26 June 2006

June 2006

Graham Bishop’s Personal Overview.

The 2008 review of the Lamfalussy Process is now beginning to impinge substantially on thinking by market participants and regulators alike. But that review is no more than a series of code words for a much more wide-ranging review of the regulatory structure – and its political underpinnings. The Commission’s proposal for the Solvency II Directive – still scheduled for July 10th – could be something of a catalyst as it seems set to propose that insurance regulators be given a common “tool kit” as the minimum requirement for a lead regulator. If governments accept that, then it may not take long before the question arises about similar treatment in banking and securities. In turn, that will pose the question of how to regulate the genuinely pan-EU financial entities that are rapidly emerging to take full advantage of the single market. One point that is emerging strongly is that these entities want to be subject to extremely harmonised regulations so that reporting burdens are minimised.

That coin has another side: how to ensure the stability of the EU’s financial system. ECB President Trichet addressed ECON and highlighted the importance of current discussions on financial crisis resolution in order to underpin financial stability. He pointed out that “this implies acknowledging the current institutional distribution of responsibilities between home-country and host-country authorities also in a crisis situation… [and] the principle of the primacy of private sector solutions as regards crisis resolution.”

In the same vein, the Commission started a consultation on the winding up of credit institutions - questioning the adequacy of existing law in relation to the reorganisation and winding up of credit institutions in financial crisis. Does the current Directive completely fulfil its objectives, could be extended to cross-border banking groups, and how can obstacles related to asset transferability within such groups be addressed. Crucially, the second part looks at issues raised in the context of crisis management. It will examine legal frameworks across member states relating to the reorganisation of banking groups, and identify possible problems preventing a smooth crisis resolution process which may involve asset transfers across banking groups.

The shadow of MiFID seems to be moving across the securities world at a rather slower pace than the calendar requires. Nonetheless, the LSE has formally unveiled a package of services that it will offer member firms to assist their compliance. These include the introduction of new market-making functions on Sets and Euroset and a new European Quoting Service for firms to advertise prices in non-UK securities. Perhaps more strategically, the LSE has announced a bid for Borsa Italiana – in part to broaden its product range into bonds.

However, that aspect was thrown into some question by the possible consequences of CESR’s guidelines on transaction reporting. The transaction reporting regime established by MiFID is key for CESR members to monitor the activities of investment firms and to ensure that they act honestly, fairly, professionally and in a manner which promotes the integrity of the market. Almost co-incidentally, ICMA’s TRAX2 received conditional approval from FSA as an Approved Reporting Mechanism (ARM). ICMA’s TRAX system is already one of a limited number of permitted mechanisms reporting to the FSA and was one of the first to apply for the new ARM status under MiFID. Final approval from the FSA should fast-track TRAX2 to becoming a recognised reporting mechanism in other EU jurisdictions. Could that change the competitive landscape for the MTS bond trading platform where Borsa Italiana is about to buy full control from NYSE Euronext?

Hedge and private equity funds have continued to attract serious publicity as the G8 heads called for continued “vigilance” in relation to hedge funds. They re-iterated that the global hedge fund industry should review and enhance existing sound practices benchmarks; in particular in the areas of risk management, valuations and disclosure to investors and counterparties in the light of expectations for improved practices set out by the official and private sectors. Commissioner Charlie McCreevy again reiterated his view of the positive role hedge funds play in Europe, underlining that the way in which this business is maturing does not currently give rise to any need for specific legislation.

But the benefits flowing from “private equity” funds were heavily disputed in the UK. A report by the GMB Congress trade union unleashed an attack, citing 96 pension funds now in the care of the Financial Assistance Scheme (FAS), and the Pension Protection Fund (PPF) as a result of private equity activity. The political momentum for a clampdown on private equity chiefs gathered pace in the UK as Tony Blair highlighted “real issues” about the sector and MPs warned they are targeting the industry’s generous tax breaks. MPs said the influential Treasury select committee could recommend that buy-out chiefs be forced to justify favourable tax treatment on a case-by-case basis. The proposal, made during a two-hour grilling of four leading industry figures by the committee, visibly shocked the buy-out chiefs, who accused MPs of making tax policy “on the hoof”.

Corporate governance issues continue to command attention as the Commission issued a summary report on its consultation on the possible reform to limit auditors’ liability regimes in the EU. The audit profession considers that there is a need for a Commission initiative but the FEE President attacked the Commission’s report “The status quo is not a policy for today’s changing global capital market and certainly not a way to foster EU integration, competition and competitiveness”. Outside the audit profession, the majority of respondents from countries where a limitation exists also supported a Commission initiative, whereas the majority of the respondents from countries without limitation rejected any Commission action.

CESR published its advice to the Commission on a mechanism for determining the equivalence of the generally accepted accounting principles of third countries. It proposed inter alia that national standard setters should assess whether the disclosures, measurement and recognition principles, and financial statement presentation required by the third country GAAP concerned, are materially the same as IFRS. If there are no significant differences, such GAAP may be deemed equivalent without the need for additional rectification disclosures.

Across the Atlantic, the SEC took a historic step and recommended publishing for public comment a proposal to accept financial statements prepared in accordance with the English language version of IFRS as published by the IASB. The SEC’s Counsel said “It is important to demonstrate that IFRS represents, in fact, a single set of global standards. It is for this reason that we recommend that the proposed amendments apply only to financial statements prepared in accordance with IFRS as published by the IASB.” The commissioners voted 5-0 to propose easing the accounting requirement for foreign companies.

But the European Parliament’s ECON committee took strong exception to this very specific formulation as they believe it undermines the role that European legislators and supervisors play in international accounting standard setting. So they have asked Commissioner McCreevy to ensure that the role legislators play in international accounting standard setting is not undermined. They also want the Commissioner ensure that conditions for recognition of US GAAP and IFRS in both jurisdictions without reconciliation - as agreed at the last EU/US summit - are created. The EU-US financial relationship is developing quickly but there are still plenty of details where devils can lurk!

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Graham Bishop

© Graham Bishop