04 March 2013

February 2013 Financial Services Month in Brussels - Report

Banking union is not yet agreed by the legislators but the practitioners and thinkers are already debating the mechanics of how it can be done on the ground. First of all, the Single Supervisory Mechanism (SSM) has to come into existence – with the Single Resolution Mechanism (SRM) very close behind.

ECB’s Constâncio stated that the SSM will operate as a system, catering for all expertise of national supervisors and at the same time possessing a strong decision-making centre. An important element will be the completion of the single rulebook - overseen by the EBA. An immediate task of the SSM will be a comprehensive review of the banks that will fall under direct supervision of the ECB. As foreseen in the Regulation, this exercise should include an asset quality review as a basis for a thorough solvency analysis. This review should be instrumental in identifying potential legacy problems.

From recent hard experience, the Central Bank of Ireland’s Elderfield pointed out that, at the bottom of the system will be the national supervisors, each feeding up dozens if not hundreds of issues and matters for decision and action, with this volume surging in times of stress. Developing a common framework for risk assessment, common language for risk and common approaches to inspection and supervisory reviews will be key. Will the SSM be a principles-based supervisor, a rules-based one or some judicious mix of the two?

Who benefits most from the SSM? Schoenmaker’s model of recapitalising banks measures the efficiency improvement of resolution for the top 25 European banks (accounting for the vast majority of cross-border banking in Europe). The model indicates that the UK, Spain, Sweden and the Netherlands are the main beneficiaries and thus have the largest economic incentives to join Europe’s banking union.

Turning to the Single Resolution Mechanism, Constâncio said it would have a Single Resolution Authority at its centre that would govern the resolution of significant banks, coordinate the application of resolution tools and reflect an organisational set-up similar to the SSM. It should have a comprehensive set of enforceable tools, powers and (most critically in this author’s view) authority to resolve all banks in the SSM.

Bruegel’s Véron & Wolff analysed the possible objectives and timetable for the creation of a SRM, and make the point that policymakers should take decisive action to restore trust in the European banking sector before the SRM is finalised, because the economic cost of waiting at least 18-24 more months would be simply too high. Article 27(4) of the SSM Regulation provides a unique opportunity for a proactive, system-wide initiative for the assessment and restructuring of Europe’s banks in late 2013/early 2014. Schoenmaker, Beck & Gros argued that even more important for the future of the banking system in Europe than the design of the SRM will be the willingness actually to let banks fail, or at least bail in creditors before public funds are used. The best resolution mechanism will not work properly if the authorities continue to follow the principle that no bank should ever be allowed to fail, and that most creditors (including senior unsecured and large depositors) should always be guaranteed full payment.

Meanwhile, the German push to accelerate bank bail-ins was joined by Dutch and Finnish policymakers - calling for regulators across the EU to gain so-called bail-in powers as soon as 2015, rather than in 2018 as currently proposed.

Implementing the Liikanen report continues to stir debate and Bruegel’s Bijlsma argued that ‘no ring-fencing’ makes sense as its benefits are quite uncertain. Bundesbank’s Dombret said: "The general direction of the Liikanen report - essentially to retain the system of universal banks but to increase the ability to wind up banks - is right from our point of view… But the proposal to separate (units of banks) also entails disadvantages and several difficulties". Nonetheless, Germany approved a draft 'Liikanen-light’ bill to force around 10-12 deposit banks to separate proprietary trading, lending and guarantees to hedge funds as well as HFT, when associated activities exceed €100 billion or 20 per cent of the balance sheet. Approval is planned by summer.

The details of the Financial Transaction Tax (FTT) for 11 Member States were published by the Commission, adding the "issuance principle" as a further safeguard against avoidance – to the consternation of non-EU11 investors. It confirmed that pension funds will fall under the scope of the controversial FTT. MEP Podimata, who oversaw the Parliament text on the FTT, said she did not support exempting pension funds wholesale, but the Dutch government withdrew its support as the new proposals do not exempt pension funds.

Turning to the generality of financial regulation, the IIF called on the G20 to strengthen the global regulatory framework as its members are 'deeply troubled' by the current tendency towards increasingly fragmented financial regulation, which they say is a 'serious stumbling block' to the global economy in its efforts to exit the financial crisis and attain sustainable growth. A dramatic divergence is opening up with the emotive topic of bankers’ bonuses. Finally, Parliament and Council struck a deal on CRD IV – in the teeth of UK resistance. Perhaps this is a foretaste of battles to come where the UK’s increasingly detached status makes it vulnerable to such high profile defeats.

The Parliament is certainly flexing its co-decision muscles and seems determined to make the scrutiny of Level 2 measures into a real exercise of power – as intended way back when the Lamfalussy Process began. On the occasion of the EMIR Level 2 technical standards, Commissioner Barnier took note of the EP decision not to object to the proposed technical standards to implement new rules on derivatives. That will enable him to reassure ‘our American counterparts’ and “I hope to make progress towards a system whereby the EU and the USA recognise the application of their respective rules on both sides of the Atlantic as equivalent”.

The derivative issue is not yet over as the Basel Committee and IOSCO issued a near-final proposal on margin requirements for non-centrally cleared derivatives. The proposed requirements would allow for the introduction of a universal initial margin threshold of €50 million. The results of a quantitative impact study (QIS) conducted in 2012 indicate that application of the threshold could reduce the total liquidity costs by 56 per cent relative to a margining framework with a zero initial margin threshold. The proposal takes account of the 2012 QIS results, which was conducted to quantify the liquidity costs associated with margin requirements for non-centrally cleared derivatives, as well as comments received in connection with the first consultative paper. These policy proposals are articulated through a set of key principles that primarily seek to ensure that appropriate margining practices will be established for all non-centrally cleared over-the-counter (OTC) derivative transactions. These principles will apply to all transactions that involve either financial firms or systemically important non-financial entities.

For centrally-cleared derivatives, a crucial aspect is interoperability between CCPs. ISDA responded to ESMA's Guidelines for establishing consistent, efficient and effective assessments of interoperability arrangements, and supports the extension of interoperability for central clearing of derivatives, though it wishes to emphasise the need for further consultation. Clearing Members do not underestimate the challenges or the risks involved in creating interoperable structures for derivatives clearing, as these include the potential for systemic risk caused by the CCP which is the weakest link in the chain. There are also potential operational complexities for clients that choose the individual segregation model that is required to be offered under EMIR.

The review of the IORP Directive continues to stir strong and explicit opinions: PensionsEurope has warned that the Holistic Balance Sheet approach is not a workable tool for IORP supervision, and that alternatives should be considered. Matti Leppälä, its Secretary-General, said: “The methodology of a Holistic Balance Sheet will not be workable as a supervisory tool. PensionsEurope has strong doubts about the quality and reliability of the current valuations within the Holistic Balance Sheet. Based on the experience of PensionsEurope members with this QIS, PensionsEurope advises the Commission not to develop a proposal for a revised IORP Directive text where quantitative requirements are based on the results of this QIS.”

Graham Bishop

© Graham Bishop