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Graham Bishop’s Personal Overview
March 2008 is likely to be seen as the month when the public authorities began to flesh out the detail of their response to the financial turmoil since last summer. In the EU, and now the US, plans began to emerge but the timescale of both is uncertain because of the arbitrary arrival of scheduled elections. For the EU, the deadline is the final plenary session of this Parliament in April 2009 as that will be the last moment that the co-decision maker is able to act until after its June elections. Thereafter, the composition and political balance of the new Commission will dominate attention until it takes office in November 2009. Already, the debate is acquiring a left-right political tinge.
So the speed of the debate has acquired an additional importance. Commissioner McCreevy has said the response of policy makers and regulators “needs to be long term, cautious, practical, and forward looking” yet went on to propose for example that there will be changes to the Capital Requirements Directive and the Commission will propose these no later than October, with a view to a First Reading agreement with Parliament by April. The essence of the Lamfalussy Process is consultation with all affected stakeholders to give adequate time for thoughtful consideration to avoid the risk of unintended side effects. The political imperative to be seen to be taking action is understandable, but the risk of haste leading to error is all too clear, especially given the breadth of proposed policy actions.
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The March European Council stressed that immediate disclosure of risks and losses of banks and other financial institutions is essential to restore confidence in financial markets and called upon ECOFIN to focus on:
o Enhancement of transparency for investors, markets and regulators,
o Improvement of valuation standards, in particular the valuation of illiquid assets,
o Reinforcement of the prudential framework and risk management in the financial sector;
o Improvement of market functioning, including the role of ratings agencies.
ECOFIN’s interim report to the European Council also added to this list: On financial crisis management, tools and procedures must be enhanced and a Memorandum of Understanding is planned for Spring 2008. The Commission wants a political agreement with the Council and the European Parliament on the October 07 “roadmap” to deliver the necessary legislative changes before April 2009.
But the voice of caution was raised by a Financial Times leader warning “Beware a regulatory backlash against banks: Banks are focused on the current crisis but they should keep their eyes on another looming problem: a regulatory backlash that is already under way in some countries. It will be costly and will have unintended consequences.” As an example, the British Bankers’ Association has set out banks’ concerns about the proposed “Northern Rock” laws, billed as the most far-reaching overhaul of British banking laws for 30 years.
Amongst the flood of ideas coming forward:
o The European Council called for a crisis alert and early warning system. Deutsche Bank CEO Ackermann also called for the creation of an international financial watchdog. "I advocate a council of wise men and women," he said, adding that they could point out market exaggerations and help avoid bubbles. The European Shadow Financial Regulatory Committee called for the creation of a “European Banking Oversight Board”, independent of national regulators and supervisors with the function of regularly observing the development of systemic risk of banks in Europe.
o ECB President Trichet called for a further significant change of culture at the national, European and global level towards enhanced transparency and anti-cyclicality as a large number of rules, regulations and procedures have a tendency to foster behaviour that is largely pro-cyclical, amplifying the booms as well the busts in the cycle.
o Commissioner McCreevy: “I am calling on the Standard Setters, Issuers, Regulators and Preparers to undertake the analysis and draw the lessons from the use of "mark to market" in the light of current market conditions”.
o IOSCO has proposed that CRAs refrain from rating a product if the complexity or structure of a new type of product causes doubts about the feasibility of a rating action. It also calls for a prohibition on analysts making proposals or recommendations regarding the design of structured finance products that the CRA then rates.
o The UK Parliament’s Treasury Committee report on the latest financial turmoil concluded that detailed regulation of products is one response to the problem of product complexity.
Analyses include:
o Senior Supervisors Group “Some firms made strategic decisions to retain large exposures to super-senior tranches of collateralized debt obligations that far exceeded the firms’ understanding of the risks inherent in such instruments, and failed to take appropriate steps to control or mitigate those risks.”
o Basel Committee has identified three fundamental shortcomings that contributed to and amplified the turmoil: the industry failed to consistently employ sound underwriting standards, its risk management and measurement capabilities did not keep pace with rapid financial innovation and the evolution to market-based credit intermediation and certain aspects of regulation, supervision and market transparency failed to reflect financial market developments and therefore contributed to weak practices at banks.
o Banque de France says that the main lessons from its analysis are that securitization should not be curtailed, and that it is useful for central banks to have a list of eligible assets that is sufficiently diversified to address an unexpected increase in collateral demand, in order to mitigate the consequences of a financial turmoil.
Amidst the rush of thinking and activity in Europe, the EU should not overlook the announcement at the very end of the month by the US Treasury of a far-reaching plan to reform US financial regulations. The short-term recommendations focus on taking action now to improve regulatory coordination and oversight in the wake of recent events. The intermediate recommendations focus on eliminating some of the duplication of the U.S. regulatory system, but more importantly try to modernize the regulatory structure applicable to certain sectors in the financial services industry (banking, insurance, securities, and futures) within the current framework. Though US elections may delay the implementation, the EU’s major financial competitor will be putting itself in a position to take full advantage of any mistakes made during an over-hasty reform in the EU.
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Graham Bishop