Following recent G20 meetings on financial reform, it included a key note address from Olli Rehn, European Commissioner for Economic and Financial Affairs, and panel debates on a variety of topics such as Financial Resources, Corporate Governance, Resolution and Tax. Panelists, including senior banking figures, regulators and representatives from the European Commission, wrestled with key issues facing the wholesale banking sector. 

The market expects
Although the stress tests, conducted last July, provided useful information, Olli Rehn, European Commissioner for Economic and Financial Affairs noted that, by nature of being applied by national regulators, the tests provided inconsistencies in the results. He added that the European Union is planning a new round of more rigorous stress tests, to be conducted through the European Banking Authority – the new architecture and powers “will improve the quality of the bank stress tests this time around.” On Basel, Commissioner Rehn noted that the Basel rules need to be implemented coherently and uniformly and suggested that financial markets have expectations that the banks maintain capital ratios above the minimum standards prescribed by regulators. “What the markets now demand from banks are capital ratios above regulatory limits“. The Systemic Risk Board will begin its work in January to identify and assess risks and warnings, which will then be addressed to EU or individual member states – “the importance of the Systemic Risk Board should not be underestimated”.

Developing ‘Sifis’
The panel debate on Financial Resources opened with reference to the delicate balance between the need for reform alongside a more robust capital liquidity regime and the need to allow the provision of credit to the ‘real economy’. The European Commission stressed its interest in examining ‘Systemically Important Financial Institutions’ (‘Sifis’), outlining that it needs to better understand the role of risk and seek ways to enhance the role of the Chief Risk Officer. Key to this is to improve the risk information provided to senior management in firms, as well as regulators.
The industry welcomed Basel reforms but suggested that the studies on liquidity requirements were lacking. The introduction of liquidity standards needs further exploration – “much of the area is technical and differences in business models have not been taken into account”. The area of ‘Sifis’ is complex as these firms are diversified, suggesting they should hold less capital, although their complexity suggests the need for more capital. However, capital adequacy regulation is not a ‘silver bullet’ and it is likely that policymakers will see the need to use a range of options. The Commission noted that the sector is in a genuine transition period with regard to regulation and that ‘one size does not fit all’. Changes will be made wherever they are needed so that “universal banks are not treated like Sparkasse”.

Risk in the boardroom
Corporate governance was a key priority for Commissioner Barnier when he took office and the panel included industry experts on supervision. April 2011 is likely to see a consultation paper on corporate governance for listed companies and, potentially, non-listed companies, which will examine the¡ composition of the board, its risk management mechanisms, the role of nonexecutives and remuneration.
Concerns were raised about forthcoming European Commission corporate
governance legislation, which could present itself either as a stand-alone
consultation paper or within another piece of legislation, such as MiFID. “Central
directives which impose unlimited personal liability will produce an odd bunch of
candidates“. The discussion also covered the usefulness of NEDs developing an external
perspective, although it concluded that using informal routes may be preferable
so that any ‘pushback’ does not come across as confrontational. To this end,
firms should examine how they can establish an independent form of advice that
is internal.

Resolve to avoid taxpayer recourse
The Resolution debate served as a follow-up from AFME’s White Paper on resolution published in August 2010, which examined how a failing financial institution can be managed through a crisis and recapitalised without requiring capital support from governments and taxpayers. Debate focused on two specific resolution mechanisms highlighted in the report, bail-in and contingent capital (‘cocos’), with explanations provided at the start of the discussion.
A ‘coco’ is essentially a debt security. The trigger could be capital based, so if capital falls below, say, 5%, the ‘coco’ is triggered either automatically or by discretion, with regulators making the decision. Discussion remains around when the mechanism should be triggered in times of stress or in times of bankruptcy. In particular, the issues of where the trigger lies, who holds it and what happens to conversion or write-down all need to be resolved.
Bail-in (as outlined in a Financial Stability Board paper endorsed by G20) can be used as a primary tool debt for equity swap – in a crisis, if the bank equity is under threat, more equity can be created to allow the bank to continue. This process may result in losses, but not as much as not using a bail-in, which is essentially a recapitalisation structure. The main benefit is the reduction in systemic contagion which enables the industry to tackle cross border resolution. The concept also puts ‘moral hazard’ back on the table, so it is important to ensure the mechanism is designed correctly, to allow market signals to have a voice - the market needs to play a role.
The Commission outlined its three key three principles: firstly, prevention; banks need to prepare and stronger powers are needed for regulators, so when a bank is going to fail, the regulator has the necessary powers. Secondly, enhanced powers for regulators and supervisors are needed to allow specific action, such as changing the management. Thirdly, with regard to resolution, when the bank is failing, the regulator can step in.

Taxing Times
In light of the myriad of tax initiatives being proposed at a national, European and global level, a keen panel debate on Tax ensued around the European Commission’s plans for a resolution fund and the ensuing additional tax on the banking sector.
Industry representatives complained of a lack of clarity as to the purposes behind individual member state taxes, as well as the EC-wide resolution fund tax, and questioned whether they are designed to change behavior. There was clear concern whether the continuing layering of taxes on the sector was sustainable in light of the potential negative impact on the ‘real economy’.
The Commission’s view is that the taxes, including the resolution fund tax, is created to raise money for the future and also to modify behavior. For example, the resolution fund tax will be a risk-based contribution.
One area agreed on by all of the panelists is that with regard to taxes, more global co-ordination is required to create consistency across jurisdictions. This point was specifically acknowledged by the Commission – “we do not think that the Financial Activities Tax is appropriate unless it is globally coordinated”.

Full notes