Too-big-to-fail banks face new limits in EU plan

The European Union (EU) may give regulators powers 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.

The EU is also proposing 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.

“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 email.

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. 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.

Subordinated debt
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 Financial Stability Board (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.

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 draft proposals in August.