Ringfencing will make it harder to wind up failing banks; Reform proposal undercuts direction of global regulation

January 29, 2014 4:03 pm

Ringfencing will make it harder to wind up failing banks

By Patrick Jenkins in London

Reform proposal undercuts direction of global regulation

The world has come along way since the G20 summit of September 2009, when political leaders sealed an unprecedented collaborative effort to make the global banking system safer. Capital levels today are much higher. Leverage is a bit lower. And liquid funding cushions are reassuringly plump.

Sadly, though, the world is showing increasing signs of fragmenting, with regional regulatory idiosyncrasies being introduced for political as well as economic reasons.

The latest evidence comes in the form of the European Commission’s plan to amend the structure of the continent’s banking system. In essence the idea is to put a ringfence around a bank’s trading activities, with specific capital and funding trapped within the trading subsidiary. The original proposal, drafted by the so-called Liikanen Committee in 2012, has already beenwatered down

by Michel Barnier, the EU commissioner, and may yet be diluted further if lobbyists have their way.

But in its current form, just like the UK’s mirror-imageVickers rule that will ringfence a group’s retail banking activities, the whole principle of the Liikanen/Barnier reform plan undercuts the direction of global regulation.

There is a particular conflict with the key unfinished business of global policy makers – to design a “resolution” regime that will allow banks to be wound down safely in a crisis. Rather than be bailed out by governments, troubled lenders would “bail in” bondholders, cutting the value of bond investments to cover losses.

The consensus view among global regulators is that, to ease resolution, banks should simplify their organisational structure so that bonds that could be bailed in during times of trouble are issued centrally by each institution, rather than by subsidiaries. This would give regulators a so-called single point of entry if they ever had to wind up the bank, making the process simpler, cleaner and quicker.

Yet the Liikanen rules, like Vickers’, insist that ringfenced subsidiaries be self-financing and independently capitalised. This principle purports to be in harmony with the resolution agenda: if you clearly fence off certain parts of a group, it would be more straightforward to wind up.

But on the core point of where the money comes from to fund the wind-up, the ringfencing idea is wholly at odds with the principle of single point of entry bail-in. If the debt that you might want to bail in is trapped within a ringfenced entity, when you need it elsewhere in the group, you have a problem. The Commission proposal acknowledges the issue but fudges the solution.

A similar argument applies to plans by US regulators to force foreign banks to set up local holding companies, and the increasing pressure on foreign banks in the UK to operate via fully capitalised subsidiaries rather than capital-light branches.

This might all sound horribly dull and technical. But it is crucial if efforts to shore up the world’s banking system are to work in practice. The usefulness of stronger capital and liquidity buffers is undermined without a clear plan on how regional subsidiaries and their regional regulators should behave in a crisis.

If the specifics of the latest regional rules cut across the global agenda, then so does the spirit. The world’s economies are continuing to deepen their global links, banks have a point when they argue that, for efficiency’s sake, financial services need to be global too.

Among the multiple complaints that banks have about the regulatory agenda, many are predictably self-interested. They do not like different rules in different places because it is cumbersome to comply. And tougher rules will mean a further hit to profitability.

But the increasingly messy and unco-ordinated agenda of regulatory change is also potentially burdensome for the economies that the banks should be financing. Companies in France and Germany, for example, have been among the most vociferous lobbyists against the Liikanen reforms, concerned that the changes would increase their own costs of funding.

Mark Carney has two big jobs. Lately he has prioritised his role as governor of the Bank of England and a mission to help revive the British economy on a stable footing. But as head of the global regulatory body, the Financial Stability Board, he faces an equally important challenge. Can he use his influence among G20 leaders to restore a disciplined global approach to regulating the banks?

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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