European Affairs

Drawing heavily from international responses to the crisis, EU Commissioner Michel Barnier, who oversees financial services, focused on two key elements in announcing the reforms on Wednesday.[2] About 30 banks would be affected, specifically those with total assets for three consecutive years that exceed €30 billion and whose trading book tops €70 billion or 10 per cent of its total assets. Foreign banks’ European subsidiaries, if deemed systemically important in the European Union, would also need to be compliance.

First, proprietary trading would be banned for the 30 megabanks, those Barnier said were "too costly to save and too complex to resolve." [3] In the U.S. this is known as the “Volcker Rule.” (See below) Currently, banks perform these transactions for their own account -- not their clients -- using their own capital. Should their investment strategies fail, the resulting losses could imperil the bank, with depositors losing their money. Proprietary trading “entails many risks but no tangible benefits for the bank's clients or the wider economy,” the proposal said. Roughly 2 to 4 percent of banks’ trading revenues would be affected, EU officials estimate.

Before the financial crisis unfolded, Lehman Brothers had amassed huge positions in real estate, derivatives, and bonds that exceeded the investment bank’s stock value. The housing collapse and rising mortgage defaults devastated credit markets, with Lehman losing more than $32 billion from its proprietary trading and principal transactions. Some have argued that such speculative trading by Lehman and others supported the meteoric rise of mortgage derivatives and other complex, hard-to-value financial instruments that fueled the credit-and-housing bubble. Barnier hopes the ban will avoid a replay of this scenario.

This approach follows that advanced by former U.S. Federal Reserve Chairman Paul Volcker, who sought to restrict U.S. banks from making certain kinds of speculative investments that do not benefit their customers. In December, all five of the necessary U.S. financial regulatory agencies finalized the “Volcker Rule,” which is set to take effect April 1 this year unless court challenges derail implementation.[4]

Where the line should be drawn between “proprietary trading” and “market making” is difficult. For some, the definition used in the Volcker rule is too narrow; others think Barnier’s tent is too widely stretched.    

Second, Barnier proposes giving national regulators the ability to require banks to legally separate high-risk trading activities from core lending and deposit-taking activity. Yet, “banks will have the possibility of not separating activities if they can show to the satisfaction of their supervisor that the risks generated are mitigated by other means,” the draft proposed. A unit within a bank could not account for more than 25 percent of the bank’s capital. The limit responds to the public anger over the cost of bailouts – roughly 13 percent of the EU’s GDP – as a result of reckless bankers.

Officials in France were among the first to attack the proposals, with Germany and the United Kingdom expressing more tempered concerns.    

Christian Noyer, the Banque de France governor, deemed the proposals “irresponsible and contrary to the interests of the European economy” because standard deposit-based services would not be separated from investment banking, as recommended in the Liikanen Report.[5]

Barnier’s proposal “seeks to compromise between Volcker and Vickers, to compromise between the lobbying of the consumer associations and the financial sector, and to compromise between the positions of the UK on one hand and France and Germany on the other," said Alexandria Carr, a regulatory lawyer at Mayer Brown in London., in a Reuters report earlier this month.[6] (“Vickers” refers to Sir John Vickers and the panel he chaired to propose post crisis regulatory reforms.)

While EU officials hope the proprietary trading ban could be implemented in 2017 and the separation of banking activities in 2018, that is unlikely since many political uncertainties lie ahead. May elections will bring a new Parliament, with its own priorities to reflect the electorate’s choices for MEPs. Disparaging the timing as “insulting,” “it would be better to keep it for the new parliament,” advised Sharon Bowles, who chairs the Parliament's economic affairs committee. Barnier will be replaced this fall, but he has clearly indicated his interest in being a candidate for the presidency of the European Commission after José Manuel Barroso departs this year.[7]

Meanwhile, European banks worry about the consequences.   The European Banking Federation fears the "far-reaching consequences on banks' structure, daily business and organization. The "prolonged uncertainty [about the regulatory proposal’s outcome] will weigh on the international competitiveness and attractiveness of Europe's banking sector.”


[3] Barnier singled out Deutsche Bank as typical of "a systemic problem at the European scale". Its Euro1.6 trillion ($2.2 trillion) of assets is roughly equivalent to roughly two-thirds of the entire German economy.

[5] “[T]he Group has concluded that it is necessary to require legal separation of certain particularly risky financial activities from deposit-taking banks within the banking group. The activities to be separated would include proprietary trading of securities and derivatives, and certain other activities closely linked with securities and derivatives markets.”

[6] Huw Jones,“EU bank trading plan stops short of U.S. Volcker Rule.” Reuters, January 6, 2014,