26 January 2009

January 2009

Europe has finally begun to consider whether the mechanics of the enforced bank re- capitalisation scheme in October may have produced some unintended side-effects, Graham Bishop says introducing the January Financial Services Month in Brussels report.

Graham Bishop’s Personal OVERVIEW -

Europe has finally begun to consider whether the mechanics of the enforced bank re- capitalisation scheme in October may have produced some unintended side-effects. Initially the FSA re-stated that, in November, it had made clear that the purpose of the recapitalisation scheme was to ensure that bank capital ratios were sufficiently high to provide a buffer to allow the banks both to withstand the challenging economic conditions and to continue lending on normal commercial criteria. It was not intended to create new statutory capital requirements for the banking sector. Then ECOFIN used the same phraseology in its own statement.

EDHEC argued that a single minor change would have made it possible to restore much of the confidence in the banking sector without requiring any capital injections in the short term: acknowledging that banking capital ratios fall during downturns would have made most of the injections of public funds unnecessary. Making this change today would give governments far more room to support the real economy.

The Czech Presidency will strive, particularly at the April G-20 Summit in London, to ensure that the EU makes a co-ordinated contribution in the search for a solution at the European and global level. So consultations and thinking ahead of the G20 meeting continue apace. The BIS is consulting on enhancements to the Basel II framework to strengthen minimum capital requirements - covering all three Pillars and the regulatory capital treatment for trading book exposures. It is also covering principles for sound stress testing - one of the key risk management actions required by the G20 leaders in November. The IASB issued a list of actions taken to address recommendations made by the G20 leaders. An outlook on future measures envisaged in 2009 include: New disclosure requirements related to impairment; broader issues of impairment on a globally consistent basis; accounting for particular credit-linked investments between US GAAP and IFRS; ensuring embedded derivatives are assessed and separated if financial assets are reclassified.

The Swiss National Bank’s Hildebrand said he strongly supports enhancing current risk-weighted capital requirements with a simple leverage ratio although this should not replace the current Basel II regime. A G30 report addressed flaws in the global financial system and included 18 sets of recommendations. The general approach is to strengthen the oversight and stability of systemically important institutions that serve the needs of individuals, businesses and governments and that are largely responsible for maintaining the market infrastructure. But competition policy must not be overlooked and Competition Commissioner Neelie Kroes said the current global crisis will not be solved through local regulation or through a protectionist re-nationalisation of global markets.

At present, the EU feels it is making the running at the G20 but that may reflect the effective absence of the Bush administration at the November meeting. The new Obama administration may have a tougher agenda. Speaking at confirmation hearing before the Senate Banking Committee, Mrs Schapiro outlined future SEC regulatory reform initiatives that she intends to undertake when she becomes the new SEC chair. Her comments raised many questions about CRAs and IFRSs as well as outlining some regulatory reforms as there is an obvious need for a modernization of the regulatory structure. She also called for federal oversight of insurance companies. Whether the SEC has to be enlarged or a new institution has to be established is yet undecided. Schapiro said she will “proceed with great caution” in regard to International Financial Reporting Standards. “I will take a big deep breath and look at this entire area carefully”, she said and underlined that she does not feel bound by the existing roadmap.

But the issue that is now firmly on the EU’s own table is not just what regulations, but which institution should apply them. The OECD argued that the Euro area needs more centralised and integrated supervision of banks and financial markets to help prevent a recurrence of the financial turmoil. It recommended creating either a single EU-wide supervisor or a central agency to work in conjunction with national supervisors.

On the institutional set-up, ECB President Trichet made several strong statements in January. He favoured a strengthening of the informal groupings, in particular the FSF and the G20. “The FSF is unique in that it links all the authorities and institutions that have a systemic influence on financial markets, which are very largely decentralised and – for many of them – independent from the political sphere”. “The proposals which will be put forward by the High-Level Group chaired by Jacques de Larosière will represent an important contribution to the policy discussions.” “Reflections have started on the specific role that could be played by the ECB and its Governing Council”, he said. However, the Governing Council has not yet taken a position on this topic but Mr Trichet recalled that a close relationship between the central bank and the banking surveillance authority was of the essence. He also reminded MEPs of Article 105.6 of the EU Treaty which explicitly mentions the possibility for the member states to decide to confer upon the ECB specific tasks in the domain of financial supervision. "The great advantage is that it is already ratified”, Trichet underlined.

The Czech Presidency will also continue the debates about enhancing the stability and development of a single European financial market by way of harmonising the regulation of the financial market and its supervision. The Presidency considers that a necessary prerequisite for more efficient communication and co-ordination of the measures adopted in the EU is the existence of a strong and independent national supervisor covering all segments of the financial market. The work of the high-level group led by Jacques de Larosière will constitute an important contribution to the debate.

Turning to the more routine work of the EU, the Czech Presidency priority issues in the area of financial markets will include: review of the CRD Directive; negotiations on the Solvency II Directive; the Regulation on credit rating agencies; and the directive on electronic money institutions. The Presidency will also strive to take forward the review of the Regulation on cross-border payments in euro and to ensure a timely and proper implementation of the road maps of the Economic and Financial Affairs Council, adopted in reaction to the financial crisis.

The European Parliament adopted the recast UCITS directive and inserted provisions for a "management company passport". The Directive still needs to be approved by the Council, but the informal agreement already reached means this is now a formality. However, the spectacular Madoff fraud is already raising question about how existing legislation was actually operated!

Hedge funds have not escaped from the spotlight as the Commission launched a public consultation on policy issues arising from their activities. The consultation will contribute to European and international reflections on whether the approach to the regulation and supervision of hedge funds should be reassessed in light of the financial crisis. Moreover, the ECB Financial Stability Review warned against risks resulting from hedge fund performance. An important source of risk for euro area financial markets in the period ahead is connected with the return performance of hedge funds, given the rising vulnerability of funds to the risk of investor redemptions. “Looking ahead, if hedge funds increasingly fail to retain their investors, the possibility of further sizeable position unwinds by the sector may pose a challenge to financial markets”.

The French Council Presidency drew up the compromise proposal on the Commission draft proposal on the regulation of Credit Rating Agencies. It specifies modalities of co-operation between supervisors by introducing colleges of supervisors and gives a strong role to the college of supervisors in the decision making process for registration and supervision. The Presidency text enables the competent authorities other than of the home Member States to take appropriate supervisory measures with effect only within their jurisdiction and clarifies the role of CESR - in coherence with the role attributed to Level 3 Committees within the CRD and Solvency II.

Correspondingly, the Parliament’s Rapporteur produced a Draft report on Credit Rating Agencies and Mr Gauzes intends to increase the role of CESR by centralizing the registration and regulation of CRAs with the Committee. On the difficult issue of products located in third countries, Mr Gauzes proposes a ‘guarantee concept’ for third countries ratings from outside the EU.

CEIOPS Financial Stability Committee has prepared a new report on the financial stability of the insurance market and the pension fund sector. The insurance industry as a whole faces several risks and challenges - in particular the risk of low or even again decreasing interest rates as well as risks related to equity markets. A prolonged period of economic recession will be particularly challenging for the underwriting performance, it states. The financial position of the defined benefit occupational pension fund sector is coming under increased pressure, due to negative developments in equity markets, low interest rates and prevailing longevity risk, the report finds. However, direct exposures to structured credit products, including subprime related risks remain limited in CEIOPS’ sectors, the report says.

To finish on a brighter note, Liffe became the first exchange to offer clearing of CDS contracts - via Bclear. CDS contracts on Bclear will combine the security of central counterparty clearing with the flexibility that OTC market participants demand. The contracts are negotiated and agreed away from the exchange before being processed through Bclear and cleared through LCH.Clearnet. Regulators identified the lack of a central counter-party as a serious shortcoming and the market has now rectified this.
 

********************

Graham Bishop

 

© Graham Bishop