Division Bank and Insurance
Austrian Federal Economic Chamber
Wiedner Hauptstraße 63 | P.O. Box 320
1045 Vienna
T +43 (0)5 90 900-ext | F +43 (0)5 90 900-272
E bsbv@wko.at
W http://wko.at/bsbv
Your reference, Your message of
Our reference, contact person
BSBV 53/Dr.Egger/St
Extension
3137
Date
12 November 2012
The Division Bank and Insurance of the Austrian Federal Economic Chamber, as representative of the entire Austrian banking industry, appreciates the possibility to comment on the report of the High-level Expert Group on reforming the structure of the EU banking sector (so-called
Liikanen-Report) and would like to submit the following position.
General Remarks
The report rightly comes to the conclusion that business models were not a driver in the financial crisis and that the benefits of the universal banking model have to be recognised.
Nevertheless the report recommends a mandatory separation of proprietary trading activities and other significant trading activities over a certain threshold and furthermore a possible additional separation of trading activities conditional upon the recovery and resolution plan.
Thus there seems to be a gap between the conclusions of the analysis conducted and the final recommendations.
From our perspective the adequate answer to the underlying problem of proprietary trading would be adequate supervision and an adequate level of loss absorbency. In our view the additional risk charge driven by Basel 2.5 and Basel 3 of three to four times higher capital charges for trading activities should be sufficient. Banks should be left a room for maneuver for an economically efficient way of capital allocation and diversification. A proper capitalization, strengthening banks diversity and appropriate regulations are the main factors of a stable and well-functioning banking sector and hence should be in the focus of any further improvement. For the time being we see no necessity for any mandatory changes of the European universal banking system.
The report intensifies the impression that the link between structural reform and financial stability was not accurately evaluated. In our view the new proposals would increase costs, but will not increase financial stability automatically to the same amount. From a todays perspective the proposal seems partly to be reaction to issues already addressed by other initiatives (Basel 2.5, Basel 3, Basel trading book review).
- 1 -

In general the model of universal banking like in Austria coped better with the financial crisis than the separate banking system. The main drivers of the crisis were partly insufficient and uncoordinated supervision, inadequate risk management, excess dependence on financing in the markets etc. and less certain banking structures, as various structures and models had been affected by the crisis.These problems have at least partly already been addressed by existing or prepared new regulations.
Furthermore, it should be ensured that the specifications of the Report (i.e. transactions/financial instruments permitted to be owned by a deposit bank) are consistent with the set of forthcoming EU regulation (e.g. CRD IV/CRR).
The second step in the decision process to require mandatory separation subject to a determination by supervisors is quite problematic as there is no legal certainty and the fundamental rights of the banks could be infringed.
Specific Comments
With regard to the scope of the activities to be in the trading activities ring-fence, we think that a clear definition of the relevant assets is needed as well as qualitative criteria like the purpose of the deal or purpose of selling or repurchasing the financial asset in the near future or holding period. All assets that are part of the strategic bank management as permanent investments set against customer deposits must remain in the deposit bank.
The use of the IAS/IFRS categories is unsuitable because
 IFRS are not developed for supervisory purposes and constantly change due to other reasons. Whatever might be determined under IFRS 9 today might have completely different implications with new IFRS rules tomorrow;
 The categories "held for trading" and "available for sale" are far too broad definitions to define proprietary trading. They include positions held o for or in connection with customer business o for market making o as liquidity buffers (i.e. sovereign bonds) o for asset/liability management o for market risk management (e.g. FX, interest) of the bank as a whole (i.e. derivatives)
Furthermore interbank business is included in these IFRS categories. This could discriminate business between banks for example within decentralized sectors. Such business has to be shown in the balance sheet and P&L. When a central institution secures the liquidity and refinancing of the members of its sector it provides it by cash clearing, liquidity & market risk management as well as other bank services for own as well as customer business.
We therefore propose to define trading assets/proprietary trading completely apart from IFRS rules.
Concerning the first threshold we do not see the reason of referring to the volume of the
Available for Sale portfolio (AfS). The AfS portfolio is a banking book portfolio which is widely used for asset/liability steering purposes. The volume of this portfolio is not an adequate indicator for the volume of proprietary trading. On page 101 of the paper it is clearly set out that these assets shall not be included in the separation obligation. Therefore we plead for a reconsideration to take the AfS portfolio into account for threshold purposes. In this context we want to highlight the IAS definitions regarding AfS. According to IAS 39 Available-for-sale financial assets are those non-derivative financial assets that are designated as AFS, or are not classified as loans and receivables or HTM investments, are not held for trading and are
- 2 -

not designated as at FVTPL on initial recognition. Given that per definition assets held for trading cannot be included in AFS it would be completely misleading to assess the requirement for a mandatory legal separation of proprietary trading activities and other significant trading activities on the volume of the AFS portfolio. One of the most important financial asset classes included in AFS are financial assets held for liquidity purposes. Based on the Liquidity Coverage Ratio required by Basel III banks have to ensure that sufficient high quality liquid resources are available for one month survival in case of a stress scenario.
Although this requirement will only be introduced in 2015 banks already prepare to meet this new ratio. The European Banking Authority (EBA) in its second report of the Basel III monitoring exercise (which presents the aggregate results on capital, risk-weighted assets, leverage and liquidity ratios in EU member states, published on 27 September 2012) concludes that “Compared to the previous period, monitoring results show improved liquidity ratios for both Group 1 and Group 2 banks with a substantial dispersion across banks and countries.”
Banks that increased their stock of unencumbered, high quality liquid assets in order to promote their short-term resilience to potential liquidity disruptions, will now be punished if they designated these as AFS. Therefore any sensible assessment of a required legal separation of trading activities must not be based on AFS but must include the trading purpose as its main parameter.
Definition of proprietary trading
The chance to define proprietary trading as one of if not the most significant issue when
discussing a mandatory separation, as well as market-making and where its differentiations are is missed by the report. We are of the opinion that a prohibition of market-making activities for deposit banks will substantially harm the liquidity of markets, especially those with medium to low liquidity – especially for instance the secondary bond market, but also investment certificates, which becomes even more harmful in smaller markets like Slovakia,
Czech Republic or Austria. Disadvantaged would not only be financial investors but also retail customers. We are underlining the fact that market making has nothing to do with speculation but is customer related business. It is a necessary bank function that is also economically reasonable to be linked to deposit taking activities. Legislators/regulators should keep in mind that market making is a substantial part of distribution of financial products, like bonds
(including governmental bonds), exchange traded funds, or investment certificates. Deposit taking banks due to their branch networks and other distribution channels are main distributors of such financial instruments throughout the EU. Moreover fundamental risks do not arise from market-making activities related to distribution of financial instruments and risks arising from these activities played no role in the origination and dispersion of the financial crisis.
Funding of the trading entity and regulatory issues
It seems unclear how the trading entity should be funded in the context of the mandatory separation: Should the trading entity issue own bonds? Here the question arises which group of investors shall be attracted by an undiversified business model only comprising proprietary trading? If the funding should take place via the holding, and the holding via external sources:
Does that mean that in the relationship between holding and trading entity a zero risk weight for large exposures and solvency purposes should take place? How is it ensured that the trading entity is not indirectly funded by the deposit bank via the holding? Do we understand the proposal correctly that a waiver (in the context of Art 6 and 7 CRR) should not take place for the deposit bank and for the trading entity (as it is being said that these entities should comply with all regulatory requirements on a stand-alone basis)? If yes: What is the room of application of Art 6 and 7 CRR? What is the risk weight of exposures of the deposit bank to the trading entity in terms of solvency (normal bank risk weight as we assume, i.e. no intra-group zero risk weight)? How is a missing zero-risk weight being argued before the background that also a consolidated requirement for the whole group should take place (or should this requirement be abolished)? What about Liquidity Coverage Ratio and Net Stable Funding ratio?
- 3 -

Do these rations also have to be fulfilled on a standalone and consolidated basis? Should a waiver (Art 7 CRR) be possible? What exactly is the benchmark for “at arm’s length”? All these questions have to be resolved in detail. The paper only gives answers to some questions but not to all relevant questions. Many details remain totally unclear. Without the details it is difficult to fully assess and analyze the impact of the recommendations.
Additional separation of activities
With regards to the proposal for additional separation of activities we are of the opinion that once a mandatory system has been set up an additional separation under the same auspices
(separating proprietary trading from deposit taking) is unnecessary and should also be avoided under the auspices of legal clarity: an issue that has already been addressed by strict mandatory rules should not be an object to additional supervisory consideration with other criteria. An intervention in economical normal times because of an assessment by authority that in a resolution scenario a bank would not be able to separate certain activities, is inacceptable considering that a resolution scenario may never occur. These interventions in the business model violate fundamental rights of the banks. At least the authority should be obliged to deliver a formal decision, against which the credit institution should have a right to appeal with suspense effect. Therefore, procedures in accordance with the rule of law should be established.
Additional non-risk based capital buffer/or floor capital requirements for all trading-book assets
To start a discussion in the context of a setup of several new buffers (countercyclical buffer, conservation buffer, SIFI-buffer, systemic buffer), higher minimum capital requirements
(Basel 2.5 and 3) and a total review of the trading book (considering new boundaries, expected shortfall instead of VaR, concentration on tail risks, etc., in effect higher capital requirements) seems inappropriate. With regards to a possible floor the discussion is anyway already opened within the context of the Basel Trading Book Review (standard method floor).
Bail-In Capital
We cannot follow the argumentation to go for specific bail-in-able capital. Specifically the argumentation does not seem to be compelling. We also do not understand the timing of this proposal as we are already discussing the proposal for a Crisis Management Directive (CMD) indicating rather a comprehensive approach than a specific bail-in able capital approach. We
rather plead for the comprehensive approach set out in the CMD-Draft. The proposal to ban financial-investors from investing in bail-in-able capital seems to be an exaggerated approach we oppose. Also in this respect we cannot follow the argumentation. This proposal would have further detrimental effects on the funding and capitalization of banks. This would tighten up the bail in -restrictions in a way, which could lead to serious consequences. A big part of these senior bonds are now hold by the banking industry. At the same time there are new regulations coming for example addressing insurance companies, which will also restrict their possibilities to invest in bonds.
Incentive Schemes
We are also cirtical concerning incentive schemes. The report partly missed a chance and again is focusing on extrinsic motivation (“carrots and sticks”; “if … then rewards”).
Furthermore the absolute levels of remuneration does not make any sense because:
In a Europe of different living standards and purchasing powers absolute numbers increase the discrimination across regions and businesses;
The absolute numbers also cause pay discrimination between industries: Financial
Services vs other industries like Telecommunications, Manufacturing, Life Sciences, etc.
Pay markets in general are dynamic and different in each country. For example,
Austria can have a lack of risk managers (i.e. negative unemployment rate in this
- 4 -

category), while Germany would have a surplus (i.e. positive unemployment rate in this category). Pay markets will have to react on these developments and be more dynamic than the regulations would allow. Another point is the competition amongst industries to find the best employees possible. A strict regulation like proposed would hinder the financial services industry to adequately compete.
Further issues concerning incentive schemes are:
A partially paid incentive via bail-in-able papers might be the wrong direction. We do not understand how this proposal is related to the already existing regulation that an important part of variable remuneration (minimum 50%) for identified staff has to consist in non-cash instruments. Should the proposal replace the cash part? Should it replace the non-cash part (at the moment shares or other common equity Tier 1 instruments, i.e. like bail-in capital after the trigger event occurred)?
We do not understand the reasoning behind the proposal to cap bonus payments at dividend level because the dividend level does not indicate the relevant level of lossabsorption. The reasons not to pay out any dividend can be manifold. To link the level of bonus to the level of dividend payouts is not appropriate and not risk sensitive. We also do not understand the regulatory aspect of this link. It should be left to the credit institutions to define their levels in this respect.
Moreover we do not understand why the shareholders should be obliged to decide upon incentive schemes as they are already represented in the management board in its supervisory function. And this board has to establish a remuneration committee, which is responsible to decide upon incentive schemes. We do not see the added value of this proposal in comparison to the current regulatory environment.
Sanctions
The proposal seems to be unclear in this context. We are already confronted with a detailed fit & proper regime, which could – in the context of important breaches of banking law – de facto end up in life long ban from management functions in banking. What is the purpose of this additional recommendation? Is it correct that the ban should also include any position in the financial industry? This would be too far reaching and opening questions touching constitutional fundamental rights. What is the proposal concerning the claw back trying to achieve? Also here we are confronted with heavy regulation, including claw back provisions?
Also these proposals are rather confusing.
Kindly give our remarks due consideration.
Yours sincerely,
Dr. Franz Rudorfer
Managing Director
Division Bank and Insurance
Austrian Federal Economic Chamber
- 5 -