The German Government has approved legislation separating
commercial and investment banking on the basis of a modified ring-fencing
approach embodied in the E.U. Liikanen Report. The legislation also provides
for the winding up and reorganization of financial groups. Finally, the
legislation provides for criminal liability for executives at banks and
insurance companies should such executives violate their duties.
The legislation, which was presented by German Finance
Minister Wolfgang Schäuble, contains important additional building blocks in Germany
Living wills for banks. The
legislation creates rules for planning the reorganization and winding up of
credit institutions and financial groups, so that preventative action can be
taken in good time to help systemically important banks that have got into
difficulties. The affected institutions will have to present reorganization
plans so that in cases of doubt the authorities can act more quickly and
obstacles to winding up an institution can be removed. The regulator will be
able to demand that obstacles to resolution be eliminated even before problems
arise.
This is an additional element that is required in order
to effectively tackle the problem posed by having banks that are too big or too
interconnected to fail. These are financial institutions that are so large and
complex that they cannot be wound up without negative consequences for
financial markets as a result of their high level of interconnectedness with
other parts of the financial system.
The new law is designed to prevent the situation arising
in the future where taxpayers are left to cover the costs of a bank collapse.
This is also the objective of Germany Germany
The German Government will continue to play a
constructive and committed role in the discussions relating to the E.U.’s Recovery
and Resolution Directive that began in June 2012. However, the German
Government wanted to take the lead by approving the draft law and is pressing
forward with national regulatory arrangements, as in the areas of high
frequency trading, short selling and fee-based investment advice.
Separation of banking activities. An important goal of the legislation is to enhance the
protection of retail banking against risks arising from speculative activities.
This will benefit retail customers and ultimately also taxpayers. The
legislation largely follows the findings and recommendations of the E.U.
Liikanen Report. The Report of the High Level Expert Group on E.U. Banking
Reform (Liikanen Report) recommended that proprietary trading and other
significant trading activities should be assigned to a separate legal entity if
the activities to be separated amount to a significant share of a bank's
business.
Under the German legislation, if certain thresholds are
exceeded, deposit-taking institutions and groups that include deposit-taking
institutions will no longer be allowed to combine in one entity deposit-related
activities and proprietary trading, which is defined as the purchase or sale of
financial instruments on the financial institution’s own account that is not a
service for a third party. Instead, the financial institution will have to spin
off proprietary trading into a company that is legally, economically and
organizationally separate and that will require a license in accordance with Germany
Separating risky activities from retail banking will
increase the solvency of an institution and contribute to the stabilization of
financial markets. If a financial group exceeds the relevant thresholds, it
will only be allowed to make loans to hedge funds and other comparable highly
leveraged companies, or issue guarantees for their benefit, if it does so via the
independent company that conducts its proprietary trading.
The thresholds, which are based on the recommendations of
the Liikanen expert group, are as follows: The relative threshold is exceeded
if assets associated with trading activities comprise more than 20% of the
total balance sheet, while the absolute threshold is surpassed if
trading-related assets are worth more than €100 billion.
The relative threshold is supplemented by a simple
criterion which stipulates that only companies with total assets of over
€90 billion will be affected by the rules. This is intended to ensure that
the regime does not apply to an excessive number of smaller banks that would
otherwise exceed the relative threshold. Additionally, a trading unit that has
been separated off may not benefit from less stringent supervisory requirements
that apply to other institutions in the same financial group.
However, deposit-taking credit institutions will still be
able to carry out proprietary trading on behalf of their clients, such as to
conduct the purchase and sale of financial instruments for their own account as
a service for third parties, including market-making. The German Federal
Financial Supervisory Authority, BaFin, will, however, be empowered to demand
the separation of market-making activities in individual cases, so that it is
able to deal with special circumstances.
Criminal-law provisions. Finally, the
legislation tackles the issue of individual responsibility by significantly
strengthening and clarifying the ability of the authorities to take criminal
action in cases of severe breaches of duty that could get an entire bank or
insurance company into difficulty. The legislation assigns specific
responsibilities for risk management to senior managers at financial
institutions. The violation of important risk-management duties will be
punishable with a maximum of five years’ imprisonment should it threaten a
firm’s viability as a going concern or if it jeopardizes insurance companies’
abilities to meet their obligations relating to insurance policies. These
provisions create sanctions for mismanagement that will help to prevent future
corporate crises and their associated negative effects on society and the
economy.