30 March 2009

March 2009

Graham Bishop’s Personal OVERVIEW -

The politics of the EU continue to move ratchet-like towards an “ever-closer union” as the financial crisis grinds down opposition. March 2009 marked two significant steps: the agreement to put forward a common position to the G20 meetings, and the speedy acceptance of the de Larosiere Group (DLG) Report. Yet it is not a completely one way-street as the Council failed to agree on the group supervision issue in the Solvency II Directive. This aspect required Member States to trust each others’ regulators to ensure that funds were in fact transferred from the home state to a host state when necessary – an acid test of a political union.

As such European laws are not made in public; it is not possible to observe whether the objecting states may include some that may wish to benefit from the dramatically expanded balance of payments support facility for non-euro area states. Economic weakness can easily lead on to political weakness and the UK illustrates that point vividly. As EU leaders considered the DLG report, the UK put forward a counter-proposal with the political adroitness that characterised the Hard ECU plan of Mrs. Thatcher in the late ‘80s.

It received the same response: leaders promptly adopted the widely-canvassed European plan as “the basis” for further, swift action instead of even considering the UK ideas. Even UK Prime Minister Gordon Brown signed up to this. Perhaps he already recognised that the looming 13% of GDP budget deficit, 30% currency depreciation and the first failure of a government bond auction had undermined his political credibility. New data on the collapse of long term savings flows in the UK underlined that the auction failure may well not be the last one, and that in due course the UK may need assistance from “Europe”.

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Away from the political drama, the legislative process continues to rumble on:

• ECON adopted the Karas report on the CRD and agreed with the Commission's  proposal on a retention rate of at least 5% of the total value of the securitised exposures. However, Committee proposed alternatively an "explicit and unconditional warranty" to be issued by the originator of the securitisation, to prove respect for due diligence criteria. The establishment of colleges of supervisors should only be a temporary step towards a more integrated system of supervision. The Commission is called to put forward a legislative proposal to address supervisory concerns with "a stronger role for an EU level supervisory system" by the end of the current year.
• Credit Rating Agencies: Coreper reached agreement on a draft regulation on credit rating agencies. The draft regulation provides for a legally-binding registration and surveillance system for credit rating agencies issuing ratings that are intended for use for regulatory purposes.
• Council adopted a Directive on Deposit Guarantee Schemes raising the coverage level to EUR 100 000 from end-2010, and reducing the payout delay to 25 working days. In the writer’s view, this law tries to abolish moral hazard and so makes another crisis inevitable in time as citizens can be completely relaxed in placing deposits with reckless institutions. Fortunately the BIS is consulting on core principles for effective deposit insurance systems so that might give an opportunity for second thoughts.

The Basel Committee on Banking Supervision announced that the level of capital in the banking system needs to be strengthened to raise its resilience to future episodes of economic and financial stress. The regulatory minimum level of capital will be reviewed in 2010 to arrive at a total level and quality of capital that is higher than the current Basel II framework. The Committee noted that current reactions in the market place regarding capital levels have been highly pro-cyclical. It will not increase global minimum capital requirements during this period of economic and financial stress.

The process of learning lessons continues and the Commission provided guidance for impaired assets in the EU banking sector: The Communication outlines various methods of dealing with impaired assets, notably through asset purchase - including bad bank scenarios - or asset insurance schemes. It explained the budgetary and regulatory implications of asset relief measures and presents details concerning the application of the State aid rules to such measures.

The OECD addressed the weaknesses in corporate governance that are related to the financial crisis in a consultation report that analysed the impact of failures and weaknesses in corporate governance on the financial crisis, including risk management systems and executive salaries. The report concludes that the financial crises can be to an important extent attributed to failures and weaknesses in corporate governance arrangements which did not safeguard against excessive risk taking. Remuneration systems have not been closely related to the strategy and risk appetite of the company and its longer term interests. The importance of qualified board oversight and robust risk management is not limited to financial institutions.

CEBS published its principles on remuneration policy addressing key aspects of a well functioning remuneration policy of banking institutions. The scope of the principles covers remuneration policies applying throughout an organisation rather than focusing exclusively on executive pay or severance pay. However, the FSA has already gone further and published a draft code of practice on remuneration policies to ensure that firms have remuneration policies which are consistent with sound risk management, and which do not expose them to excessive risk. It is not concerned with setting levels of remuneration, which are a matter for the boards of companies and their shareholders.

The private sector is playing its part in developing governance codes and the European private equity industry proposed a unified code of conduct. The private equity and venture capital industry is prepared to commit to unify industry professional standards coverage across Europe, The paper calls for a unified Europe-wide set of standards based on a code of conduct and corporate governance guidelines in the management of private-equity held standards.

In the accounting field, the IASB is seeking views about the FASB proposals that deal with guidance on fair value measurement and impairments of financial instruments. The IASB considers publishing formal proposals for public comment following the feedback. Both of FASB’s proposals are in the form of draft Staff Positions and are intended to provide additional application guidance with a remarkably short comment period given the pressure from the US Congress for swift action. David Tweedie commented “Whilst these are US proposals specifically targeted at US capital markets we have been asked by the G20 and others to deal with financial reporting issues on a globally consistent basis”.

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Graham Bishop
 

© Graham Bishop