04 May 2010

April 2010 - with Podcast

The crisis in Greece has highlighted the risks from rising levels of public debt. The Overview highlights Graham Bishop’s latest article proposing that CRD IV apply higher capital requirements to eurozone States that fail to implement Excessive Deficit Procedure requirements.

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OVERVIEW

The crisis in Greece has highlighted the risks from rising levels of public debt. The BIS pointed out that industrial country public debt levels have increased dramatically, and they are set to continue rising for the foreseeable future. In recent months, we have included more coverage of this “macro” issue amongst our financial services regulatory reporting as we felt that this aspect of the crisis could trigger another round of thinking about regulation.

The role of market discipline on fiscal excesses in a monetary union was examined in Graham Bishop’s writings from 1989/3. These papers were controversial during the Maastricht Treaty negotiations as they doubted the willingness of finance ministers to discipline profligate states. Now, the outlook for public debt is being questioned to the extent that we believe it necessary to add a provision in CRD IV that would apply higher capital requirements and limit “large exposures” for banks lending to eurozone Member States that fail to implement Excessive Deficit Procedure recommendations by Council. This can be structured so there is a progressive reduction in the EU banking system’s exposure to a deteriorating state. A policy along these lines could be implemented quickly as there is no need for a Treaty change. View full article

In the meantime, the policies which are being developed at G20 level to deal with the banking crisis are being questioned increasingly. Though the moral standing of bankers to push back against higher capital and liquidity standards is manifestly reduced, politicians must beware of ignoring careful analysis of the risks. The European Financial Roundtable wrote to G20 finance ministers, the Basel Committee and the European Commission concerning the recent regulatory developments. A fundamental reconsideration is needed on the proposed new capital and liquidity requirements given their potential impact on economic growth. Preliminary analysis by individual banks and banking associations of the Basel Committee’s capital and liquidity proposals reveals a severe impact on the banking industry, disproportionate to the actual experience of the financial crisis. This could seriously hamper the banking industry’s capacity to finance the wider economy, thus threatening economic recovery and growth. Most European countries mainly have a banking-dominated financial system.

The Europeans are not alone in expressing their fears and the Japanese Securities Dealers Association is also concerned that uniform regulations excessively focused on capital requirements without proper consideration of such differences among jurisdictions may lead to skewed risk-taking incentives and impair the stability of real economies and financial markets.

Another area where G20 policymakers have rushed to act is the OTC derivatives market. A key element of that policy is the role of central counterparties and the IMF has produced a report that shows that soundly run and properly regulated CCPs reduce counterparty risk. However, there is a “but”: movement of contracts to a CCP is not a panacea, since it also concentrates the counterparty and operational risk associated with the CCP itself. Nonetheless, the European Commission intends to publish a legislative proposal to improve transparency and stability in derivatives markets (CCP) during the second quarter of 2010.

 

The IASB and FASB quarterly report shows continued progress towards the convergence goal, though many nay-sayers doubt their ability to achieve it. On the key fair value measurement, the boards will deliberate issues jointly, with a goal of issuing common standards in the fourth quarter of 2010.

The corporate governance field looks set to develop as the FSA’s objective on corporate governance is to make regulation more effective and to reduce the likelihood of a future crisis. The FSA needs to change focus and look closer at behaviour and culture in firms, particularly ensuring two key things: that good culture and behaviour in firms are being driven by senior management; and that good culture and behaviour are being reinforced by effective corporate governance and the role of the boards. The FSA has now interviewed over 300 applicants for approved persons roles. There are four stages to go through and it is the firm that remains responsible for making the application. Naturally, a key part of that responsibility is the need for firms to assess the fitness and propriety of candidates thoroughly before proposing them for an approved person role. Yet about 8% of the candidates withdraw from the process!

The European Commission work programme for 2010 underlined the continuing scale of the legislative proposals that are likely. Under the “Tackling the crisis” heading, there will be legislative actions on short selling / Credit Default Swaps; Deposit Guarantee Schemes; Market Abuse Directive and Capital Requirements Directive (CRD IV). There will be Communications on enhanced policy coordination based on broader and deeper surveillance; effective and efficient crisis management framework and bank resolution funds.

 

But that is not the end! There will also be a review of the securitisation retention; A revision of Credit Rating Agencies directive; a Communication on Retail Market Monitoring; a Green Paper on corporate governance practices in financial institutions; a revision of Financial Conglomerates Directive; the "Omnibus II" Directive; A Directive on Legal Certainty in Securities law;  Review of the Investor Compensation Schemes Directive; Legislation on end date for migration to SEPA; Measures on responsible lending and borrowing; White Paper on protection of insurance policy holders / insurance guarantee funds; Communication on best practices in Mortgages (avoiding foreclosure); Solvency-II implementing measures including remuneration provisions; Review of Markets in Financial Instruments Directive (MiFID); Directive amending the UCITS Directive(V) covering the responsibilities of depositaries; Review of Institutions for Occupational Retirement Pensions Directive; Revision of Insurance Mediation Directive.

 

All sectors of the EU financial services industry will find some part of their business under review: banking, securities, asset managers, pension funds and insurance. For many of them, these reviews will be a fundamental challenge.

 

Graham Bishop

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