9.2.1.2 Critique on Class 1 investment firms

369. Regarding the first aspect of the changes in the CRR definition of credit institution, i.e. the relevant activities, it should be noted that the IFR and IFR nor the EBA reports and the proposals by the European Commission contain a clear argumentation as to why these activities should be seen as “bank-like”. Although dealing on own account and underwriting are both activities that can lead to significant risks for the investment firm,1 the conclusion that these are, therefore, always “bank-like” is not obvious.2 A bank is defined in the CRR as an “undertaking the business of which is to take deposits or other repayable funds from the public and to grant credits for its own account”.3 Dealing on own account and underwriting do not in themselves lead to an undertaking with a risk profile similar to that of a bank that takes deposits or grants loans. The EC then further argues that the current CRR “has clear and corresponding requirements”4 for dealing on own account and underwriting, but this argument does not truly convince as it does not include an assessment of whether the current CRR requirements for dealing on own account and underwriting are indeed appropriate for an investment firm that does not take deposits. This study has argued against applying these CRR requirements to investment firms in Chapters 2, 7 and 8. Furthermore, if the CRR indeed has clear and corresponding requirements for investment firms that deal on own account and perform underwriting services, why are these requirements only applied to Class 1 investment firms and not to all investment firms performing these functions?

370. The EC repeatedly makes a comparison between these types of ‘bank-like’ investment firms that deal on own account and underwrite and ‘investment’ banks that also perform these activities. Both types of undertakings (the ‘bank-like’ investment firm and the ‘investment’ bank) do indeed perform similar activities, whereas the investment bank is also allowed to take deposits from clients. The EC uses the similarities as justification for keeping these types of investment firms under the rules laid down in the CRD 2013 and CRR, and seems to ignore the differences between these types of enterprises. The EC purports to build further upon this argumentation by referring to the risk to the financial system posed by these types of investment firms. “[These types of investment firms] present a higher risk to financial stability, given their size and interconnectedness”.5 However, a conclusion that a firm might pose a higher risk to financial stability does not mean the current CRR regime is the appropriate regime to manage these risks. By simply keeping these types of ‘bank-like’ investment firms under the application of the CRD 2013 and the CRR, the EC has missed the opportunity to truly assess how these risks to the financial stability could be managed by competent authorities.

371. Given the differences in activities between a bank and an investment firm, a true assessment of the most effective prudential regime to address systemic risks could very easily have resulted in a different requirement than that imposed by the EC in the IFR.6 Based on the discussion in Chapter 2 on the risks associated with the provision of investment services, the discussion in Chapter 4 regarding asset segregation and the discussions in Chapter 8 regarding a gone-concern focus and the merits of the BRRD for investment firms, merely stating that certain “bank-like” investment firms should be subject to prudential requirements similar to those applying to a bank does not take into account the actual risks of these activities. Providing a certain investment service or activity does not necessarily mean that an investment firm immediately has a risk profile similar to that of a bank.

372. Perhaps unknowingly, this seems to be a direct implementation by the European legislator of the systemic risk dimension as proposed by Moloney.7 It should be noted that the EBA and the European legislator do not mention Moloney nor do they explicitly refer to Moloney’s framework. As such, if the IFR and IFD might seem to be built upon her framework, this would appear to be a coincidence. It does however highlight that the framework proposed in section 2.1.4 of this study, which builds upon the Moloney’s framework, is an adequate means of assessing prudential risks of investment firms, as the IFR and IFD regimes address risks along the lines of that framework even without an explicit choice by the European legislators to build the regime on such a framework. As discussed in Section 2.1.2, Moloney’s framework and the justification provided by the European legislator do not consider that there are other factors that can have a bigger influence on the risk profile of an investment firm which should have been used to assess whether if an investment firm should be subject to more stringent capital requirements. This study, and in line with the discussion in section 2.1.4, will propose a possible means to do this.

373. Regarding the second part of the new CRR definition of credit institution, i.e. the €30 billion threshold, the European Commission gives no clear indication as to why a threshold of €30 billion is appropriate. The EC states that the proposed change in the definition of ‘credit institution’ would “also have implications for the SSM Regulation and thereby imply not only that systemic investment firms would remain subject to the CRR/CRD 2013, but also that their prudential supervision is ensured by the SSM to the extent that they are established in member states participating in the Banking Union”.8 Under the SSM regulation,9 credit institutions where the total value of assets exceeds €30 billion are under direct supervision by the European Central Bank (ECB). According to the EC, it would then make sense if a Class 1 investment firm whose total value of assets also exceeds €30 billion, were subject to direct supervision of the ECB, especially now that the EC intends that investment firms with a total value of assets of €30 billion or over need to apply for a licence as a credit institution.10

374. The only, implicit, argumentation by the EC for the €30 billion total value of assets threshold for investment firms to be considered Class 1, appears to be this additional effect of then also having these Class 1 investment firms within the supervisory scope of the SSM. The questions whether investment firms that have total consolidated assets of over € 30 billion are indeed ‘riskier’ than investment firms that fall below this threshold, remains unanswered by the EC. The €30 billion threshold, therefore, seems to be a political solution to make sure these investment “banks” are subject to the supervision of the SSM.

375. The intention of the EC with the introduction of the IFR and the IFD is to provide a framework that better captures the specific risk profile of an investment firm, which should therefore also be a better prudential framework for those large Class 1 investment firms. Instead of forcing those Class 1 investment firms to comply with the CRD 2013 and CRR regime and therefore also subject them to the requirements that address systemic risk, these requirements could also have been included in the IFR or the IFD. This would then have obviated the need to change the definition of ‘credit institution’.

376. With the final IFR and IFD texts, the EC implicitly acknowledges that, given the reasoning provided by the EC for drafting the IFR and IFD, a Class 1 investment firm is subject to CRD 2013 and CRR requirements which are not risk-sensitive enough to capture investment firm risks that are not related to dealing on own account or underwriting. The benefit of being able to apply the CRD 2013 and CRR requirements concerning systemic risks to those Class 1 investment firms have thus been considered more material than the disadvantage of losing the new risk-sensitive prudential regime of the IFR. It should be noted that by having the Class 1 investment firms subject to the CRD 2013 and CRR requirements, this will also mean that these Class 1 investment firms will not be able to make use of certain exemptions and specific risk treatments within the “market risk” framework in the IFR.11 The Class 1 investment firm will be fully subject to the strict and stringent market risk framework of the CRR. The deviations between the CRR market risk regime and the regime in the IFR will be further discussed later on in this Chapter.