27 January 2009

McCreevy outlines issues to come on financial regulation

McCreevy does not rule out legislation on credit derivatives. “We have asked the industry to come forward with a clear roadmap”, he said. "Given the inadequate industry response so far I am keeping open the option of legislating".

“It must now be clear to everyone that there is a growing gap between the EU supervisory structure, which is primarily organised on a national basis, and market developments, where integration and internationalisation lead to complex interdependencies and growing spill-over effects”, Commissioner Charlie McCreevy said in a conference held in Brussels. The results of the de Larosière Group will be incorporated in a Communication which is foreseen for early March, in time for the Spring European Council, he announced.

 

As for Credit Derivatives the Commissioner does not exclude  coming up with a legislative proposal. “Aside from all of this, we have asked the industry to come forward with a clear roadmap as to how the risks from credit derivatives can be mitigated”, he said. “Given the inadequate industry response so far I am keeping open the option of legislating.”

 

Next to this, the Commission is working on several other issues. “The current proposed CRD amendments must and will be only the beginning of a far more comprehensive review of the entire Basel 2 Accord which clearly requires some fundamental overhaul”, McCreevy said. “The shortcomings include the absence of any overall gearing cap on bank balance sheets, wholly inadequate and inappropriate risk weightings for AAA rated structured products, the stupidities of intellectually refined value at risk models, over-reliance on External Credit Rating assessments undertaken by agencies who are paid by the issuer, and the absurdities of some mark to market requirements when markets are totally illiquid”, the Commissioner outlined.

 

“Lets be clear: The fundamental flaw in the financial theory underlying value at risk models that justified unsustainable levels of leverage needs to be widely exposed”, he said. “Sub-set forms of leverage will also be required to prevent excessive embedded leverage within on or off balance sheet assets or derivatives so as to limit the scope to game the overall headline, transparent balance sheet cap”, he said.

 

Further issues include other pro-cyclical elements that impact on the bank capital requirement regime, in particular the dynamic provisioning which enabled banks under the old accounting rules to build bigger buffers in good times in anticipation of portfolio impairment which invariably rises materially in less benign economic circumstances. “The notion that the creation of these buffers is a denial of shareholder rights is, in my view, utter nonsense”, McCreevy said.

 

With regard to Credit Rating Agencies, McCreevy said that “it is very doubtful whether ratings by issuer-pay rating agencies should, in the longer term, be used at all for the purposes of determining risk weightings on rated securities or loans”. This issue will be reviewed within the context of the G20 work, he said.

 

Any future reform package for EU Financial Markets will also include those measures that focus on addressing perverse incentives, he noted.

 

Full speech

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