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Opinion

EU banking: Kneejerk reaction

EU’s me-too demand for non-regional bank holding companies could harm non-EU bank funding in the region.

EU string-600

Sometimes playing tit for tat can have unexpected consequences. 

When the European Union included the requirement for non-EU banking groups to establish Intermediate Parent Undertakings (IPUs) within the EU as part of its November 2016 bank regulation reform package, it argued that the move was necessary to support an orderly resolution process. 

This was met with deep cynicism in the market where the decision was widely viewed as a tit-for-tat response to the US requirement for non-US banking groups to operate international holding companies (IHCs).

The EU regulators don’t seem to have done their homework, however, and the IPU proposal immediately prompted a chorus of criticism from the US banks it was aimed at. They pointed out that they would be unable to comply with the new rules even if they wanted to (which they don’t). Under US regulations, banking activities and broker-dealer activities must be held within separate chains in the group structure; they cannot be held within the same IPU. 

Egg on faces

While the EU regulators who drafted the proposal and didn’t seem to realize this have certainly been left with egg on their faces, the broader consequences of the blunder could be more far-reaching. 

On the surface of it, the establishment of an EU IPU for a US banking group is less onerous than the establishment of a US IHC is for a European bank because large US broker-dealer subsidiaries of non-US banks were added to the capital requirement for US IHCs, whereas EU broker-dealer subsidiaries of US bank holding companies are already subject to Basel-based capital requirements.

An EU IPU poses a different problem for US banks, however, because if it is held in the corporate chain of a US bank group structure it will limit the funding opportunities of its EU bank entity and conversely if the EU IPU is held in the bank chain it will restrict a US corporate broker’s ability to conduct ECM activities in Europe. 

So, the unintended consequence of the EU’s ‘me-too’ approach is that there could be a substantially negative impact on funding by non-EU entities in the region. That looks like something of an own goal, the implications of which are magnified by the fact that banks from other jurisdictions that have similar separation of bank and broker-dealer activities – such as Japan – will face the same problem.

The solution being mooted is for non-EU entities to have two separate IPUs in Europe – one for banking activities and one for broker-dealer activities. As the EU is highly unlikely to back down on the requirement, this seems to be the most sensible – albeit expensive and irritating – way around it. But the episode is a telling example of the kind of escalation that is now a real risk as the commitment to global rules starts to unravel

The EU already had the power to ask non-EU groups to create IPUs if it thought it were necessary within existing legislation. Inserting this requirement into the November banking reform package seems to have been a purely retaliatory move. Watch this space for more of the same. 

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