Financial Regulatory Forum

FACTBOX – Comparing EU and U.S. financial reform

May 21, 2010

LONDON, May 21 (Reuters) – The U.S. Senate approved a reform of Wall Street on Thursday and President Barack Obama may be signing into law the most sweeping changes to financial rules since the 1930s as soon as next month.

It implements pledges the United States, the European Union and other leading countries in the Group of Twenty made in 2009.

With the United States set to adopt its reform soon — and thus easily meet G20 deadlines — the EU has to play catch-up in some cases. Banks are watching carefully as transatlantic differences are emerging that will affect business models.

The following compares U.S. and EU reforms.

PREVENTING MORE TAX-FUNDED BAILOUTS

The G20 wants to end the belief among banks they are “too big to fail” by requiring resolution mechanisms and “living wills” for speedy windups that don’t destabilise markets.

The Senate sets up an “orderly liquidation” process.

The EU, a collection of 27 states with no common insolvency laws, faces a much harder task of thrashing out a pan-EU mechanism even though cross-border banks dominate the sector.

EU executive European Commission will publish a policy outline on resolution funds next week so that banks pay for future bailouts with legislation due in 2011. Internal splits over what to do with money raised.

Winners/Losers: Banks face and extra levy on top of higher capital and liquidity requirements. Taxpayers should be better shielded. Messy patchwork for global banks who will come under pressure to “subsidiarise” operations in difference countries.

OVER-THE-COUNTER DERIVATIVES

The G20 agreed that derivatives should be standardised where possible so they can be centrally cleared and, if appropriate, traded on an exchange by the end of 2012.

The U.S. Senate wants to go much further by requiring banks to spin off their swaps desk to isolate risks from depositors but it is unclear if this will make it to the final law.

The EU proposes its draft law on derivatives by July and will focus on mandatory clearing of contracts. It is less fixated on mandatory exchange trading and won’t look at the issue until much later in the year. It has no appetite so far to force structural changes on bank swap desks.

EU and United States likely to agree exemptions for companies who hedge but could be differences in scope.

Winners/Losers: Global banks could shift some trading from the United States to the EU. Corporates face costlier hedging as there will be heavier capital charges on uncleared trades but differences in exemption scope could be exploited.

BONUSES

The G20 has introduced principles to curb excessive pay and bonuses, such as requiring a big chunk of a bonus to be deferred over several years, with a clawback mechanism.

United States and EU are applying these principles and taking their own actions, such as a one-off tax in Britain.

Winners/Losers: Harder to justify big bonuses in future.

CREDIT RATING AGENCIES

The G20 agreed that ratings agencies should be required to register, report to supervisors and show how they manage internal conflicts of interest. An EU law to this effect comes into force later this year and the bloc is looking at how it could be toughened up. U.S. reform plans are similar so no real differences expected.

The EU will beef up its rules in June to introduce pan-EU supervision and make it easier for new entrants into the sector.

Winners/Losers: Ratings agencies will have to justify what they do much more in future. The “Big Three” — Fitch, S&P and Moody’s may face more competition in the EU. The sector faces more efforts to dilute their role in determining bank capital requirements.

HEDGE FUNDS/PRIVATE EQUITY

The United States and EU working in parallel to introduce G20 pledge to require hedge fund managers to register and report a range of data on their positions.

U.S. law in line with G20 but exempts private equity and venture capital. The EU wants to go much further by including private equity and requiring third-country funds and managers to abide by strict requirements if they want to solicit European investors, a step the United States says is discriminatory.

Managers of alternative funds in the EU would also have curbs on remuneration, an element absent from U.S. reform.

Winners/Losers: U.S. hedge fund managers may find it harder to do business in the EU. European investors may end up with less choice. Regulators will have better data on funds. EU managers may decamp to Switzerland, though also for tax reasons.

BANKS TRADING

The Senate has adopted the “Volcker rule” which would ban risky trading unrelated to customers’ needs at deposit-insured banks though unclear if it will be in the final law.

Key EU states against the rule as they want to preserve their universal banking model.

Winners/Losers: Some trading could switch to the EU from the United States inside global banks.

SYSTEMIC RISK

The G20 wants mechanisms in place to spot and tackle system wide risks better, a core lesson from the crisis.

The Senate bill sets up a council of regulators that includes the Federal Reserve but the House wants a bigger role for the Fed. The EU is approving a reform that will make the European Central Bank the hub of a pan-EU systemic risk board.

Winners/Losers: ECB a big winner with an enhanced role that many see as a platform for a more pervasive role in future. Banks will have yet another pair of eyes staring down at them.

BANK CAPITAL REQUIREMENTS

The push to beef up bank capital and liquidity requirements is being led by the global Basel Committee of central bankers and supervisors which is toughening up its global accord as requested by the G20 to take effect from the end of 2012.

The U.S. bill directs regulators to increase capital requirements on large financial firms as they grow in size or engage in riskier activities.

The EU is approving new rules to beef up capital on trading books and allow supervisors to slap extra capital requirements if remuneration is encouraging excessively risky behaviour. It will debate a further set of rules at the turn of the year to toughen up definitions of capital and introduce leverage caps.

Winners/Losers: Bank return on equity set to be squeezed. Regulators will have many more tools to control the sector. Higher costs likely to be passed on to consumers, investors. Could be timing issues as EU has been more willing than United States in past to adopt Basel rules.

FIXING SECURITISATION

The Senate bill forces securitizers to keep a baseline five percent of credit risk on securitised assets. The EU has already approved a law to this effect.

Winners/Losers: banks say privately the 5 percent level is low enough not to make much difference and that key problem is restoring investor confidence into the tarnished sector.

((Reporting by Huw Jones, editing by Ron Askew; huw.jones@thomsonreuters.com; + 44 207 542 3326))

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