17 December 2007

Forum Notes

Notes on the meeting held at the European Parliament,
17th December 2007.

 


A preliminary look at the way the MiFID Directive is functioning in its first few weeks and a broader overview of the EU’s response so far to the turbulence in credit markets were the focus of discussions at Graham Bishop’s European Finance Forum.

Graham Bishop opened the meeting by suggesting that the market response so far to MiFID had been very low key. Regulated markets had introduced price cuts and announced their own platforms for systematic internalisers but the market landscape had not been transformed except to the extent that, according to the CESR web site, alongside the 9 firms that had registered as systematic internalisers and 91 Regulated Markets in the EU, 100 firms had registered to become multilateral trading facilities (MTFs). Perhaps as few as a dozen would finally survive as serious players, he said. One, Chi-X, is even offering free data reporting, an innovation which if broadly followed could eat into the profits of exchanges such as the LSE for whom this is an important business line.


Critically, he went on, MiFID opens up clearing and settlement to non-regulated exchanges – previously it had been a critical bottleneck - but it is still unclear whether interoperability is being made to work in practice as the clearing and settlement code requires. If not, then a major competition-enabling element of MiFID will not have been put into effect.


Piia-Noora Kauppi MEP started her presentation by saying that although financial institutions were still busily complaining about the regulatory burdens and compliance costs of MiFID, she did not doubt that long term benefits would accrue. This would, however, require a big change in compliance culture, for example, and that would take time. She said there would be first mover advantages for Chi-X and Turquoise, for example. MiFID is principles based and not therefore old fashioned “tick the box” regulation. But old attitudes linger, particularly amongst law firms who are still seeking 100% safe harbour assurances for their clients from local regulators for example.


She pointed out that Commissioner McCreevy had highlighted areas of commercial banking operations where Europe is making more rapid progress and where growth is expanding faster than in the US, including for example, foreign exchange trading, equity IPO’s, derivatives innovation and bond and equity markets more generally. She added that MiFID is on its way to becoming a global standard – a recent visit to Mumbai in India confirmed for her the extent of local interest in MiFID-style regulation, for example. Japan too is interested. It also can play a big role in promoting trans-Atlantic convergence. Anthony Belchambers, of the Futures and Options markets Association, has drawn up a list of deliverables on convergence.


But, she pointed out, there have been problems with MiFID implementation, with Hungary, Spain, Poland and the Czech Republic missing the transposition deadline, although the first two should be compliant by the end of 2007. Worryingly, there has been another outbreak of “gold plating,” with the UK’s Financial Services Authority trying to pre-empt the details of MiFID implementing rules by rushing out its proposals first, which included considerable “gold plating,” a move which encouraged other jurisdictions to follow suit. This tended to undermine the single market. The Commission should act to stop this sort of behaviour, she maintained. The big challenge facing Parliament, she went on, is raising the quality of pan-EU financial supervision. (Fuller discussion of these issues comes later in this note.)

A Commission official said that the Commission will soon start checking whether there are inconsistencies in MiFID implementation The Commission also needs the private sector to signal incorrect application of MiFID as it cannot police all EU markets. Looking forward, he said that the Commission would soon be producing reviews of “non-equities transparency” and of commodity derivatives trading by the end of 2008.

Internal Market Commissioner McCreevy has made it clear he does not see a market failure requiring legislation to promote greater price transparency in EU wholesale bond markets. This might be an issue on the retail bond market side, although it does not call for MiFID-style transparency. As for the credit market turmoil, it is not apparent that more price transparency in bond markets would have made any difference to the current credit market upheavals.
The Commission is also looking at commodity markets and whether exemptions for certain commodity firms from MiFID and the CRD are appropriate. The issue at this stage is less about “soft” commodities such as cocoa or sugar and more about the gas and electricity sectors. He outlined four main options for tackling these issues.

Turning to issues relating to the three Level 3 Committees, the Lamfalussy process and financial market supervision, he said that the Commission has put forth its proposals for enhancing financial supervision (stronger EU mandates for CESR, QMV etc). As far as the trans-Atlantic dialogue is concerned, he said this was making positive progress with mutual recognition of securities markets a hot topic for 2008.

Commenting on this presentation a participant expressed concerns about the implementation of MiFID, noting that, as far as “best execution” is concerned, some markets are narrowing down client options in ways which undermine the spirit of the Directive. Pia-Noora Kauppi expressed her concerns at this.

Turning to the broader issues of the credit market upheavals and their implications for supervision, the Commission official said that McCreevy had been quick to call for an examination of the conflicts of interest facing credit rating agencies, of their methods of valuation for structured products and of whether they have adequate resources in relation to their responsibilities.

Graham Bishop intervened to say that the debate over supervision is obscure since it is not clear what people actually mean by certain proposals they are putting forward. What, for example, did Italy’s finance minister Tomasso Padoa-Schioppa have in mind when the floated the idea publicly of a single EU rule book for supervisors and how did he come to the conclusion that no Treaty changes would be needed to implement a move towards a lead supervisor model. A participant suggested that these were longer term proposals aimed at achieving a more harmonised EU rule book for banks and greater pooling of information by supervisors, which could be implemented by the Level 3 Committees. But, clearly, if this was to turn into a move towards a single EU supervisory authority, then you would indeed need Treaty changes.

These options could be seen as operating in parallel, strengthening the Level 3 Committees’ role or moving towards something different in the form of an EU lead supervisor. There is also the problem that the EU does not have good crisis management tools. Graham Bishop pointed out that even though Northern Rock is not a large cross-border bank, its rescue has put a strain on the UK Government’s balance sheet. Were there to be a cross-border banking crisis and inadequate tools were available to manage it “the damage which could be done to the idea of Europe would be huge.”

Another participant suggested that Northern Rock was a one-off event, precipitated by an inadequate depositor protection scheme, which could not happen again. Pia-Noora Kauppi remarked that “this issue of who bails out a failing bank, who is the lender of last resort and who gives liquidity cannot wait for the next crisis.” It was, she went on, the way regulated banks were taking risks they were not aware of which sowed the seeds for the credit market turmoil in Europe.

Mateja Jansa, from the Slovenian Permanent Representation, briefed the Forum on the priorities of the forthcoming Slovenian Presidency. It is likely to be an exciting six months. The market turmoil will dominate thinking in the run-up to the spring informal ECOFIN meeting and the March European Council meeting. The opening stance is that the market should take care of what it has created. Based on more accurate information and analysis of the situation, there will be reviews in February to see if any re-assessment of the lines at the October ECOFIN will be needed. As follow-up to the Lamfalussy review, the Presidency will also continue the discussion on possibilities for enhanced L3 supervisory co-operation. Further work is also envisaged on strengthening financial stability arrangements.

On formal legislation, the proposed Solvency II directive will be the priority. The Slovenian Presidency will build on the excellent work of the Portuguese and take Solvency II forward as the group supervision issues are still open as well as the solvency requirements which are key. Policy holders’ protection is the main objective of this directive. Some issues will be further elaborated in QIS4. There are legal obstacles to the group regime and they need careful examination. This prompted a wide-ranging discussion among participants on the exact nature of a “lead regulator” and the extent to which anything agreed for insurance would automatically be read straight across to banking, given that many financial firms are conglomerates that include both businesses.

The Presidency awaits news from the Commission about two proposals: UCITS and Settlement Finality/Collateral. Then there are topics flowing from the Single Market Review on Mortgages and financial education. Finally, a strategic discussion by ministers on clearing and settlement is envisaged in the second trimester, focusing inter alia on the Code of Conduct’s progress, removal of Giovannini barriers and the T2S project.


Graham Bishop closed the meeting by thanking all the speakers for their contributions.

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© Graham Bishop