Including updates on EBA consults on remuneration and the European Parliament Committee reviews State aid for banks


EBA consults on remuneration

From October 2011, ‘significant’ financial institutions will be required to provide EU consolidated data on remuneration for all their staff on an annual basis, according to proposals issued by the European Banking Authority (EBA), which are open for consultation until 2 September 2011.

A significant financial institution is defined as a large, cross-border banking group, active in the EU, or institutions determined as significant by national supervisors.

The data requirements will be graduated: all staff versus ‘identified’ and high-earning staff. Staff reporting requirements is usually comprised of total number of staff, net profits, and the total fixed and variable remuneration in the relevant year. The number of ‘identified’ staff (i.e. in senior management, risk taking and control positions) will need to be collected together with details of their fixed and variable remuneration packages. Other data collection requirements include:
  • the total amount of variable remuneration deferred for identified employees
  • the number of staff with guaranteed variable remuneration
  • details of number and amount of severance payments made, and
  • discretionary pension benefits paid.
A separate report detailing the fixed and variable remuneration packages of individuals with salaries greater than €1 million is also required.

The data mentioned above relates to remuneration for performance during the year prior to the year of payment. Therefore, the first submission will be based on remuneration awarded in 2011 relating to the 2010 performance year. The tight timelines associated with this requirement could pose significant challenges for firms in the run up to October 2011 deadline.

Data collected by national supervisors or, where relevant, by the coordinating supervisor, will be passed on to the EBA, enabling it to carry out a benchmarking exercise. The EBA will look at annual changes on remuneration across the EU supplementing national benchmarking exercises. They intend to highlight differences depending on where groups are headquartered.


IMF report justifies need for a global financial safety net

The IMF has reaffirmed the need for a global financial safety net to coordinate liquidity injections and other policy responses in the face of extreme volatility in capital flows. In a recent report on financial linkages, they suggest that national measures are “insufficient” on their own to reduce the source of global systemic risk which arises from cross-border linkages.

Cross-border financial linkages are very strong between advanced economies which can increase the probability of herding behaviour, flight to quality and liquidity crunches throughout the system when a particular advanced economy experiences a liquidity shock. As a result, even countries not considered to be systemic (i.e. small and less connected countries) could trigger systemic market responses, as their crises may serve as a wakeup call to creditors, leading to a broad-based pull back from other similarly-situated countries.

The IMF’s findings support G20 recommendations for an enhanced set of crisis prevention and resolution instruments which countries can use in the face of heightened volatility and contagion from a crisis. Increased coordination between the IMF and financing arrangements in the following areas would also strengthen the global financial safety net:
  • national arrangements (e.g. self insurance, taxes);
  • bilateral arrangements (e.g. swap lines between central banks during periods of stress); and
  • regional arrangements such as those in Asia, Europe and Latin America
National policy makers face a delicate choice between country-level benefits from increased international risk diversification and the instability that this generates at the global level. While responses to recent financial crisis were effective in providing liquidity support, they were generally reactive and unpredictable and mostly uncoordinated.

According to a separate IMF report on systemic crises, a globally agreed financial safety net providing rapid and adequate short-term liquidity to countries during systemic crises could boost market confidence and help reduce the overall cost of crises. Such actions could also help limit contagion and prevent a localized shock from becoming a full-blown systemic crisis or from occurring in the first place.


European Parliament Committee reviews State aid for banks

Investors should have to bear a higher portion of restructuring costs at banks, according to a European Parliament’s Economic and Monetary Affairs Committee (ECON) report into State aid during the financial crisis.

State aid during the crisis increased as much as 7-fold compared with annual amounts in the previous decade, and roughly 80% of that aid was dedicated to bank rescues. The report found that the European Commission’s (EC) temporary framework for State aid during the financial crisis worked properly, and extending it to the end of 2011 is justified. However, when the crisis is finally over, “the provision of State aid should return to the objective of less and better targeted aid”.

The ECON report found that the EU as a whole was ill-prepared for a major banking crisis. The EC reacted swiftly once the crisis was recognised by releasing four communications between October 2008 and August 2009, but this recognition came very late. In addition, the existing EC guidelines on rescue and restructuring were developed with troubled manufacturing firms in mind, not banks. Their deficiencies within the EU financial services context were highlighted:
  • They did not fully reflect the European Central Bank’s integral role in the ‘rescue phase’ through the provision of substantial liquidity to the EU financial markets generally
  • National legal systems were not calibrated to deal with failing banks in an orderly manner, so national authorities showed a tendency to “jump directly and very quickly into the ‘restructuring phase’”, leaving little opportunity for ‘healthy procedures’ such as making sure that shareholders bear losses, repairing balance sheets, injecting new (non-public) shareholder capital, or considering mergers.
The ECON report asserts that the reform of financial regulation is a prerequisite for effective banking State aid rules, focusing on (i) making the entire financial sector more resilient and less risky; (ii) creating better incentives for good risk management, and (iii) targeting directly the weak, and in some cases, ultimately failing financial institutions. It recommends the introduction of separate rescue and restructuring guidelines for the banking sector including:
  • Separation of rescue and restructuring phases: during the rescue phase, the focus should be limited to short term bridging loans and not measures which could subsequently jeopardise an orderly restructuring or winding-down of the bank(e.g. capital injections)
  • Higher contribution from investors in restructuring operations: the Committee recommends increasing the minimum contribution in a restructuring operation for existing non-public investors (currently at 50%). Public investment under solvency requirements should also be accompanied by a rigorous prior write-down of asset values to make sure public funds are not diluted following investment
  • Role of state ownership: a number of checks and balances associated with State ownership to protect taxpayers’ interest, such as limiting governments from buying new shares in banks rather than conducting pure capital transfers. The State should act as rational investor on the assets, requiring a normal market return as soon as possible. The report also questioned whether public controlled banks, which have an implicit State guarantee, should have to pay an additional charge for a reduction in funding rates associated with this advantage
  • Transparency: the report calls for swifter processes and better transparency of the information underpinning decisions on State aid cases, and states that the EC should be tasked with making sure that transparency guidelines are applied consistently across the EU.
While emphasising the importance of adopting stringent prudential requirements (i.e. Basel III), of undertaking annual stress tests on individual institutions, and improving corporate governance, the ECON report surprisingly does not address the interaction between future State aid rules for the banking sector. The proposals from the EC on a bank resolution regime aren’t scheduled for release until September 2011. Introducing this EU-wide regime will take the banking sector even further from the ‘manufacturing’ position on rescues and restructuring, at least from a State aid perspective. Nevertheless, this ECON report is likely to influence the European Parliament’s views when it comes to the negotiations on the bank resolution regime.


Barriers to competition in the EU mortgage market

Differences in legal and regulatory frameworks between countries are the most significant barriers to competition, according to a European Parliamentary study. The study found that harmonising mortgage foreclosures legislation and bankruptcy procedures are the two areas most likely to stimulate competition in the EU mortgage market. Arrangements which facilitate the transfer of information on borrowers between banks may boost cross-border competition. However, agreements between mortgage lenders and intermediaries do not appear to affect competition given the fragmented nature of the market.

The study also pointed to a number of demand side barriers that act indirectly by creating constraints for consumers’ mobility and choice. Unsurprisingly, switching and transaction costs are largely viewed by consumers as an important obstacle to their mobility in the mortgage market. Legal restrictions appear to have a stronger impact than penalties in terms of switching costs. The key transaction costs are property valuations, solicitor’s fees, and mortgage registration and taxes. The complexity of contracts can also severely restrict customers’ ability to change mortgage providers. The study calls for EU-wide regulations aimed at providing better pre-contractual information together with educational programmes to help consumers make informed choices based on their risk profile and individual preferences.

The study is timely, coming when the EC is looking to introduce legislative measures to create an efficient and competitive single mortgage market, following its release of a proposed Directive on 31 March 2011. The EC has been working up to this Directive for nearly a decade: it sees it as a key milestone in realising its vision of a truly single market for financial services in all EU Member States. The scope of the proposed Directive includes pre-contractual disclosure, advice, advertising, creditworthiness assessments and early repayment provisions: it has been met with much resistance from banks and industry associations who are questioning the need for such onerous measures. However, the costs associated with the proposals (€383 million - €621 million) are likely to be less than by the benefits (€1,272 million-€1,931 million), according to EC calculations if the Directive can stimulate competition and drive cross border activity by removing some of the identified barriers .