Why Kay, Volcker are wrong about ringfencing


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UK lawyers insist it is possible to effectively ringfence retail and investment activities without restructuring banks into essentially two separate entities. But the cost and energy of creating a ringfence could force some universal banks to opt for complete separation. Speaking last week before the UK Parliamentary Commission on Banking Standards (Commission), Professor John Kay said it was incredibly difficult to write rules that make a ringfence sufficiently robust. The market, however, thinks differently. “It is entirely feasible for a valid and workable ringfencing system to occur within the existing banking and financial sector,” said Mayer Brown partner Dominic Griffiths. In his submissions before the Commission, Kay said: “The reason I wrote the Narrow Banking pamphlet is because I concluded it was incredibly difficult to write rules that make a ringfence sufficiently robust.” An impermeable ringfence, he said, would require separate governance such that retail and investment units were essentially separate entities held by the same parent company. He noted that this was, in any event, tantamount to separation. Griffiths, however, noted that many large European and US banks with retail and investment banking operations have for some time been seeking to separate those activities, anticipating reforms requiring some form of separation. Dr Richard Reid, chief economist at the International Centre for Financial Regulation, agreed there was a trend of investment banks spinning out their trading operations to standalone businesses, but with some affiliation with the parent. He added that these decisions were often made to take advantage of the free-flowing capital seen pre-2007, and not just for regulatory reasons. Kay’s stance, however, has the support of UK and US regulators. His comments echo those made by former US Federal Reserve chairman Paul Volcker before the Commission earlier in the month. It also follows Bank of England’s Andrew Haldane statement that an impermeable ringfence would “require entirely separate governance, risk and balance sheet management on either side”. One result of EU and UK ringfencing, which is often overlooked, is the advancement of a level playing field between banks on either side of the Atlantic. Federal Reserve regulation W prohibits federally-insured divisions of US banks lending to investment divisions. “Something that is much misunderstood is that ringfencing would lead the UK and EU to (very) roughly the same place where the US is,” said London-based Linklaters partner Benedict James. This is in light of the combined effect of Regulation W, the Volcker rule and the swaps push out rule (Lincoln provision). In any event, James expects that the expense and logistics of implementing a ringfence will encourage banks to separate their units. “The effect of Vickers/Liikanen, coupled with new capital and liquidity rules, may be a significant shrinkage in universal banking,” he said. Professor Kay did not respond to IFLR’s request for comment. 

 See International Financial Law Review for the full article, and for more bank reform coverage