Fitch Says Some German Banks to Ditch Trading

Rating agency Fitch sees some of the large German banks reducing or eliminating trading activities in the face of new regulations rather than split into two institutions.

The comments come following news last week that German regulators agreed to draft legislation that requires that banks cannot mix risky trading activities with more traditional banking ones.

Fitch sees nearly a dozen of Germany's biggest banks falling under the new regulations, however the firm only sees a few of the banks actually being required to split into two firms to divest trading businesses. Fitch said, "The separation will have minimal impact at the consolidated group level. However, it could lead to greater ratings differentiation between legal entities within a banking group."

Some of Germany's largest banks, including giants such as Deutsche Bank DB and Commerzbank CRZBY, may be forced to shed vital trading operations or spin them off into new entities.

The resulting shifts could alter the financial services industry as a whole, changing the balance of power in global financial markets presences, and could be very serious for shareholders depending on how tax efficient spin-offs or divestitures could be.

"Placing 'risky activities' into separate subsidiaries would be neutral to slightly positive for bank credit profiles. We understand that the parent banks would not be allowed to make declarations of backing or profit-sharing agreements, which are typical support arrangements for German companies. We would expect some support to flow to the subsidiaries to avoid reputational damage. However, as the regulator would restrict parent banks from supporting them in times of stress, downside risk for the parent banks could reduce."

Banks with assets in activities deemed risky that exceed $135 billion or 20 percent of balance sheets greater than $121 billion would fall subject to these new regulations. Risky assets would include the entire trading book, excluding hedges that qualify for hedge accounting.

Proprietary and speculative trading, credit and guarantee business with hedge funds and leveraged alternative investment funds, and high frequency trading will have to be separated or closed according to the draft legislation. Like French banks, and positively for German banks, market making activities would not have to be separated.

"Deutsche Bank is the most obvious candidate for setting up a separate subsidiary, but smaller capital market banks may also be affected, for instance Commerzbank, LBBW and Unicredit Bank AG."

"If collateralised exposures, such as secured prime brokerage operations, are included the activities being separated would be much greater than just cordoning off unsecured exposures.

In addition, the regulator, BaFin, could force a stop or spin-off of market-making or other businesses that it views as risky or speculative if they pose a threat to the solvency of the bank. BaFin has discretionary power to assess all lenders."

The regulations are set to come into place in 2014, before any structural reforms are agreed at the European level, showing Germany's desire to lead from the top and by example. German banks would be required to divest necessary business by July 2015, and German banks would be subject to any additional European restrictions should EU rules be made more harsh than the ones created by Germany.

Deustche Bank shares rose 0.81 percent in German trading and U.S. listed shares rose 1.02 percent pre-market. Commerzbank shares, meanwhile, were flat in German trading. LBBW and Unicredit Bank are privately owned companies.