to resolve in bad times. Structural
reforms have therefore been put forward as a complementary way of dealing with
the problems outlined above. For example, structural reforms could complement
the current regulatory reform agenda. The CRDR/CRDIV and BRRD already will provide
supervisors/competent resolution authorities with powers to intervene and pre-empt
bank crises by restructuring and/or resolving a financial institution triggered
by prudential or resolvability concerns. Structural reform could complement
these regulatory reforms and increase their effectiveness for too large and
complex banks. For example, structural reform will increase the options
available to the authorities when dealing with large banking groups. It also provides
a direct way of addressing intra-group complexity, intra-group subsidies, and
excessive risk-taking incentives. In addition, structural reforms aim at a
broader set of objectives, such as ensuring that the deposit taking bank is not
unduly influenced by a short term oriented trading culture and prone to
conflicts of interest to the detriment of its customers. The changes implied by
structural reform imposed on the limited set of TBTF banks under consideration could
therefore complement existing powers. 

3.                      
Analysis of subsidiarity

An increasing number of Member States are
currently pursuing different forms of structural reforms of banks in their
jurisdictions. Given the fundamental freedoms set out in the Treaty of the
Functioning of the European Union (the "TFEU") divergent national
legislation may affect capital movements and establishment decisions of market
participants and could also undermine efforts to achieve a single rulebook
applicable throughout the Internal Market. It can also create specific problems
regarding supervision, notably for cross-border banks.
Therefore, action at European level is
needed.

4.                      
Objectives

The overall objectives of structural reform
are first to reduce the risk of systemic instability by reducing the risks of
banks becoming or wanting to become TBTF, TCTF and TITF. A key objective of
structural reform is to make banks that provide essential services to the real
economy more resilient in the event of endogenous or exogenous shocks but also
more resolvable in the event of a failure, thus reducing the severity of future
financial crises. A second general objective is to reduce single market
fragmentation. Many of the banks that will be affected by structural reform
legislation operate across borders and seek to benefit from the opportunities
created by the single financial market. A common legislative framework on
structural reform would prevent the fragmentation of the Internal Market and
increase the effectiveness of the future SSM and SRM.
Within these overarching objectives,
structural reform addresses the following specific objectives: (1) facilitate
bank resolution and recovery; (2) facilitate management, monitoring and
supervision; (3) reduce moral hazard; (4) reduce conflicts of interest and
improve bank culture; (5) reduce capital and resource misallocation; and (6) improve
competition.
The following set of quantifiable
operational objectives would form the base of future evaluations: (1) Reduction
of the size of implicit public subsidies (as reflected in the funding cost
advantage of TBTF banks); (2) Reduction of excessive trading by TBTF banks (and
increase the relative share of credit provision to non-financial customers).

5.                      
Policy Options

Reforming the structure of banks requires a
decision on what activities to separate and how strong the separation should
be. Chapter 4 of the report therefore presents a number of options in each
area. The combination of these gives rise to a number of reform options to be
assessed both against the baseline scenario of no further policy action at EU
level as well as against each other. 
Activities
The banking activities undertaken by large
EU banking groups today range from retail and commercial banking (RCB)
activities to wholesale and investment banking (WIB) activities. Examples of
RCB activities include, amongst others, insured deposit taking, lending to
households and SMEs, and the provision of payment system services. Examples of
WIB include, amongst others, underwriting, market making, brokerage services,
and proprietary trading. The report considers three stylised options for
separating activities:
(1)                   
“Narrow” trading entity and “broad” deposit
entity: A first polar case is that in which only
relatively few trading activities are being separated from a broad deposit
entity, namely those types of trading where traders are speculating on markets
using the bank’s capital and borrowed money, for no purpose other than to make
a profit and without any connection to trading on behalf of customers (that is
proprietary trading); 
(2)                   
“Medium” trading entity and “medium” deposit
entity: A second option is one in which market
making, complex derivatives and complex securitisation are added to the above
set of activities; and 
(3)                   
Broad” trading entity and “narrow” deposit
entity: This option would foresee the separation of
all wholesale and investment banking activities. 
Strength
When determining the strength of
separation, a starting point is to consider three broad forms: (i) accounting
separation; (ii) functional separation through subsidiarisation; and (iii)
ownership separation or prohibition of certain business lines. These forms of
separation display a varying degree of severity and intrusiveness in banks’
business structure.
Accounting separation (obliging banks to
publish more information about their different business lines) is unlikely to
achieve the objectives outlined above and is therefore discarded. Functional
separation through subsidiarisation would require banking groups to separate
the activities of different business units into separate subsidiaries (legal
entities) but they could continue to provide their clients with a diverse set
of banking services (“structured universal banking”). The report considers two
different subsidiarisation options, based on a set of different legal, economic
and governance rules of subsidiarisation (limited vs stricter subsidiarisation).
Ownership separation would require that certain business lines are provided by
firms that are not affiliated with the banking group. More specifically the
three options considered in the report are:
(1)                   
Subsidiarisation with intra-group links
restricted according to current rules: in terms of
legal separation, this option would require a separate legal entity. In terms
of economic separation, it would restrict itself to the economic and governance
requirements that currently result from this degree of legal separation;
(2)                   
Subsidiarisation with tighter restrictions on
intra-group links: in order to more effectively
address intra-group funding subsidies, this option would require a more
significant degree of subsidiarisation in legal, economic and/or governance
terms (such as rules on ownership rules and intra-group exposure limits) ; or
(3)                   
Ownership separation: under this option, banking groups would not be allowed to engage
in certain activities. They would accordingly have to divest or wind down any
such activities that they currently engage in.
Reform options
On the basis of the above, the combination
of the different range of trading and capital markets activities to be
separated and strengths of separation yields nine stylised reform options, as
visualised in matrix form in Table 1. To the extent possible and for
illustration purposes only, the Commission services have mapped the different
structural reform proposals and/or legislative initiatives into the matrix.
Table 1:
Overview of options
 Activities strength || Functional separation 1 (SUB) Current requirements || Functional separation 2 (SUB+) Stricter requirements || Ownership separation Ownership separation 
 Narrow trading entity/ broad deposit entity E.g. Proprietary trading + exposures to HF (PT ) || Option A || Option B [≈ FR, DE baseline] || Option C [≈ US Volcker] 
 Medium trading entity/ medium deposit entity E.g. PT + market-making (MM) || Option D || Option E [≈ HLEG; ≈ FR, DE if wider separation activated] || Option F 
 Broad trading entity/ narrow deposit entity E.g. all investment banking activities || Option G || Option H [≈ US BHC; ≈ UK] || Option I [≈ Glass-Steagall; ≈ UK with electrification of fence] 
Implementation issues
The IA compares the benefits and costs to
society of the options outlined in table 1 against each other and against the
“no policy change” scenario. In addition, the IA also assesses three
implementation issues common to all options:
·                        
Institutional scope: a structural reform initiative should in principle target TBTF banks
only and would accordingly only apply to a small subset of the more than 8,000
banks incorporated in the EU. Therefore, the reform does not affect small
cooperative and savings banks that play an important role to serve the
financing needs of local communities and small businesses. The report assesses
different approaches to set thresholds in order to select relevant banks. It
concludes that such thresholds should be based on a combination of a systemic
risk metric and an accounting-based methodology. In addition to all European
systemically important banks structural reform would  apply to banks with
trading activity above an absolute threshold of €70bn and a relative threshold
of 10% of total assets. Small banks with less than €30bn in assets in principle
would be excluded. . In practice and based on historic data, the Commission estimates
that this may lead to 29 of the largest and most complex European banks being
subject to structural separation;
·                        
Role of supervisors: a separate issue is the role of supervisors in reviewing the scope
of institutions as well as the activities subject to potential separation. As
regards the institutional scope, any threshold may not always perfectly capture
the right institutions. There should therefore be some room for supervisory
judgement in assessing the institutional scope of separation resulting from an
application of the thresholds elaborated above to ensure that the right banks
are captured. Similarly, there should be room for supervisory judgement in
determining the scope of activities to be separated should particular
circumstances warrant it. However, supervisory judgement needs to be closely
framed and constrained for political, practical and legal reasons. Otherwise
inconsistent outcomes across the Internal Market can arise. The report outlines
a number of principles guiding the supervisory process foreseen under both
options to ensure that it does not lead to distortions in the internal market;
and
·                        
Timeframe for implementation: Structural separation, no matter how beneficial to society, will
yield private costs. Furthermore, the transfer of existing assets and
liabilities to a potentially new separate legal entity requires time. Finally,
the EU has adopted or will soon adopt several initiatives in related areas,
including Basel III, BRRD and the SRM that will not become fully applicable until
2018 or 2019. The report concludes that a similar transition period should be
foreseen to implement a future structural reform initiative.

6.                      
Impact and comparison of reform options

Chapter 5 of the report assesses and
compares in qualitative terms the different reform options identified above.
Two criteria are applied for the purpose of comparing the options. The first – effectiveness
– measures the extent to which the specific reform objectives are being
met, e.g. facilitating resolvability. The second – efficiency – assesses the
costs to society incurred when implementing the respective reform options
(mainly foregone economies of scale and scope). A third – coherence – measures
the extent to which a reform option is in line with the Commission’s overall
policy objectives in general and complementary to the current reform agenda. As
all options are broadly coherent with these objectives, this criterion is not
used further to score options. 
Assessment of reform options based on
subsidiarisation according to current rules
Options A, D and G would
deliver a certain degree of separation of the trading entity, but they risk
being ineffective in achieving the specific objectives of facilitating
resolvability and monitoring, reducing moral hazard, reducing conflicts of
interest, reducing resource and capital and resource misallocation, and
improving competition and are therefore discarded. This is due to the fact that
mere subsidiarisation does not effectively sever the economic and operational
links between the trading and deposit-taking subsidiaries.
Assessment of reform options based on
subsidiarisation according to stricter rules
The options based on subsidiarisation
according to stricter rules (B, E and H) are reform options that roughly
correspond to reforms currently being pursued by EU Member States or
recommended by the HLEG. These options would effectively sever the economic and operational links between the trading and
deposit-taking subsidiaries. They would still enable
banking groups to engage in a broad set of activities although some activities
would have to be transferred to separate legal entities within the group
(structured universal banking). Among the three options, the report finds that that implementing reform option E is the best
way forward in the EU context and would represent a significant improvement
over the no policy change alternative. Option E yields greater benefits
compared to reform option B due to the latter option’s narrower activity scope.
Option E is also preferable to reform option H,  additional
activities are unlikely to bring significantly higher benefits while would
impose further costs. 
Assessment of reform options based on ownership
separation
Options C, F and I have the potential to be
the most effective set of options in terms of achieving the specific
objectives. However, it is also the set of options that may come with the
highest social costs in terms of foregone economies of scope. The report
concludes that the social benefits associated with option C outweigh the social
costs, as it addresses the risks, complexity and interconnectedness associated
with proprietary trading (a trading activity that  is inherently risky and is
most prone to conflicts of interest) without incurring significant social costs
(given that it does not contribute to the financing of the economy). A
significant positive balance between benefits and costs is more difficult to
argue for options F and I. At this stage of economic knowledge and evidence and
given the relatively high uncertainty, cautiousness as regards the activity
scope for ownership separation of activities (are than proprietary trading) seems
appropriate. Hence, the report finds that only option C provides a good net
balance of social benefits and social costs and is worth exploring further.
Comparing retained options
The report therefore retains option C and E
for further comparison in terms of benefits and costs to society. As regards
the former it finds that option C is less effective than E in yielding such
benefits due to its narrower activity scope. At the same time, option E may
yield higher costs to society by virtue of its broader activity scope, which
would have a larger effect on foregone economies of scope. Nevertheless,
because of its significantly broader activity scope, option E delivers greater
social benefits compared to option C and hence may be deemed more effective, at
limited additional efficiency cost. 
Even so, the report finds that there may be
ways of raising the limited effectiveness of option C and bringing it closer to
option E. Option C could, for example, be complemented by an ex post (albeit
framed) procedure for separating additional activities, notably market making,
complex derivatives and complex securitisation (“option C+”).. In a similar
vein, there are ways of reducing the potential efficiency cost associated with
option E should that cost be considered excessive (by e.g. exempting from the
separation requirement certain activities where existing markets are
particularly shallow and/or illiquid by means of a framed supervisory process,
“option E-”). 
There are accordingly ways – the ones above
are not the only ones – of making the options broadly comparable. However,
considerations of a more political nature, such as complementarity with other
policy objectives, timing of the reform, implementation difficulties, expected
views and position of co-legislators etc., need to be taken into consideration
before making a choice between these acceptable and justifiable options. As a
result this report does not state a preference between the options.
Issues related to implementation
The options involve operational challenges.
For option C+ the main implementation challenge stems from the difficulty of
defining and disentangling proprietary trading from market-making. This makes
it costly to comply with and supervise the implementation, particularly for C
that requires full divestment. For option E- the main challenge stems from
governing and monitoring inherently opaque intra-group linkages of legal,
economic, governance and operational nature.
Supporting the qualitative assessment
Several important elements of the draft IA
have been subject to extensive quantitative modelling or analysis. Firstly,
quantitative work estimates the level of implicit subsidies. Implicit subsidies
are found to be significant and to depend on the size of the bank, the level of
interconnectedness with other banks, its level of leverage as well as the
rating of the sovereign on which it is headquartered). Secondly, work on the
calculation of thresholds has been used to identify relevant European banking
groups. Thirdly, the analysis of the relative economic incentives of investment
versus commercial banking activities shows that there are regulatory incentives
for banks to engage in trading activities rather than deposit taking activities.
In order to support the qualitative
assessment of reform options, the Commission services have attempted to
quantify to the extent possible some of the costs and benefits that could
result from structural separation. However, given the inherent complexity and
special nature of banking and given that many benefits and costs are dynamic in
nature, no quantitative model exists that can fully estimate the social
benefits and costs of structural reform proposals. This is further compounded
by the lack of data. The Commission services have attempted to assess some of
the costs (banks’ private funding cost) and benefits. Notwithstanding the
above-mentioned methodological and data limitations, the results are consistent
with the conclusions arising from the qualitative analysis that separation of
trading activities would produce economic benefits, such as reducing total
losses generated by the banking system. 
The Commission services also invited EU
banks in the context of the stakeholder consultation to model and estimate the
impact of stylised structural reform scenarios on the group's balance sheet,
profit and loss account and selected other bank variables. A very limited
number of banking groups responded. Moreover, the simulated impacts differed
substantially between respondents and were not internally consistent. 
Stakeholder views and impacts
As part of preparing this report, the
Commission services held a public stakeholder consultation during the course of
spring 2013. The Commission services received more than 500 replies, including
a substantial number of responses from individuals and consumer associations. The
consultation responses highlight a fault line between the responses of banks
and consumers and individuals. The former are to an overwhelming extent against
structural separation. The latter are largely in favour. These divergences are
reflected in responses on the type and strength of structural measures and what
activities to separate. The Commission services also held a public consultation
about the HLEG’s report in autumn 2012.

7.                      
Monitoring and Evaluation

Monitoring will take place during the
phase-in period. Ex-post evaluation of all new legislative measures is a
priority for the Commission. Evaluations are planned about 4 years after the
implementation deadline. The forthcoming proposal, once adopted, would also be
subject to a complete evaluation in order to assess, among other things, how
effective and efficient it has been in terms of achieving the objectives
presented in this report and to decide whether new measures or amendments are
needed.
In terms of sources of information that
could be used during the evaluation, the data provided from the national
central banks, the national regulators, European bodies such as the ECB, EBA
and ESRB and from international organizations such as BIS, OECD, IMF and FSB.
Relevant data could also be collected by relevant market participants or
intermediaries. Relevant indicators to evaluate the proposal could include e.g.
number and aggregate assets of banks subjected to structural separation
requirements; measures of trading and lending activity; and, estimates of
implicit public subsidies and reduction of artificial funding cost advantages.
[1]               Too-big-to-fail is meant to cover
too-interconnected-to-fail (TITF), too-complex-to-fail (TCTF), and
too-systemically-important-to-fail (TSITF). See European Commission (2013),
“Structural reform in the EU banking sector: Motivation, Scope and Consequences”,
Chapter 3 of the European Financial Stability and Integration Report 2012, 24
April, SWD(2013) 156 final.