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04 May 2011

April 2011 Financial Services Month in Brussels - Graham Bishop's personal overview of April events and near-term risks


Even in this Easter-shortened month, there were still many major developments. The most far-reaching continue to focus on the future economic governance of the EU and more specifically the eurozone. But the most immediate events could be pre-emptive reactions to the bank stress tests.

The results are scheduled to be reported in mid-June and the EBA agreed to adopt a benchmark of Core Tier 1 against which to assess banks. The CT1 benchmark will be set at 5% of risk-weighted assets but this definition will be used solely for the purpose of the EU-wide stress test. To ensure a fully harmonised computation by all the banks involved in the exercise, the EBA has mapped the different capital elements of CT1 to the current COREP reporting framework and the 5% CT1 benchmark is not a legal minimum requirement. However, the EBA expects any bank failing to meet the benchmark, or showing specific weaknesses in the stress test, to agree with the relevant supervisory authority the appropriate remedial measures and execute them in due time.

The April Informal ECOFIN meeting agreed on the need for stricter and more robust stress tests to make them more credible for investors and markets than in the first two cases. It was highlighted that the governments of Member States have to get ready to handle the consequences of stress tests and to take measures to have back stops before carrying out the tests. Therefore, if needed, they could assist vulnerable financial institutions immediately.

What do these fine sentiments really mean in practice? In the next 2-4 weeks, Governments will presumably prepare for providing the extra capital that could be shown as necessary by the stress tests and the key issue is seen by the markets as the exposure to weak countries – both sovereign and private. Trading book exposures will be marked to market – as in the last round. But the EBA has now said that banking book exposures will be published – by country and by maturity. So analysts will be able to make their own adjustments for such exposures.

If it transpires that some banks have much greater capital shortfalls than their host government have planned to meet, counter-party banks could well respond by withdrawing credit lines until the necessary clarification has happened. That could herald another period of illiquidity for significant parts of the banking system. Such scenarios could pose particular problems to the ECB in providing liquidity.

Wolfgang Münchau, for example, expects the EU to pursue the ill-fated route of a “voluntary restructuring”, as he believes there is an emerging consensus among policymakers that the Greek public sector debt is not sustainable.  For this realisation to look consistent with the “Deauville pledge”, the most likely route chosen will be a voluntary restructuring that involves a maturity transformation of Greek bonds. If turned into reality, the ECB might find the need to call for fresh capital – in line with its capital key that reflects the size of Member States. But the bigger problem for Member States could be the need to re-capitalise their banks that had lent to the weaker states. So the larger states would find their tax-payers were bailing out their own banks directly and also the ECB – so only indirectly making payments to the weak states. Would that be less politically toxic?

ECON voted to back a legislative package introducing tougher sanctions to address the root causes of the crisis: a worrying build-up of economic imbalances within European economies and the propensity of governments to finance spending by getting deeper into debt. MEPs tabled over 2,000 amendments to the "six-pack" of legislative proposals, calling for a tougher regime to deal with spendthrift member states than that proposed by the Commission. The main difficulty faced by lead MEPs was to strike a balance between stepping up the "automaticity" with which Member States reluctant to reform would have actions and sanctions imposed upon them. The texts step up recourse to "reversed qualified majority" voting.

The findings of the US Financial Crisis Inquiry Commission were presented by its chairman, Phil Angelides, to the European Parliament's CRIS Committee. MEPs found its account of the causes of the crisis plausible, and stressed the need for EU-US co-operation to help overcome it. “We are on the same wavelength" notably on the "causes" of the crisis, its "social element" and the "fact that serious imbalances exist", said committee chair, Wolf Klinz, summing up the debate. "Like you, we are convinced that we are nowhere near exiting this crisis. We shall need to co-operate with you", although "we are not going to get everyone in the G20 to agree. But certainly the US and the EU should walk forward hand in hand", he concluded.

Commissioner Barnier intends to keep the Single Market Act high on the political agenda to ensure delivery of the actions by the end of 2012. But free movement of goods, services, capital and people does not always happen smoothly. Pieces of legislation are missing and administrative obstacles and lacking enforcement leave the full potential of the Single Market unexploited. With its draft common consolidated corporate tax base for businesses (CCCTB), the Commission plans to harmonise the methods for computing the tax base, so that the businesses so choosing can be subject to the same set of rules, irrespective of the Member State in which they are taxed.

Turning to detail technical matters, ECON debated  amendments to EMIR and was informed by CFTC Chairman, Gary Gensler, that the US Congress has postponed the adoption of the part of the Dodd-Frank Act related to OTC derivatives. Concerning commodities trading, Rapporteur Langen said that the EC will tackle this issue on a separate piece of legislation, and that a recital in EMIR could be introduced.  The FSB reported on progress with OTC derivative reform and is concerned that many jurisdictions may not meet the G20’s end-2012 deadline and believes that, in order for this target to be achieved, jurisdictions need to take substantial, concrete steps toward implementation immediately.

Financial market plumbing continues to attract attention and “Advanced Trading” pointed out that when standardised swaps are centrally cleared and traded on a Swap Execution Facility, margin will be an increasing aspect of the business as only approximately 75 per cent of rates and 73 per cent of credit swaps currently are collateralised. Moreover, end-users that need to manage commodity, interest rate or credit risk stemming from their normal course of business may not be able to migrate their swaps toward more standardised products because of hedge accounting rules.

Financial News reported that the European Commission will push ahead with a settlement shake-up.  Its proposals to harmonise settlement systems across Europe have been met with cautious optimism after years of failed attempts to reform this last leg of the trading cycle. But debate is growing as to how to define settlement functions and the settlement consultation launched in January will address the final stage of the trading cycle - the activities of central securities depositories.

There is a slowly-dawning realisation that the EU needs to join up its thinking about micro regulation and the macro-economic impact. On Solvency II, the CEA, the Pan European Insurance Forum, the CFO Forum and the CRO Forum sent an astonishingly powerful letter to Commissioner Barnier about the implementing measures."It is absolutely imperative that changes are made." BUSINESSEUROPE went on to underline the importance of a comprehensive quantitative impact study on the cumulative effects of both Basel III and Solvency II, which assesses both macroeconomic effects and the consequences for the financing of European companies. The EBF expressed its concerns that the impact of the measures may adversely affect the financing of European economies due to their multiplicity and cumulative overall effect.

Graham Bishop



© Graham Bishop

Documents associated with this article

MiB Final April 2011.pdf


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