New structural reforms being proposed for the European banking sector will likely further restrain trading by these banks, says Fitch Ratings.
In a new report, the rating agency says that proposals from the European Commission include a ban on proprietary trading and the prospect of having to split other risky trading activities into separate subsidiaries. The proposed ban on proprietary trading would take effect in January 2017, and the potential requirement to separate other trading activities would come into effect in July 2018.
Fitch says that banks are already withdrawing from certain businesses “as they realign their strategy with the evolving regulatory landscape and revenue prospects.” Nevertheless, it suggests that the proposed ban on proprietary trading would add additional constraints and impose implementation and compliance costs; while the possibility of requiring other high-risk trading activities, such as market-making, complex derivatives and securitisation businesses, to be placed into separate subsidiaries could also limit trading.
“Some banks may choose to reduce trading rather than risk incurring the costs of a separation. These could be significant since strict rules would be in place to ensure the trading entity remains economically and operationally separate, including funding arrangements,” it notes.
The proposed ban on prop trading is likely to have less impact than the Volcker rule in the U.S., “because it has a narrower definition for restricted trading activities and will only apply to European banks deemed to be of global systemic importance.”
Where banks choose to spilt off a trading subsidiary, this would likely be neutral to slightly positive for the credit profiles of the overall bank, Fitch says. “It could reduce downside risk as the bank would not be obliged to support its trading operations in case of problems, although some may still do so to avoid damaging their reputation,” it notes.
Already, bank structures are changing, Fitch says, particularly as they engage in resolution planning. “Plans are underway to place proprietary trading activities into separate subsidiaries in France and Germany, so the ban will mean exiting or selling these operations instead,” it says. And, it notes that UK banks have already begun steps to ring-fence their retail arms. “They may have to contend with separating more than one part of their business, if these proposals are agreed by the European Parliament and Council,” it says.
“Much will depend on how the European Central Bank, when it takes up its role as single supervisor in November, requires banks and their subsidiaries to be capitalized and uses the proposed separation powers,” Fitch concludes, as most of the European banks covered by these structural reforms will come under its supervision.