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Graham Bishop's Personal Overview.
As the holidays recede into the distant past, financial services policy-makers are grappling with the implications of the summer’s turbulence in financial markets. But there was already a heavy legislative schedule.
October: Planned agreement on the Reform Treaty; the review of the Lamfalussy Process gets under way with the final report from the Inter-institutional Monitoring Group (IIMG); Undertakings for Collective Investment in Transferable Securities (UCITS) amendment proposal.
November: Markets in Financial Instruments Directive (MiFID) comes into force on the first day of the month; TARGET2 begins operations with a first wave of migration; consideration of Quantitative Impact Studies 3 (QIS 3) report for Solvency II.
December: Capital Requirements Directive (CRD) comes into force; separate accounting for unbundled clearing and settlement services.
Autumn: Solvency 2 starts its journey through the co-legislators of the European Council and European parliament; single market review – the Citizen’s Agenda – including results of retail financial services green paper.
Though much of this is technical, there should be a growing realisation that the EU faces some difficult political choices. It may be 2009 before there is a new Commission but the key deadline for enacting legislation is the last plenary session of the Parliament – now established firmly as co-legislator. That will probably be April 2009 – only 15 months of effective legislative time away.
The push to get Solvency 2 agreed quickly by the co-legislators via the use of “fast track” procedures may raise questions about how this can be done effectively yet not lose democratic input. CEIOPS is aware of the contentiousness of a number of aspects under discussion on the political level including group supervision. Such issues are bound to arise in the review of the Lamfalussy Process because the risks and problems of the single market are already with us. This has developed much faster than many observers recognise. The bids for ABN AMRO have been cleared by DG Competition in principle and this will reduce the number of large cross-border banks to just 15, holding nearly a third of all EU banking assets.
Unsurprisingly, the European Financial Services Round Table stressed that the framework of prudential supervision has to be adapted to the increasingly integrated European financial market. EFR strongly suggests that, in the light of the current financial market turmoil, the EU makes progress in implementing a lead supervisor model for the banking and insurance industries and strengthens the role of the European Committees of supervisors. CEIOPS also wrote to the Commission “that building a better harmonized, risk based regulatory framework is a key precondition for enhanced convergence of supervisory practices, and not only in the insurance sector. This should illustrate the need for CEIOPS’ status and role as a level 3 Committee to be reinforced in the Lamfalussy review process.”
At present, consensus is required for the Level 3 regulatory committees to make a decision. Can that last as they move to “reaching consistent regulatory solutions and removing undue differences in regulatory practice”? It seems inevitable that the market will push for decisions that realistically can only be reached by majority voting – whatever the type of majority – to get efficient decision-making that corresponds to the speed of market developments. The debate about the future of the Lamfalussy Process may well pivot on this issue.
The market turmoil has given these discussions an added point. ECOFIN announced that the EFC will review how to improve further the transparency of complex financial instruments, of institutions and vehicles, as well as how to improve valuation processes, risk management and liquidity stress testing. EFC will also consider the role of rating agencies in structured finance. ECOFIN also announced that the 2005 Memorandum of Understanding (MoU) between EU Banking Supervisory Authorities, Central Banks and Finance Ministries on co-operation will be extended. But market confidence in such MOUs may not be high while there is any suspicion that the Northern Rock episode in the UK represented a failure of regulatory co-operation within a single Member State.
As it happens, CEBS has just tendered some of its advice on Liquidity Risk Management: But the second part should be delivered by January 2008 and seems particularly timely in the light of current market problems. CEBS is to identify any other areas and problems that appear not to be adequately addressed by the current regulatory framework at the EU level, including variables that may significantly affect liquidity risk management; the interaction of funding liquidity risk and market liquidity risk; and the use of internal methodologies by sophisticated firms and by credit rating agencies. Comparison of these methodologies and those of the ratings agencies may be interesting for CESR’s discussions with the CRAs about implementation of the IOSCO Code and, more specifically, how they develop ratings for structured finance products.
The Commission has published a report from the European Securities Markets Expert Group (ESME) on the Prospectus Directive. Disturbingly, ESME found there are some unwanted side effects of the push for complete transparency. Due to disclosure requirements, cost and subsequent obligations, issuing structures have been developed to avoid the provisions of the Prospectus Directive. But even worse, due to its length and complexity, most investors do not use the prospectus as a means of information prior to investment decisions!
But there are some silver linings to these clouds that should not be overlooked. The OECD found that activist hedge fund and private equity strategies can actually improve companies' corporate governance “by increasing the number of investors that have the incentive to make active and informed use of their shareholder rights". "Such active and informed ownership is expected to stimulate the search for the best possible use of corporate assets and thereby contribute to better risk and resource allocation in the economy as a whole."
In just three months, SEPA will go live so it is welcome news that Deutsche Bank has announced a four-pillar approach to the handling of all payments with SEPA criteria. They will be implemented in the same way as legacy domestic mass payments. “By effectively treating all payments, regardless of amount, as domestic transactions Deutsche Bank goes far beyond the requirements of the current EU Regulated Payment”.
Another reminder of the EU’s growing role as a global standard-setter came from Tokyo. Following the EU’s adoption of IFRS for all listed companies in the EU, the Accounting Standards Board of Japan (ASBJ) and IASB jointly announced an agreement to accelerate convergence between Japanese GAAP and International Financial Reporting Standards, a process that was started in March 2005. The agreement reflects the growing acceptance of IFRS by major economies throughout the world, and it calls for the elimination by 2008 of major differences between Japanese GAAP and IFRS.
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Graham Bishop