Wednesday, March 20, 2013

Banking Reform in France – “Nobody can hide behind barbaric shortcuts or blurry algorithms!”

The introduction to the Banking reform proposal does not lack strong language. France’s economic and finance minister, Pierre Moscovici, says:

D’aucuns s’abritent derrière ses acronymes barbares et ses algorithmes obscurs pour parer aux tentatives de régulation.”
Nobody can hide behind barbaric shortcuts or blurry algorithms!”

La finance au service de l’économie, et non au service d’elle-même”
Finance for the benefit of the economy, not for the benefit of itself”

Remettre la finance au service de l’économie réelle.”
Shift finance to the benefit of the real economy!”

Let’s put this language aside and have a look at the proposed regulation:

Separation and Regulation of Banking Activities in France

The French government intends to

  • guarantee the stability of financial institutions,
  • endorse the solvency of banks in the interest of depositors, and
  • ensure the financing of the economy.

The draft law provides for four prohibitions: A financial institution cannot

  • practice proprietary trading;
  • trade with hedge funds (whose characteristics are to be defined by the Regulator later on);
  • practice high frequency trading;
  • trade forward financial instruments, whose underlying is agricultural commodities.

Proprietary Trading

In principal, financial institutions will no more be allowed to negotiate financial instruments on their own balance sheet.

However, this constraint shall only apply if the trading business goes beyond thresholds to be defined by the French regulator later on.

In addition, specific market activities are still allowed if they are carried out in legally separated subsidiaries of the financial institution. Such activities include

  • Financial investment services for the benefit of clients
  • Set-off of financial instruments
  • Risk management for the financial institution
  • Market making activities (Acting as an intermediary, the financial institution provides simultaneously offer and demand quotations for financial securities to keep markets liquid, or it executes put or call orders from clients.)
  • Wise and prudent cash management activities
  • Intra-group transactions
  • Strategic long-term or intra-group investments of the financial institution

The subsidiaries who do the above activities cannot receive client deposits or supply payment services.

Trading with hedge funds

French financial institutions will only be allowed to trade with hedge funds if their operations are backed by legal securities.

Liquidation Regime for Financial Institutions

With its reform, the French government strives for

  • preserving the financial stability;
  • ensuring the continuity of activities, services, and operations of institutions which are crucial for the functioning of the economy;
  • protecting deposits;
  • avoiding or, at least, limiting, the exposure of taxpayers’ money in case of a crisis.

The main features of France’s new liquidation regime for financial institutions are twofold:

  • Elaboration of a prophylactic restructuring plan by the financial institution and communication of such plan to the regulator
  • Injunction of restructuring (namely nominate a temporary administrator, dismiss the management team, impose of spin-offs, call other financial institutions or the depository and liquidation fund for help, “expropriate” shareholder’s equity, reduce the balance sheet, inflict equity rights’ issues, and limit the distribution of dividends) on a failing financial institution.

When reading the draft legislation, it becomes clear that important questions such as thresholds for the application of the law have been put aside for now. The full picture has not yet been painted.