24 November 2008

November 2008

Graham Bishop’s Personal OVERVIEW -

In the continuing fog of the financial crisis, some outlines of the future shape of financial regulation have begun to emerge. There will be much more international co-operation – with the term “international” now defined far more broadly than just the EU plus US. But how far it will really go down the G20 list remains to be seen. Regulation will no longer be “pro-cyclical” - but that is much more easily said than done as the current wave of enforced “re-capitalisations” of many healthy banks seems to be a dramatically pro-cyclical policy.

Ahead of the G20 meeting, the European Heads of Government reached joint conclusions on their common positions and agreed on four main principles including proportionate and adequate regulation, or at least oversight. Five approaches were agreed and included the decision that  “no market segment, no territory, and no financial institution should escape proportionate and adequate regulation or at least oversight” as well as agreement to give the IMF a central role in a more efficient financial architecture. The G20 leaders incorporated these into an action plan of 50 measures and 31 concrete immediate actions should to be taken by 31 March 2009, including the establishment of supervisory colleges for all major cross-border financial institutions.

ECB President Trichet underlined that global responses are required for short-termism, transparency, and pro-cyclicality are the three principal fundamental elements of the reform agenda. [But he also warned that “Large domestic and external imbalances have to be reduced in systemically important economies”. The UK responded to this type of stricture by proposing to expand its projected budget deficit to a level that would be unprecedented in modern times whilst pretending that the policy would be consistent with international agreements.] The global aspect was taken up by Commission President Barroso said calling for an institutional framework for global governance. “We need a critical mass of players involved, and that must include China and India”.

In the context of the G20 Summit, there was a welter of comments about future regulation:
• The European Commission is to revise the institutional set-up of 3L3 Committees as the current institutional set-up may not be adequate to operate in the new integrated reality. But the first test seemed to be failed when the French Presidency issued a compromise proposal deleting the issue of group support from the Solvency II draft Directive. At this point, an agreement in the Council on the Solvency II draft directive can only be reached if the issue of group supervision is dissociated from the remaining parts of the text.
• The German government appears to be supporting a report which calls for an EU-level supervisor for the large cross-border banks as German newspaper “Spiegel” quotes from the Issing report that such changes were necessary to create integrated financial market in the EU, and to secure the euro’s future.
• BIS Wellink outlined key issues to address the fundamental weaknesses revealed by the financial market crisis that relate to the regulation, supervision and risk management of internationally-active banks. “The primary objective of the Committee's strategy is to strengthen capital buffers and help contain leverage in the system arising from both on- and off-balance sheet activities”.
• IOSCO stated that regulatory gaps, such as those posed by certain unregulated or under-regulated products, must be closed. “While financial regulatory structures may remain national, consistent global solutions are desired by many”.
• Treasury Secretary Paulson outlined a new regulatory framework which would include market infrastructure, transparency and wind-down authorities. “We need more effective regulations within an entirely new regulatory framework and a stronger capacity for resolution and crisis intervention that reinforces market discipline …No institution should be deemed to be too interconnected or too big to fail." On a global basis, cooperation between national regulators should be strengthened.
• IIF calls for Global Financial Regulatory Co-ordinating Council as regulatory reform “should be guided by the principles of greater co-ordination, consistency and efficiency…It is imperative that regulatory and supervisory structures built on national platforms be more fully integrated and co-ordinated within a global framework”.
• CFTC Lukken called for complete regulatory overhaul: “Courageous regulatory reform is most needed”. This broad restructuring must be preceded or accompanied by a complete rewrite and modernization of the laws and regulations governing the financial markets, Lukken said.
• The President's Working Group on Financial Markets announced a series of initiatives to strengthen oversight and the infrastructure of the over-the-counter derivatives market. Initiatives include the development of credit default swap central counterparties.

The BIS issued its OTC derivatives market statistics and these helped give a better perspective of the size of the derivatives problem as most commentators refer to the notional amounts of all types of OTC contracts - $683.7 trillion at the end of June. But gross market values measure the cost of replacing all the existing contracts and are a better gauge of market risk than the notional amounts. This figure was $20.4 trillion – just 3% of the usual headline!

Nonetheless, the Commission is setting up a clear roadmap to ensure that CDS are cleared through a central clearing counterparty by the end of this year and the working group set up to find a solution confirmed that this was a reasonable timing.

The Commission proposal for a regulation on Credit Rating Agencies finally appeared and still breaks new ground on corporate governance rules that may turn out to have wider ramifications. CRAs should have at least three independent directors on their boards whose remuneration cannot depend on the business performance of the rating agency; be appointed for a single term of office which can be no longer than five years; can only be dismissed in case of professional misconduct; and at least one of them should be an expert in securitization and structured finance.

Finally, accounting standards were changed by the EU with remarkable speed after the IASB gave revised guidance on measuring the fair value of financial instruments when markets become inactive. But the process raised concerns about influencing the Board’s independence.
 

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

Graham Bishop

© Graham Bishop