The EU’s response to the fiscal crisis of some it‘s members now seems to be moving decisively into the phase of having a direct impact on financial regulation. The European Council finally agreed to a small Treaty change that may bail-in private creditors. At a stroke, that would demolish the fiction that the public debts of eurozone members should always be regarded as risk-free so casting doubt on the 0% risk-weighting for banks that hold such debts. (Click for a detailed analysis). This whole subject will be discussed again at the December meeting with a view to ratifying any treaty change by mid-2013.
However, the reform impetus that is coming from the G20 is not over by a long way. G20 Finance Ministers and Central Bank Governors prioritized the following issues on the agenda for the Seoul Summit: implement within the agreed timeframe the new BCBS bank capital/ liquidity framework; endorse the FSB’s recommendations to increase supervisory intensity and effectiveness; endorse the FSB’s work process on SIFIs; and commit to implementing all aspects of the G20 financial regulation agenda, in an internationally consistent and non-discriminatory manner, including the commitments on OTC derivatives, compensation practices and accounting standards and FSB principles on reducing reliance on credit rating agencies.
The next few years will indeed be busy at the international level. But the EU will add its own activities and the Commission launched a consultation on further capital buffers for banks. They will consider whether capital buffers should be introduced in the EU through the upcoming amendment to the Capital Requirements Directive, due to be proposed in the first quarter of 2011.
However, the insurance industry has taken the precaution of sending an industry letter to the G20 to point out that the insurance business model differs from the banking model: The letter covers issues such as global trade, accounting, regulation, capital requirements, levies and taxes. It states that it should be acknowledged that the vast majority of insurers were relatively unscathed in the financial crisis owing in large part to the unique characteristics of their business model and products. It is essential to distinguish between the core insurance business model and those of other financial services such as banking.
Insurers use rigorous risk management strategies and direct premiums into secure investments that appropriately match the expected amount of benefits paid and the duration of the policies. Banks generally have a liquidity mismatch between their assets and liabilities since they tend to fund themselves short-term. Insurers do not have the same liquidity risks since their liabilities are generally not liquid given the deterrents and penalties to early surrender by policyholders.
The Commission outlined its vision for taxing the financial sector. At a global level, the Commission supports the idea of a Financial Transactions Tax (FTT) but at EU level, they recommend a Financial Activities Tax (FAT). This idea found favour with ECOFIN though there was recognition of the risk of competitive distortions and multiple charging of cross-border banks. In fact, Council called for consideration of the cumulative impact of all the measures on capital, liquidity, funding deposit guarantees etc.
The FSB published a report on improving OTC derivatives markets with21 recommendations on practical issues such as standardisation, central clearing, exchange or electronic platform trading, and reporting of OTC derivatives transactions. Co-incidentally, ISDA’s Mid-Year 2010 Market Survey threw up some eye-catching numbers:The total notional amount outstanding of interest rate, credit, and equity derivatives was $466.8 trillion and the 14 largest international derivatives dealers account for 82% of that. Each of them has a net credit exposure, before collateral, averaging $160 billion. As former CESR chairman Eddy Wymeersch put it SIBOS “The real answer is that we have to look at reducing risks in these markets. You may pile up all the collateral you want but in the event of crisis, collateral loses its value and solidarity disappears.”
AIFMD finally arrived in a first-reading agreement between the co-legislators. ECON claimed that Parliament shaped the requirements on the three key problems: a passport for non-EU AIF and AIF managers, combating asset stripping, and ensuring tough rules on depositary liability.
The ripples from the crisis spread steadily wider and the auditors are now coming under scrutiny. Commissioner Barnier wondered aloud why the audit firms did not see this crisis coming as they were in the front line of financial reporting. Then he launched a consultation on whether audits provide the right information to all financial participants or not? 70% of the European market is in the hands of the Big Four and the crisis highlighted failings in the audit sector. “I believe it is important to approach this discussion in a frank and open manner. No subject should be taboo."
The FSB published principles for reducing reliance on CRA ratings and they aim to catalyse a significant change in existing practices, to end mechanistic reliance by market participants and establish stronger internal credit risk assessment practices instead. There is a plaintive call for standard setters and authorities to develop alternative definitions of creditworthiness. But there was little guidance as to how this might be done!
Graham Bishop
© Graham Bishop
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