Is there any legislation or proposed legislation in your jurisdiction under which financial institutions are prohibited from dealing in investments as a principal?
On 29 January 2014, the European Commission issued legislative proposals – a draft Regulation on structural measures improving the resilience of EU credit institutions (the draft Regulation).
The draft Regulation provides for the structural separation of banks that are within scope as defined in article 3. Article 6 of the draft Regulation sets out provisions for a prohibition on proprietary trading.
To which financial institutions do the prohibitions relate?
Article 3 of the draft Regulation sets out those banks that are within scope. These are EU banks that have been identified as being of global systemic importance (including all branches and subsidiaries irrespective of where they are located) or any of the following entities that have had for three consecutive years total assets of at least €30 billion, and trading activities amounting to at least €70 billion or 10 per cent of its total assets:
- any bank established in the EU which is neither a parent undertaking nor a subsidiary, including all its branches irrespective of where they are located;
- an EU parent, including all branches and subsidiaries irrespective of where they are located, where one of the group entities is a bank established in the EU; or
- EU branches of banks established in third countries.
It is worth noting that the draft Regulation provides for the possible derogation from the separation measures for banks that are already covered by equivalent Member State national legislation. In addition, the draft Regulation provides that third country subsidiaries of EU banks and EU branches of third country banks can be exempted from separation if the Commission determines that they are subject to equivalent separation rules. However, the derogation does not appear to extend to the prohibition on proprietary trading.
What exceptions to the ban on proprietary trading are contemplated by the legislation?
The Commission notes that it is difficult to define proprietary trading and distinguish it from market making. Accordingly in article 5(4) there is a narrow definition of proprietary trading. Desks’, units’, divisions’ or individual traders’ activities specifically dedicated to taking positions for making a profit for own account, without any connection to client activity or hedging the entity’s risk, would be prohibited.
Article 6(2) provides that where banks falling within the scope of the draft Regulation operate dedicated structures for buying and selling money market instruments for the purpose of cash management, they are not captured by the prohibition. Trading in EU government bonds is also exempted from the prohibition.
Can any other entity within the relevant financial institution’s group of companies carry on the prohibited activity?
While in principle the prohibition on proprietary trading could extend to all banks, the draft Regulation applies the ban only to those banks that are within scope.
To prevent these banks from circumventing the prohibition by, for example, owning or investing in hedge funds, article 6(1)(b) states that banks subject to the proprietary trading prohibition are also prohibited from investing in or holding shares in hedge funds (or certificate/derivatives linked to these), or entities that engage in proprietary trading or sponsor hedge funds.
Unleveraged and closed-ended funds are exempted from this prohibition. Banks covered by the prohibition will be able to continue to provide banking/custody services to hedge funds.
When will the proposed legislation come into effect?
The proposals are now being reviewed by the European Parliament and the Council of the European Union and it is difficult to say when agreement will be reached particularly in light of the European Parliament elections this year.
However, the explanatory memorandum to the draft Regulation states the following on the basis that it is adopted by the European Parliament and the Council of the European Union by June 2015:
- a list of covered and derogated banks is published 1 July 2016 and on a yearly basis thereafter;
- the prohibition on proprietary trading becomes effective on 1 January 2017; and
- the draft Regulation’s provisions on the separation of trading activities from credit institutions become effective on 1 July 2018.
Links to the proposed legislation and any other relevant material
The European Commission has a page on bank structural separation which includes links to the draft legislation and FAQs.