UK bank ring-fence remedy risks EU legal challenge

By Huw Jones

LONDON (Reuters) – Britain could be hauled in front of the European Union court if it implements proposals requiring retail banks on its turf to amass higher levels of capital in case of any future economic crisis.

The UK’s Independent Commission on Banking (ICB) recommended in an interim report on Monday that all big retail banks should protect depositors with a capital cushion of at least 10 percent.

That is three percentage points above globally agreed new levels from 2013, and although it is in line with international regulators’ overall requirements for larger banks, lawyers are already asking how such a move fits in with EU law on bank branches.

That law says a bank approved in one EU state has the right to open up a branch in another without being bound by the same local regulatory requirements a standalone would face.

Aimed at removing barriers to the free movement of capital and services, the rule says branches are regulated by the bank’s home country, which decides how much capital it must hold for the group overall.

“It is abundantly clear that EU law prohibits the UK government or its regulators requiring subsidiarisation of UK branches of European banks,” said Bob Penn of Allen & Overy law firm.

EU internal market chief Michel Barnier who is in charge of enforcing the branching law, declined to be drawn on a potential clash with Britain over ring-fencing.

“The timing and substance of this interim report is particularly useful for us,” Barnier said in a statement.

Barnier welcomed the ICB’s “interesting contribution” and looked forward to the final report in September.

In the meantime, he will publish a draft EU law before the end of summer to implement the tougher new global bank capital requirements known as Basel III.

For now it is not set to specify the ring-fencing of deposit taking bank branches across the EU but look at the overall capital of a bank.

“Continental Europe has long had a successful universal bank model mixing retail and investment banking, and therefore is unlikely to pay much heed to the report, or if it does, will likely see British moves as a source of future comparative advantage for the Continent,” said Richard Reid, head of research at the International Center for Financial Regulation.

Banks from outside the 27-country EU operating in the UK would have little legal protection against compulsory ring-fencing.

TREATY OBLIGATIONS

Simon Gleeson, a financial services partner at Clifford Chance lawfirm, said there could be EU legal challenges to the British plan but added the UK would probably seek to find middle ground.

“It is highly unlikely that the UK would act in direct contravention of its treaty obligations. The interesting question is whether the UK can sell this to Brussels as an EU policy initiative,” Gleeson said.

“If it can, the problem is solved – if it can’t, there is no easy way out,” Gleeson added.

An EU source in Brussels said branches are not separate legal entities like a subsidiary where national laws are applicable.

“It is not possible for a member state to impose specific national rules on branches,” the source added.

The ICB report said its proposed ring-fence was designed to fit within EU law but accepted that branches of EU banks remain primarily regulated by home authorities.

EU banks which keep their retail and investment banking businesses integrated will have the right to establish and expand their UK deposit-taking businesses through branches, putting UK domestic banks adhering to UK regulation at a disadvantage, legal experts said.

The ICB said “careful examination” showed it was far from clear whether domestic banks would suffer a significant disadvantage from “branching” by EU banks into the UK market.

It also doubted the appetite among UK banks to set up elsewhere in another member state and open branches in Britain.

“EU law contains provisions to constrain such behavior, for example a bank relocating to avoid stricter prudential standards requiring improved resolvability, and banks would also face significant practical obstacles,” the ICB said.

UK bank ring-fence remedy risks EU legal challenge