26 July 2013

July 2013 Financial Services Month in Brussels - Graham Bishop's personal overview

Lithuania took over the EU's Presidency and set priorities to include strengthening the economic and monetary union and building a banking union. President Barroso outlined a number of economic governance developments including the first implementation of the so called two-pack “we will be reviewing national budget plans from October - and in moving forward the work on deepening the Economic and Monetary Union. The Commission will come with legal proposals on ex-ante policy coordination and on the Competitiveness and Convergence Instrument.”

The European Council conclusions stated that concrete new steps towards strengthening economic governance will need to be accompanied by further steps towards stronger democratic legitimacy and accountability at the level at which decisions are taken and implemented. In the short run, the key priority is to complete the Banking Union and pursue the building blocks of a reinforced EMU, as they are closely interrelated. There must be a more effective framework for the coordination of economic policies and the Commission intends to present a proposal on the ex ante coordination of major economic reforms in the autumn. The discussions will be continued in December 2013, with the objective of taking decisions on these issues, in particular on the main features of contractual arrangements and of associated solidarity mechanisms.

But the Council underlined that all developments must be open to all EU members and preserve the Single Market so Commissioner Barnier’s call to the UK was welcome “The single market in financial services - We need the UK on board”. He believes the UK would lose out on many of its interests if it were to leave the single market, and that in the interest of stability on the continent, it would make sense for the UK to support the Banking Union even if it did not want to belong to it. However, he was explicit in one respect “I know one thing. The single market cannot be 'pick and mix'. I've heard some people suggest that financial services should be repatriated. It’s the wrong cause to fight for, because financial services are an integral part of the single market.”

Banking union

The European Parliament Plenary adopted a non-legislative resolution - by 528 votes to 87 with 73 abstentions – on a further broad overhaul of banks. Bank board members must be personally liable for mistakes, and banks' riskier trading activities must be clearly separated from their more conservative lending ones.  It is an input to Commission proposals due in September and stressed the need for more competition in the banking sector and for further reform of banks' remuneration and corporate governance structures.

These longer-run structural ideas have to co-exist with more immediate problems. The EBA published a report on risks and vulnerabilities of the EU banking sector and noted there is increasing uncertainty about the quality of banks' assets and valuation. The agreement reached at the EBA table on the need to conduct asset quality reviews across major EU banks will contribute to dispel concerns over the deterioration of loan books, especially if appropriate and consistent disclosure is provided. However, the low interest rates environment creates some pressure on bank net interest margins, particularly for banks with exposures to tracker-type mortgages, and increases the risk of hidden forbearance, which in turn leads to the build-up of latent credit risk.

Clearly, resolving such doubts about banks’ asset quality is a key requirement for a successful SSM start-up. The Bundesbank pointed out that many measures will be needed, such as the disclosure of existing or expected losses, a decision on the resolution, restructuring or recapitalisation of troubled banks and legislation designed to prevent new vulnerabilities from arising in the future. CEPS’ Gros laid out the significance:

“Europe's ailing banking sector is undercapitalised, too large and populated by too many players without a viable long-term business model. What should be done is clear: recapitalise much of the sector and restructure those parts lacking a viable business model. But as this is unlikely to happen any time soon, it also unlikely that Europe can recover fully from its present slump.”

The Commission proposal for a Single Resolution Mechanism (SRM) to complement the Single Supervisory Mechanism (SSM) should have crowned the Banking Union process but instead triggered some serious push-back, especially from Germany. How much is pre-election posturing is debateable but Europe may find that the current SRM proposal has been fatally undermined by casting doubts on its legality. Fortunately, a robust preparation for the SSM should mean that  no significant bank is likely to need to be resolved for some years once any necessary re-structuring has been done in the next year or so – but under the existing national systems.

The proposed SRM would apply the substantive rules of bank recovery and resolution and, at the June European Council, leaders set themselves the target of reaching agreement on the mechanism by the end of 2013 so that it can be adopted before the end of the current European Parliament term in 2014. This would enable it to apply from January 2015, together with the Bank Recovery and Resolution Directive. That would dovetail neatly with the SSM coming into operation. The SRM is to be controlled centrally by the European Commission under Article 114 of the TFEU. Although current problems identified can be treated within this framework, Commissioner Barnier said he wouldn't exclude Treaty change at a later stage. Reactions from the European Parliament were supportive of this timetable.

However, German Finance Minister Wolfgang Schäuble referred to the Commission's proposal for Banking Union as a project with "feet of clay". “What we need now is a credible and legally viable solution. If a bank has to be closed, this decision has far-reaching consequences and cannot be made solely from Brussels; especially as it might involve national taxpayers' money. It may happen that the taxpayer has to step in - and in that case we do not want Brussels to decide and the Member States to pay. Responsibility and decision-making have to go hand in hand.”

In contrast, the EBF said  “We strongly believe that the target level of a common fund should be set, taking into account the enhanced prudential framework, the crisis prevention role of Recovery and Resolution Plans and accompanying far-reaching powers of supervisory authorities as well as the early intervention regime and the broad loss absorbing capacity of bail-in”. The Commission also proposed amendments to the State aid crisis rules for banks.

In principle, a bank needs to work out a restructuring plan, including a capital raising plan, which convincingly demonstrates how it will become profitable in the long term before it can receive recapitalisation measures. If the viability of the bank cannot be restored, an orderly winding down plan needs to be submitted instead.

Credit impairment accounting is becoming a hot topic but the debate amongst accountants seems detached from the immediate (and urgent) need to produce an Asset Quality Review within a year to launch the SSM. This review must satisfy investors that banks really have provisioned for expected losses rather than incurred losses. In its response to IASB proposals on Expected Credit Losses, the EBA supported the introduction of an expected loss model. The current incurred loss model has resulted in the well-known “too little too late” recognition of credit losses. The move to an expected loss model will improve the decision usefulness and relevance of financial reporting for users, including prudential regulators.

EBF said it is supportive of the objective to achieve a sound expected loss provisioning approach and supports the IASB in developing a principle-based model. The EBF believes that the IASB approach is a step in the right direction and regrets that the FASB has decided to develop its own expected loss model. In the EBF´s view, the FASB does not meet the objectives of financial reporting as it would obscure information about credit deterioration and risk management, resulting in financial reporting which does not faithfully portray the economics of transactions. It is crucial that the new provisioning system recognizes impairment allowances that are meaningful for different portfolios in different jurisdictions on a timely manner, permits banks to draw from their risk management systems, incorporates a broader range of credit information and is operational and applicable to open portfolios.

The TTIP negotiation with the US were launched - the biggest trade and investment negotiations ever. The EU has also taken the unprecedented step of making available to the public some of its initial position papers on the negotiations. Barnier said he believed ambition could be turned into reality - on two conditions (i) we need to be ambitious enough to build a real transatlantic marketplace and (ii) We need to build ever closer political transatlantic ties. Remaining tariffs must go – but they are already very low: 4 per cent on average. And we need to prove that we trust each other by ensuring equivalence or “substituted compliance”.

He argued that the EU’s single rule book also allows Europe to negotiate on an equal footing with other jurisdictions. Transatlantic exchanges still account for 70 per cent of the world’s financial services market. The UK and the Commission both strongly believe that financial services should be part of the mandate of the TTIP to ensure a real level playing field between EU and US companies, and avoid regulatory arbitrage, in the interest of global financial stability. But the United States does not agree. “Our only chance of persuading them is if we show up at the negotiating table speaking with one voice. I don’t think any European country – however special their relationship with the US is - can succeed alone. But when you sit at the negotiating table representing the biggest consumer market in the world, you’re in a much stronger negotiating position. And what is true for a cross-cutting trade negotiation is also true for individual financial services issues.” He pointed to the example of reaching a landmark agreement on cross-border derivatives last week with the CFTC. It establishes that our rules are essentially identical in important areas. Firms from the US and the EU will be able to choose which rules to apply to a trade: EMIR or Dodd-Frank.

The Basel Committee consulted on derivatives-related reforms to the capital adequacy framework. It released two consultative papers setting out proposals for calculating regulatory capital for a bank's exposures to central counterparties (CCPs).

The ICMA European Repo Council signed a MoU with Clearstream, Euroclear and Eurex Clearing for a joint project enabling their systems to work together to increase the efficiency of the repo market. Establishing triparty settlement interoperability with both triparty service providers will improve the movement of collateral between the connected settlement locations in Europe. It will also reduce collateral pool fragmentation, which currently can cause technical fails, while allowing banks to supply liquidity to the real economy through the intervention of the repo markets. The initiative will increase the efficiency of collateral management for repo basket trading throughout Europe and will boost the fluidity of collateral across the eurozone.

The FT reported that banks are warning of risks at clearing houses on both sides of the Atlantic - posing a growing risk to the stability of the financial system. Concerns have mounted as clearing houses have shot to the top of banks’ lists of counterparties, following the shift of over-the-counter trading to centralised clearing houses. But, as trading volumes through the clearing houses ramp up, banks increasingly fear this new counterparty risk. Banks have voiced concerns to regulators in Europe and the US that central clearing houses are providing insufficient data on their own risks and demanding lower-quality collateral for swaps transactions. But the world's largest exchanges operator, CME Group, promptly rejected this charge.

Insurance Europe believes the EIOPA proposals on LGTA do not fully address the underlying issues and concerns, particularly the volatility and pro-cyclical incentive features of Solvency II. It listed changes needed to the EIOPA proposals in order to make them workable. The European insurance industry fully supports the objectives of Solvency II. However, there are some vital issues that must be resolved before the Solvency II framework is ready to be implemented and will achieve these objectives.

The IAIS's new capital requirements for G-SIIs will lay the foundation for a global capital standard for all insurance groups. But there are concerns as to whether a global capital standard could be applied uniformly across all jurisdictions, despite efforts to converge accounting practices. The wording of the latest policy measures signal that policy-makers' plans to develop a global capital standard for all internationally active insurance groups (IAIGs) are accelerating, say experts. Previous drafts of the measures specified that any capital requirement would be targeted primarily at groups' non-traditional, non-insurance activities (NTNIA).

The AIMA/EY survey found mixed progress towards AIFMD transposition. Although a majority of EU Member States have either already transposed the AIFMD into law within the deadline of 22 July 2013, or have drafted the final legislation and are awaiting parliamentary approval, only 12 Member States have completed full legislative transposition. At least five Member States are known to have made little or no progress. “So the Directive has not yet achieved the single market for non-UCITS products it was aiming for, and so firms will have to operate across a patchwork quilt of regulatory standards for the next few years at least."

Finally, another skeleton of the banking industry’s morals during the boom years seems about to fall out of the cupboard. The Commission has sent a statement of objections to 13 investment banks, ISDA and Markit about its CDS investigation. It informed them of its preliminary conclusion that they infringed EU antitrust rules that prohibit anti-competitive agreements by colluding to prevent exchanges from entering the credit derivatives business between 2006 and 2009. It considers that they may have coordinated their behaviour in order to jointly prevent exchanges from entering the CDS market in that period.

 Graham Bishop

© Graham Bishop