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The European Union is still only partway through an extraordinarily testing time, and it will emerge from this period as a very different entity from the loose political and economic grouping that went into the crisis. Remarkably, when speaking to the College of the European Commissioners even the President of the European Parliament questioned the ability of the EU to survive as a community. But the core of his concern reflected the increased tendency of the Member States to make the big decisions amongst themselves as separate nation states, cutting out both Commission and Parliament. The first steps towards new Fiscal Compact Treaty epitomised this tendency but, he argued, in the end the Parliament and Commission had maintained their roles. As voters react against austerity, the string of new Governments – especially the probability of a new French President – will raise many questions about the conduct of economic policy.
The new Treaty may be changed somewhat – preferably to give it a more elegant name and perhaps including the magic word “growth” – but this author has argued forcefully that the real changes are in the agreement on the “six pack” and now “two pack”. The latter is in the final stages of negotiation and Bruegel pointed out that it is quite striking to see how the on-going discussions revolving around the two-pack and the fundamental changes it would bring to the euro area governance have been overlooked, both by the general public and by financial markets. In many ways, this will put the entire euro area into the equivalent of a permanent IMF programme – or prepare the way for a financial assistance programme if a State asks for it.
A natural implication of the closer union is that the euro area members are more likely to take an accepting view of an evolving “banking union” that reflects the oversized banking sector in the EU as a whole. Whatever the euro area wishes, the relative size of cross-border banks means that any resolution of such banks is bound to have major spill-over effects on host States. So they will demand a say in what happens – and correspondingly must contribute to the solution.
At the recent IMF Spring meeting, Managing Director Lagarde was particularly outspoken about the implications: “To break the feedback loop between sovereigns and banks, we need more risk-sharing across borders in the banking system. In the near term, a pan-euro area facility that has the capacity to take direct stakes in banks would help. Looking further ahead, monetary union needs to be supported by stronger financial integration, which our analysis suggests should be in the form of unified supervision, a single bank resolution authority with a common backstop, and a single deposit insurance fund.”
The Financial Transaction Tax (FTT) continues as a major topic of debate – about both practicality and desirability. ECON adopted a proposal by 3:1 that went wider even than the Commission’s proposal. It builds on the UK’s stamp duty concept so the text links payment of the FTT to the acquisition of legal ownership rights. "This is a very ambitious proposal and it is a key part of the Socialists and Democrats' strategy to exit the crisis", stressed Rapporteur Anni Podimata after the vote. However, S&D Group Leader Hannes Swoboda said after the informal ECOFIN meeting: "It is regrettable that the Economic and Finance Ministers have moved away from the Commission proposal for a real FTT”.
ECON had a second exchange of views on amendments on CRD IV/CRR. Almost all political groups are going in the same direction concerning SMEs' risk weight. The EP wants to start the trialogue negotiations as soon as possible and there are five main points where broad guidelines have been agreed: SMEs’ risk weight; liquidity remuneration and bonuses; systemically important financial institutions (SIFIs); and different business models. The ECB gave its formal Opinion – welcoming the proposed Regulation, which limits Member State options and discretion. Moreover, the ECB strongly supports the development of a single European rulebook for all financial institutions. The EBA launched a consultation on Draft Regulatory Technical Standards (RTS) on Own Funds – which are expected to be applicable as of 1 January, 2013. ECB President Draghi stressed that the ECB, the ESRB and the three new European supervisory authorities are all working to fill remaining data gaps and to meet the data challenge for their macro-prudential functions.
Amidst all the debate about the nature of bank capital and leverage, there is a rising feeling that regulators may be losing sight of the basic fact that bank equity and bonds must remain an attractive investment to potential investors – or there will be a major deleveraging that is very damaging to the European economy, given that bank assets are around twice the size of GDP. Importantly, the regulatory treatment of bank debt in the hands of investors may be as important as the actual riskiness of the bank. So a string of recent surveys and analyses are not good reading.
Risk.net ran a poll on the consequences of the new resolution plans: Over three-quarters of respondents believe the plans will hurt the market for bank debt and, according to some estimates, could add 100 basis points or more to bank financing costs. But Oliver Wyman estimates European banks will have to issue around €2.7 trillion (equivalent to around 20 per cent of EU GDP) in long-term debt to comply with Basel III's net stable funding ratio (NSFR). According to the Securitisation Investor Survey, a new survey of leading asset managers and insurance companies carried out by AFME, a third of insurers polled said the new rules would stop investment altogether, with the remaining two-thirds saying they would dramatically reduce allocation of funds to the securitisation sector. In late 2011, the European Commission proposed Solvency II capital charges of 7 per cent of market value per year of duration on AAA-rated securitisations held by insurance companies, compared with 0.9 per cent for corporates and 0.7 per cent for covered bonds.
Securitisation regularly features in the list of activities of “shadow banking” that commentators warn against the dark side of finance: non-bank companies taking the risks banks used to take. The FSA’s Lord Turner highlighted some of the underlying drivers and characteristics that could manifest themselves in future in new specific forms. He also analysed how and why shadow banking played a central role in the 2008 financial crisis, suggesting that ‘securitisation’ per se might have had some potential to be a useful financial innovation, but that the developments of ‘shadow banking’ were inherently dangerous.
Another aspect of the regulatory treatment of investors comes from the Omnibus II treatment of the matching adjustment for insurance premiums for long-term savings such as annuities and the discount rate to be applied to the liability. The industry remains deeply concerned that the hasty deal struck in “trialogue” is inadequate. Meanwhile, questions remain over the position of the US in terms of equivalence with Solvency II. The proposals for temporary equivalence have not been modified to include a process for establishing this for the US. In February, the EC released a list of seven countries identified for the second wave of Solvency II equivalence assessments. While the US was absent from the list, the Commission said a “different approach” for determining temporary equivalence should be sought.
Under current MiFID rules, all UCITS funds are considered as "non-complex" products, meaning the buyer's knowledge of financial products does not have to be assessed. But under the proposed changes in MiFID II, distributors must assess the buyer’s knowledge before selling so-called “complex” UCITS funds” to retail investors. Distributors with “execution-only” sales teams would be particularly affected by the change.
Graham Bishop