26 February 2008

February 2008

Graham Bishop's Personal Overview.

The continuing fall-out from the sub-prime problems dominated EU policy-makers thoughts in February – but market participants should recognise that many other strands of activity are continuing unabated. Certainly Commissioner McCreevy was quite frank that the speed and severity of the turmoil that has swept through the financial markets since last summer has taken both market participants and regulators by surprise. But this has “prompted a reality check of the financial system, both globally and for Europe”.

So he felt that financial sector corporate governance will need to be strengthened -including management of credit, market, liquidity, and operational risk. The Financial Stability Forum suggested focus on six areas in their response to the sub-prime crisis and the exposure of weaknesses in the financial system: the supervisory framework and oversight, underpinning of the originate-to-distribute model, reassessing the uses and role of credit ratings, increasing market transparency and strengthening the authorities’ ability to respond to crises.

That breadth seems to chime with ECOFIN’s contribution to the Spring European Council Summit so there is likely to be a powerful call for actions along these lines from the Heads of Government. These issues are a priority for the Slovenian Presidency and will feature at April’s informal ECOFIN meeting. Moreover, Jean-Pierre Jouyet, French Minister of State for European Affairs, has highlighted the importance of financial market regulation for the French Presidency starting mid 2008 “France’s main priority will be to strengthen financial supervision and harmonisation in Europe …We would also like supervision of multinational financial groups to be better integrated”.

But there are other elements that will be addressed. CESR has launched a consultation on rating agencies, stating that “CRA’s concerted initiatives put forward so far are not enough …The rating industry response needs to be supported by further prompt and firm actions”, especially concerning the nature of CRA interaction with issuers during the structured finance rating process. ECB President Trichet added his voice to the deposit guarantee debate, warning that an ill-designed deposit insurance scheme can have important adverse effects “Partial insurance, or the so-called co-insurance, for smaller deposits could be removed where it still exists, as recent experience seems to suggest that it may reintroduce incentives”.

In international relations, the EU is continuing to broaden its sphere of influence as Japan moves forward with its modernisation plans and India signed a co-operation agreement with France’s AMF. Internal Market Director General Jörgen Holmquist recently stressed that the adoption of Solvency II would set a world-leading standard, underling the importance of this factor. But Commissioner McCreevy’s visit to Washington struck a somewhat muted note on progress on mutual recognition for securities. Nevertheless and as a first step, SEC and European Commission staff, assisted by CESR, would need to develop a framework for mutual recognition discussions. As an aside, the SEC made clear it is to beef up its inquiries into the background to the subprime crisis.

Consumer markets have not been overlooked as SEPA was finally launched for credit transfers. But perhaps the biggest news in the retail space was the launch of a new EU consumer investigation aimed at breaking down barriers that distort consumer choice and competition in retail markets. These barriers include issues on price distortion, limited consumer choice, barriers that prevent switching, and so-called ‘competition killers’. “This is a fundamental re-orientation of consumer policy in the European Union”, Commissioner Kuneva said. “It is breaking new ground for the Single Market – focusing on malfunctioning and barriers in the retail market where goods and services are finally delivered to consumers. It is a hugely ambitious and far reaching project. It will in time become the biggest and most comprehensive system to screen and investigate consumer market outcomes in the European Union or elsewhere in the world. Interestingly in the light of the retail banking competition enquiry, this is being sponsored by Consumer Protection Commissioner.

The securities markets also witnessed a new development when press reports surfaced that a group of Europe’s biggest banks are preparing to launch a new trading platform for financial derivatives to compete with the region’s exchanges. Even the name – Project Rainbow – is reminiscent of Project Turquoise and several of the same banks are involved. However, the key to its success is likely to hinge on its ability to clear the trades and the fifth meeting of the C&S Monitoring Group seemed to focus more on what remains to be done rather than actual implementation of the C&S Code.

Insurance commentators are now focussing on the progress of Solvency II – “Our key priority for this year is ensuring that the Solvency II Proposal is adopted without the substance of the Proposal being compromised”. However, Commissioner McCreevy did make the explicit point that some amendments will be proposes – but only to the parts relating to re-casting the old Directives. The question of its application to pensions continues to stir much debate. The Commissioner is un-persuaded but many officials – for example, from Austria this month – believe it will be a political decision as there are “no technical arguments” against such a step.

Any adverse consequences would be unwelcome as Axa’s Barometer revealed that more and more people see the responsibility to provide guaranteed retirement income as falling to the employer. But the accounting standard–setters are re-visiting the accounting standards on pension benefits that are related to employment. The UK example is a toughening of longevity assumptions – driven more by the regulator - and the use of a less risky interest rate for calculating the present value of the liability than the AA-corporate bond yield.

Lurking in the background is DG Competition’s assessment of the Northern Rock state aid case, as there are other banking cases in the offing. How much distortion of competition – and for how long – can they permit? The “Rock” has already triggered reviews of many parts of the EU’s banking legislation. Is there another component that may burst upon the scene?

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Graham Bishop

© Graham Bishop