25 July 2011

July 2011 Financial Services Month in Brussels

Graham Bishop's Personal Overview - The escalating public debt crisis was meant to be resolved by the July European Council meeting and the Heads of Government went away content that they had dealt with the immediate problem of Greece. But the positive reaction from the financial markets was short-lived.

The eurozone’s governance mechanisms seem to be only capable of achieving the barest minimum necessary to prevent an immediate melt-down.  In the longer term, that is unlikely to be sufficient and Council President van Rompuy was asked to produce concrete proposals in October. An unexpected surge in global economic activity may float the good ship Eurozone away from the looming rocks. But there is also a rising chance that the trans-Atlantic ship may decide to sink itself – with incalculable ripples (or a tsunami?) over here. The Eurozone continues to sail in extremely perilous waters. (See my concerns in “Why is no-one satisfied with the results of the July Crisis Council?”)

The Heads of Government stated that private sector involvement (PSI) in “Greece requires an exceptional and unique solution.” It is quite laughable to attach any significance to this statement as the years of re-assurances by political leaders that no eurozone member would be allowed to default were exploded after Chancellor Merkel and President Sarkozy went for a walk on the beach at Deauville in October 2010. The Treaty change to build in PSI is underway and all government bonds after 2013 will include “collective action clauses” to facilitate “private sector involvement”. 

So the laughter may turn to tears all too quickly, as it becomes ever more apparent that the Heads of Government simply do not understand the natural, logical consequences of their actions. Until the hard evidence shows that they have come to terms with these consequences, increasingly flowery and grandiose gestures are only likely to fuel scepticism that they can realistically deal with the problems posed by 40 years of ever-rising public debt.  At the low point of the 1930’s US depression, Roosevelt said: "the only thing we have to fear is fear itself". The eurozone does not have to fall to such a low. At this vital moment, Europe’s leaders must show the same visionary capacity. 

MEP Sharon Bowles (ECON Chair) said real change is needed to consolidate the eurozone and not only fight the fires. “Now, more than ever, we acutely need further reforms of our macro-economic governance framework to strengthen the long-term credibility of the euro: the summit announcement falls short of a long-term comprehensive solution. The EP welcomes the commitment to reach  agreement on the voting within the preventative arm of the SGP in the Economic Governance Package. Over the coming years, the needed courageous reforms to the EU's economies will not happen by watering down Commission recommendations.

Bruegel published an action plan for the European Leaders warning that more ambitious reforms are necessary down the road. They should promote immediate growth-enhancing measures to be financed through unused EU structural funds and EIB loans (€16bn) and address risks to financial stability in the eurozone by breaking the vicious circle between sovereign debt and banking risk. 

ECB director Lorenzo Bini Smaghi made two major interventions, arguing that deferring decisions creates uncertainty, entails substantial costs and may undermine the political cohesion of the European Union. If people do not realise how close they are to the abyss, and thus do not support the adoption of the unpalatable decisions, policy-makers have to make them aware of the risks by appealing directly to them, which may in turn frighten and unsettle the markets. He argued there are three components to strengthening the EU’s capacity to make collective decisions: first, drop the requirements for unanimity for some cases; second, strengthen the rules that constrain national decision-making; and third, enforce all of the EU’s rules better. Strengthening collective decision-making would require the EU to modify the rules of the European Financial Stability Facility, so that bailout decisions can be made by a qualified majority instead of unanimity. The risk of paralysis and worsening of the crisis might prompt some rethinking on the issue.

The Commission published CRD IV – nearly 700 pages that include a directly applicable Regulation as “A single market needs a single rule book.” For capital rules. The Directive part covers conduct of business and will seek to reduce reliance by credit institutions on external credit ratings. Commissioner Barnier stressed that CRD IV will have a fundamental impact on European banks and this is indeed the Commission's objective, noting that around 8,200 banks in Europe will be affected by CRD IV, which represents 50 per cent of the total global assets held by banks. The US will only apply Basel III to its 20 biggest banks, which represent only 10 per cent of the total global assets.

The FSB consulted on proposals to remove obstacles to resolution arising from complex firm structures and business practices, fragmented information systems, intra-group transactions, reliance on service providers and the provision of global payment services. It sets out a comprehensive package of proposed policy measures to improve the capacity of authorities to resolve failing SIFIs without systemic disruption and without exposing the taxpayer to the risk of loss.  AIMA commented that no hedge fund today should be deemed systemically important.

The EBA published the stress test results, after allowing for €50 billion of new capital raised this year. On the adverse scenario, 8 banks failed and 16 were too close to the borderline for comfort. There was little comment about the baseline scenario where the banks would have nearly twice the minimum capital by 2012.

ECOFIN confirmed that backstop measures have been drawn up by Member States, should remedial actions become necessary in response to the vulnerabilities identified by the tests. Priority is to be given to private sector solutions, while a solid framework for the provision of government support in case of need in line with state aid rules, has been agreed. “Stress tests can of course contribute to restoring confidence in the banking sector”, declared Guido Ravoet, Chief Executive of the EBF, “but it must be made clear that they rely on extreme scenarios, which largely exceed reality and go far beyond the requirements made by Basel III or even by current minimal legal requirements.”

EIOPA announced the results of its second European insurance stress test which confirmed that European insurers (representing 60 per cent of the market) are robust. At end-2010, they showed an aggregate solvency surplus of €425 billion, falling to €275 billion under stress.

Eight global and regional trade associations called on regulators to intensify cooperation to prevent, alleviate or limit the harmful effect of overlap, inconsistency and ambiguity resulting from extra-territoriality in regulatory efforts to implement G20 commitments. Non-US officials and bankers are frustrated at what they see as an implicit threat from Washington that it could demand that banks follow American rules worldwide if they want to retain access to US markets.

FSB published a report on 'The Financial Crisis and Information Gaps':  The BIS international banking statistics will provide more granular information and higher frequency cross-border security holdings data.  The BIS has started publishing data on real estate prices. There will be more data on CDS, public sector debt and more economic data.

Graham Bishop

© Graham Bishop