31 January 2011

Financial Services Month in Brüssel - Januar 2011

Graham Bishop’s personal Overview of January 2011

The eurozone debt crisis is at a tipping point which may lead to an effective political union of the eurozone during 2011[1]. The first issue by the EFSF went very well:  BUT this was probably a reflection of the market assumption that the eurozone Heads of Government really will do whatever is necessary, as they declared at the December Council meeting,  “The euro is and will remain a central part of European integration”.  The EU leaders also agreed on a limited amendment to the Treaty on the establishment of a future permanent mechanism to safeguard  the financial stability of the euro area as a whole and called for the acceleration of work on the Commission’s six legislative proposals on economic governance.  These are to be adopted by June 2011.

The European Commission presented its Annual Growth Survey, as part of this comprehensive response. This kicks off the so-called ‘European semester’, a new attempt to provide effective prior co-ordination of national and EU economic policies, before governments create their 2012  budgets.  President Barroso hailed the European Semester as being at the heart of the reformed economic strategy as it will change the way governments shape their economic and fiscal policies. Once agreed by the European Council, Member States will reflect these recommendations in both their policies and national budgets.  For the first time ever, therefore, Member States and the Commission will jointly discuss macro-economic stability, structural reforms and boosting growth measures in a comprehensive way. This author argues that such a process will create collective economic governance that will develop into an effective political union – if matched with a greatly expanded EFSF that becomes the joint funding vehicle of choice for many eurozone states.

Commissioner Barnier stressed that the newly-launched supervisory framework demonstrates   that Europe is leading the way and upholding its international commitments.  These new authorities will work with others across the world to ensure better global supervision.  The date  of 1st January 2011 marks a turning point for the European financial sector.  Today, three new European Authorities for the supervision of financial activities – for banks, markets, insurances  and pensions respectively - start their work a few days after the launch of the European Systemic Risk Board.  The ESRB will monitor the entire financial sector, to identify potential problems which could contribute to a crisis in the future. 

The incoming Hungarian Presidency underlined its determination to support these initiatives and also its hope to progress on some form of ‘bank tax’, though MEPs criticised the latter as ‘a risky move’ because it can discourage banks from financing.  Amidst the concerns about the eurozone, Simon Tilford of the CER pointed out that the eurozone’s fiscal position is better than that of the US and the UK.  His view is that the crisis-hit members of the currency union are doing more to strengthen their public finances than either of these countries but, despite this, those who are suffering the most are still the eurozone countries.  So why are borrowing costs so much higher  for countries in the eurozone periphery than for Britain and America?

Moving to technicalities.  The new EBA lost no time in announcing that the 2011 stress test will be carried out in cooperation with the national supervisory authorities:  the European Systemic Risk Board, the European Central Bank and the European Commission and they will cover a broadly similar group of banks as last year.  However, Nicolas Véron wondered if it would be third time lucky with European bank stress tests? He argued that a government-led process of ruthless triage, recapitalization, and restructuring of the system’s most important banks is needed.

The European Commission consulted on technical details of a possible European crisis management framework. Currently, there are very few rules at EU level determining which actions can and should be taken by authorities when banks fail and, for reasons of financial stability, cannot be wound up under ordinary insolvency rules.  It intends to come forward with a legislative proposal for a comprehensive framework for dealing with failing banks before the summer of  2011. The framework was particularly welcomed by the EBF since its proposed tools for resolution of banks in distress may solve the ‘too-big’ or ‘too-interconnected to fail’ conundrum.

Several replies to the Commission’s consultation on Credit Rating Agencies highlighted concerns about the approach. The European Issuers want a clear distinction between structured finance instruments and corporate financial instruments (corporate bonds) as they are well established securities - and ratings were not inflated before the crisis.  Moreover, it makes sense to continue to use the ‘issuer-pays’ model for corporate debt.  The corporate treasurers – EACT – hope to rely on the ability of the Commission to make its considered judgment and refrain from endorsing proposals that may be politically attractive but lack substance in analysis and fact.  AFME and BBA also commented that the political pressure to reform CRAs further, in particular in the sovereign space, is not grounded in any evidence that ratings in Europe have failed to perform according to expectations.

Accounting standards and audit also came in for comment.  IASB and FASB plan to publish a proposed joint approach on credit impairment of loans and other financial assets managed in an open portfolio and will propose an impairment model based on accounting for expected losses. The FASB also discussed measurement of financial assets, at amortised cost, where an entity manages for the collection of contractual cash flows.   IFRSs continue to march forward as Africa is embracing them.  UEMOA, the Economic and Monetary Union of West Africa, is on the road to implementing them; the Eastern Central and Southern African Federation of Accountants is also convinced,  "The countries in the ECSAFA regions have all agreed to adopt IFRSs"

The Commission adopted a decision recognising the equivalence of the audit oversight systems in 10 third countries.  The FT reported that the four biggest auditors have denied that their dominance on the market for large company audits had created a systemic risk akin to that posed by leading banks.  They have told the European Commission that they are willing to help draw up contingency plans addressing the possible scenario of a collapse of parts of their businesses. 

Graham Bishop

© Graham Bishop