11 October 2011

EACT: Presentation to Committee on Economic and Monetary Affairs of the European Parliament

The importance of consistency between EMIR and CRD IV

The September 2009 G20 resolutions proposed three actions on derivatives: a move to standardised contracts and central clearing; mandatory trade reporting; and punitive bank capital charges for any remaining uncleared (bilateral) derivatives. CRD IV and Basel III continue the G20 implementation process; in their drafting however there is a conflict with the positive end-user exemption outcome. Specifically, if CRD IV moves ahead as proposed, its effect on the pricing of derivatives could be so adverse that the new capital requirements regime will perversely deliver the opposite of what legislators agreed.

In the discussions on EMIR, end-users sought to underline that systemic risk does not arise from risk-mitigation activities. The G20 resolution, on the other hand, can only be interpreted as reflecting a view that all derivatives are necessarily linked to the creation of systemic risk. Higher bank capital should be directed at protecting the financial system from such risks; but without any linkage between systemic risk and risk mitigation by end-users, there is no case to support the punitive application of capital charges for uncleared end-user derivative transactions.

The proposed CRD IV impact on the pricing of derivatives is based on the CVA capital charge calculation. This is a very technical area, but the general view seems to be that the CVA capital charge could be double the level prior to implementation of CRD IV. This will both increase costs for the real economy and dissuade some organisations from prudently mitigating their risks with derivatives.

The wider impact that CRD IV will have on the real economy

• The impact on borrowing costs continues to be difficult to quantify, but it is self-evident that costs will increase. The additional costs can be between 50 and 164 basis points (in case of full implementation of the net stable funding ratio), or from 20 to 142 basis points (without the ratio in place). For EU companies, with their relatively high dependence on bank funding, these are material increases.
• Pressure will be put on smaller companies, due to the fact that they typically cannot switch their funding from bank and into capital markets as large companies will do.
• On trade finance, the economic impact appears to exaggerate the risk level associated with trade finance and the duration of the exposures for banks. There is also concern over the impact of CRD IV on longer-term export credit finance, often guaranteed by an export credit agency.
• Issues of international competiveness arise from concerns about a globally level playing field and the European dependency on bank finance referred to earlier. Failure to implement globally-consistent approaches in export credit finance could severely disadvantage EU exporters.

Full speech

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