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Too-Big-to-Fail Banks Face Trade Limits Under EU Plan

The proposals are aimed at avoiding a repeat of the financial crisis that followed the failure of Lehman Brothers Holdings Inc. in 2008. Photographer: Chris Ratcliffe/Bloomberg
The proposals are aimed at avoiding a repeat of the financial crisis that followed the failure of Lehman Brothers Holdings Inc. in 2008. Photographer: Chris Ratcliffe/Bloomberg

Jan. 4 (Bloomberg) -- The European Union may give regulators power to block new products and limit trading risks at banks deemed too big to fail, as part of plans to protect public finances from future financial crises.

National regulators of cross-border banks may be able to require “changes to legal or operational structures” if the lender would need “extraordinary public financial support” during a crisis, according to draft proposals obtained by Bloomberg News.

The EU is aiming to avoid a repeat of the financial crisis that followed the 2008 failure of Lehman Brothers Holdings Inc. and resulted in European governments setting aside more than $5 trillion to support banks. The plans echo calls from the Financial Stability Board for regulators to be able to force structural changes on banks.

“They are clearly thinking along the lines that, if they believe that any institution is too risky to be salvageable, it should be broken up,” Simon Gleeson, a financial regulation lawyer at Clifford Chance LLP, said in an e-mail.

The plan also envisages measures “requiring the credit institution to limit its maximum individual and aggregate exposures” or forcing banks to “limit or cease” some activities, according to the document, dated December 2010.

Regulators should assess lenders and “satisfy themselves that critical functions could be legally and economically separated from other functions” during a crisis, according to the draft proposals.

Judicial Review

If a bank disagreed with the changes imposed on it, the regulator would have to “give reasons” or “propose revised measures.” The lender could then appeal the decision in the courts or demand a judicial review, the document said.

The Brussels-based European Commission, the executive arm of the EU, is scheduled to propose the measures as early as this week. It will seek views from banks, consumers and investors on the plans before submitting a final proposal for discussion with the 27 EU member states later this year.

Authorities would have a “statutory power” to “either write off subordinated debt or convert it into an equity claim,” as well as the ability to enforce losses on senior debt “by a discretionary amount,” via one policy option considered by the commission and mentioned in the document.

The FSB, a global group of regulators and finance ministry officials, said in October it would look for viable methods for investors to help shore up troubled banks, including imposing losses on bondholders. The FSB plans to complete this work by the middle of 2011.

Junior Debt

Regulators should be able to wipe out holders of banks’ junior debt and preference shares, or convert it to common equity, when a lender is at the point of failure, the Basel Committee on Banking Supervision said in separate draft proposals in August.

Deutsche Bank AG was ranked as world’s most systemically important financial institution by Japan’s Financial Services Agency and central bank, the Mainichi newspaper reported last week. Goldman Sachs Group Inc. and JPMorgan Chase & Co. followed on the list of 60 institutions, according to the report, which didn’t say how the information was obtained. The banks were ranked on the impact their failure would have on the global financial system, the paper said.

The FSB has said that by mid-2011 it will identify a list of lenders “of such size, market importance, and global interconnectedness that their distress or failure would cause significant dislocation in the global financial system.” Such banks should be subject to tougher regulation and oversight, the FSB said.

Authorities “should have the powers, exercisable under clear criteria, to require a financial institution to make changes to its legal and operational structure and business practices” to ensure that it can be wound down, the FSB said in a report to the Group of 20 countries in October.

To contact the reporters on this story: Ben Moshinsky in Brussels at bmoshinsky@bloomberg.net.

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net

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