20 July 2009

July 2009

Graham Bishop's Personal OVERVIEW.

The “summer break” is now upon us, so a flood of consultations and reports were issued by official bodies – often requesting comments soon after the end of the holiday season. So there may not be such long holidays for those who have to comment! Moreover, many national policy statements were issued, but the need for international co-ordination was usually a feature so the G20 process of co-ordination seems to have become an ingrained habit. Some of the UK-based media commentary seems to overlook this aspect, instead regarding proposed changes as some sort of EU plot. But analysis of UK official comments shows a corresponding determination to make big changes in financial regulation – with commitment across the political spectrum.

ECOFIN welcomed the four policy responses to reduce pro-cyclical effects of financial regulation: the monitoring of system-wide risks; the building of counter-cyclical buffers through capital and provisions; the improvement of accounting rules, the establishment of a sound framework for remuneration schemes. It agreed that fundamental changes were needed to banking and accounting rules to push banks to build up extra capital in good times, which could be drawn on in an economic downturn.

The BIS Annual Report argued that financial instruments, markets and institutions all require reform if a truly robust system is to emerge. Financial instruments need mechanisms that rate their safety as this limits their availability and provides warnings about their suitability and risks. Markets need to encourage trading and clearing through central counterparties and exchanges. Finally institutions need the comprehensive application of enhanced prudential standards that integrate a system-wide perspective.

The US Treasury’s Mark Sobel highlighted the role of US-EU co-operation and said that the “momentum” must be maintained once the crisis is over. “I can assure you that the proposed U.S. regulatory reform has international co-operation at its heart and we remain committed to working bilaterally with the EU and multilaterally through the G-20, FSB, and standard setting bodies to advance our shared agenda”, he concluded. SEC Commissioner Luis Aguilar underlined that the lack of transparency and oversight over hedge funds gives rise to a number of concerns. There are a number of questions as to exactly how, and to what extent, hedge funds may have contributed to the economic crisis and how they contributed to the overall systemic risk of the financial markets so hedge funds advisers with over $25 million in assets should register with the SEC. “But that may not be enough”, he said.

The Walker Review of Corporate Governance of UK banks and other financial institutions recommended strengthening bank boards, making rigorous challenge in the boardroom a key ingredient in decisions on risk and measures to encourage institutional shareholders to play a more active role as engaged owners of banks and other financial institutions. FSA chairman Lord Turner underlined that excellent supervision is a necessary but not sufficient condition to prevent future crises. “Unless we change the rules quite radically, we will not be able to avoid future crises”. The Bank of England’s Bi-annual Financial Stability Report discussed five broad areas where policy changes are needed and concluded that banks should not be too big or complex. BoE Executive Director Paul Tucker considered how the banking system should bear the cost of insuring retail depositors against loss.

In the rush to analyse the problems of the banking and securities markets, it is easy to forget that the Commission was about to launch a major set of actions to create a single market for consumers. For the moment that has been pushed on to the back-burner, but Commissioner McCreevy reminded market participants that "The Commission is renewing its focus on the citizen ... consumer protection is a focus for most of our work”. He went on to discuss the investor, depositor and insurance guarantee schemes that are now under scrutiny. Indeed CEIOPS members approved 13 recommendations on the design of insurance guarantee schemes.

However, the Commission did put forward a further revision of EU rules on capital requirements for banks that is designed to tighten up the way in which banks assess the risks connected with their trading book; impose higher capital requirements for re-securitisations; increase market confidence through stronger disclosure requirements for securitisation exposures; and require banks to have sound remuneration practices that do not encourage or reward excessive risk-taking. The proposal amends the existing Capital Requirements Directives. Competition Commissioner Kroes argued that "National solutions to the crisis will not be enough... we must restructure our banking and financial services industries to ensure long term stability and growth”. CEBS proposed that, when building their liquidity buffers, credit institutions consider three types of stress test scenarios; a time horizon of at least one month; and that the core of the buffer should be composed of cash and assets that are both highly liquid in private markets and central bank eligible. Meanwhile, the BIS issued guidelines for computing capital for incremental risk in the trading book and is taking measures to mitigate any excess cyclicality of the minimum capital requirement and to promote a more forward-looking approach to provisioning; strengthening capital quality and introducing a leverage ratio.

In the securities markets, the Commission issued a study on trading and post-trading prices, costs and volumes showing that costs are now decreasing. But it consulted on reforms of EU derivatives markets and threatened that, if industry is unable to deliver on its commitment by end-July, the Commission will have to consider other ways to incentivise the use of CCP clearing. In CESR’s view, any post-trade transparency regime for structured finance products should be seen as complementary to existing initiatives designed at improving transparency earlier in the transaction chain. It recommended to the Commission the adoption of a mandatory trade transparency regime for corporate bond, structured finance product and credit derivatives markets as soon as practicable. IOSCO consulted on disclosure requirements for public offerings of ABS. CESR is now working on the details of its co-ordination and advisory functions for setting common standards for CRA’s presentation of historical and performance information, and for the design of the potential output from the central information repository.

The arguments about the AIFM proposal rage on. COMPLINET's Elstob pointed out that the split is to a large extent along national lines, with the strongest proponents on each side in the UK and France. To oversimplify somewhat, the French sell-side — banks and fund management industry — believe that the directive does not go far enough in regulating the alternative investment sector, which is predominantly based in London, and they are backed in this by the French government. A major sticking point for non-UK market participants, particularly the French traditional funds and banks, is the commission's proposal to extend passporting rights to offshore centres such as the Cayman. The majority of both types of fund are, of course, managed in London.

 Asset managers and investors in the UK believe that the French and others, including socialist members of the European Parliament, have exploited post-crisis stability concerns and post-Madoff investor protection fears to push through an essentially euro-protectionist measure which will also damage London, home to the majority of hedge fund, private equity fund, and property fund managers.

But UK Treasury Minister Lord Myners worried about the protectionist impact of the directive and argued that “to deny institutional investors a global choice of fund manager would come at a direct cost to pension savers and others who rely on the returns from institutional investment funds”. He said of the custody elements of the directive that “imposing strict liability for delegated custodians would impose large capital costs, make investing in some emerging markets impractical and increase costs to investors”. On the leverage caps within the directive, he argued that “systemic risks posed by the leverage of any one fund can only be assessed in the context of wider market conditions so capping leverage on a fund-by-fund basis cannot be an effective protection”, adding that it could even be counter-productive.

However, the industry is not standing still and the Hedge Fund Standards Board proposed a toughening of standards for hedge funds’ administration and redemptions in the light of the financial crisis. The changes would involve introducing new standards requiring fund’s governing bodies to appoint an independent third party to administer the fund, prepare accounting records and carry out NAV calculations as well as having an independent custodian.

Accounting standards continue to make the headlines and the IASB proposed improvements to financial instruments accounting to reduce complexity and make it easier for investors to understand financial statements. The proposals will also deal with, for example, eliminating the different impairment approaches for available-for-sale assets and assets measured using amortised cost. The IASB plans to finalise the classification and measurement proposals in time for non-mandatory application in 2009 year-end financial statements. It also consulted on the feasibility of expected loss models in IAS 39, seeking input on the practical issues in developing formal proposals that it plans to publish in an exposure draft in October 2009. The IASB also sought views on accounting for ‘own credit risk’ as existing IFRSs require profit or loss resulting from changes in ‘own credit’ to be booked when debt is fair valued. Recent developments in the financial markets have led to increased concerns about gains that result from changes in the value of an entity’s liabilities.
 

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Graham Bishop

© Graham Bishop