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London versus Europe: the deep division over banking regulations and rules

It’s EU elections time, and so the mad moments begin.

All of the eurocrats are keen to push through their final legislative agendas and so, just in the past week, we’ve seen the introduction of or revisions to everything from the Tobacco Products Directive to the Package Travel Directive to the  Collective Rights Management Directive.

Of course it’s all in the spirit of harmonisation, and that is no truer than in financial services where we are seeing the final I’s dotted and T’s crossed for the Payment Services Directive 2  (PSD2), the Mortgage Directive and the Savings Directive  (not forgetting MiFID2 and EMIR of course).

In fact, as articulated by Financial Services Club friend Graham Bishop yesterday, Michel Barnier’s proposals to reinvent European financial services are quite radical, with the investment markets hit with various policies that are quite dramatic, including:

  • Banning proprietary trading in financial instruments and commodities (that is, trading on its own account for the sole purpose of profiting the bank).
  • “Subsidiarisation”: giving supervisors the power, sometimes the obligation, to require the transfer of other high-risk trading activities (market-making, complex derivatives and securitisation operations, etc.) to subsidiaries. This aims to avoid any gaming of the rules but banks can avoid this if they satisfy their supervisor that the risks are mitigated in other ways.
  • Providing rules on the economic, legal, governance and operational links between the separated trading entity and the rest of the banking group.

Some of this is sabre rattling and some of it is serious, bearing in mind that Michel Barnier is bidding to replace Jose Manuel Barroso as EU President.

The most radical part of all of these hastily drawn up directives – most energy traders weren’t even aware of EMIR’s requirements for reporting of OTC derivatives until they were told they were non-compliant – is the impact it has on London markets, the City and the UK economy.

The UK GDP from financial services is anything from 10 to 15 percent, dependent upon what figures you read, and is a core constituent of the economy.  London employs more material bank traders than any other European economy and the act of cutting their bonuses is causing real friction between the Treasury, Government and European Parliament.

According to stats from Bloomberg, Britain is home to 2,188 investment bankers earning more than €1 million in 2012 while France and Germany had 117 and 100 respectively.

This is why the UK has taken the European Commission to court over their limits on bonuses – the Commission brought in laws in January that limit bonuses to 100% of annual salary or 200% with shareholder approval – citing a list of six reasons why it is unworkable:

  • It is unfit for purpose, and was introduced without any impact assessment
  • It unlawfully delegates to the European Banking Authority (EBA) because it concerns policy and is not simply a technical matter
  • It is legally invalid because it contravenes the legal base of regulation that expressly excludes legislation "affecting the rights and interests of employed persons"
  • It is being rushed into effect without the necessary legislation in place – including rules determining to whom the cap will apply
  • It fails to protect personal data
  • It wrongfully applies outside the European Economic Area

Add on to this a Financial Transaction Tax and other moves by the EU to reconstruct banking and you get a sense as to why we are a little bit anti-EU in London.

Nevertheless, much of these changes are impossible to police or implement.  For example, the bonus caps resulted in many banks saying stuff this and just hiking up base pay as a result.

HSBC Holdings Plc (HSBA) became the first U.K. lender to reveal its plans to sidestep European Union caps on bonus payments for more than 600 senior managers as it awarded Chief Executive Officer Stuart Gulliver 8 million pounds ($13.3 million) in compensation.  A total of 665 HSBC employees will receive a fixed-pay allowance that is neither salary nor bonus to circumvent the rules, Gulliver, 54, said on a conference call with reporters today. Of those, 111 will get the allowance in shares and 554 in cash, he said. Bloomberg, February 2014 

Sir Richard Branson's banking arm will this week become the latest of Britain's high street lenders to say that it is supporting the payment of higher bonuses under new European rules. Sky News, March 2014 

Taxpayer-backed RBS warned it should not be 'dishing out' £576million in bonuses after losing £8.2 billion, Daily Mail, February 2014 

The fact that the UK government is supportive of banks, the bnaking sector and their needs to circumvent stupid rules that make the London City markets less competitive in respect to New York, Hong Kong and others, has resulted in calls for the UK to be taken to court for flouting EU rules.

"What we are witnessing now is an attempt by the major banks, with the support of the British government, to circumvent the rules and that is to compensate what we did on terms of structure, by just raising the fixed rate of remuneration," said Philippe Lamberts, the Belgian Green MEP who helped devise the restrictions. 

This all comes on top of the announcement that, for those 2,188 bankers in London who earn more than €1 million, they will be scrutinised heavily by the regulators as material risk takers.

According to the commission plan, national regulators would need to give prior approval for any such exemption for a banker earning 750,000 euros or more, while the European Banking Authority would also need to be notified in advance in the case of carve outs for bankers earning more than 1 million euros.

In each case, “the burden of proof will rest squarely on the institutions to demonstrate that, despite the very high remuneration, the staff member in question does not in fact have any material impact on the institution’s risk profile,” the commission said.

Regardless of such moves, it is clear that the UK is going its own way as Mark Carney, the Governor of the Bank of England, announces his own review of bank bonus rules.

According to the Financial Times, the Prudential Regulation Authority will start consulting this month on strengthening rules for clawing back bankers’ bonuses that have already been paid, as well as extending the period for bonus deferral beyond the current three to five years and paying more of bonuses in the form of “bail-in” bonds, which can be written off, or converted to equity, during a crisis.

What is really concerning in Mark Carney’s announcement is not all of this quibbling over payments to bankers, risks, capital requirements and such like, but this line:

In his letter, Mr Carney also addressed separate questions from MPs about the size of UK banks’ exposure to China.  The exposures of UK institutions have increased 2.5 times since the end of 2009, compared with a 1.5 times increase across all the banks that report their exposures, Mr Carney noted … Britain’s banks have the biggest exposure to China of any banking system, with claims of $184bn as of the second quarter of 2013.

Now, that is slightly more worrying isn’t it?

About Chris M Skinner

Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, the Finanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal’s Financial News. To learn more click here...

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