G20 summit fails to quell market concerns
With bank stocks sliding, Italian borrowing costs spiking to unprecedented levels and the IMF suggesting that we could face a lost decade of economic activity, the Cannes G20 summit failed to live up to its billing. The G20’s inability to deliver concrete plans to tackle the eurozone sovereign debt crisis leaves bankers and investors in a void, with no clear resolution strategy in place, and demonstrates the inadequacies of the current international economic and regulatory governance architecture.
Even though G20 nations are ‘nowhere near a consensus’ on a range of fundamental issues according to Jim Flaherty, Canada’s finance minister, a second meeting, possibly before Christmas, will probably go ahead with the aim of agreeing an international firewall around Greece to prevent contagion spreading to other eurozone countries and further afield. Given recent developments, Italy should be high on the agenda for this meeting as well.
Following a wave of agreements in previous summits, the tricky task of designing rules and timelines seems to be slowing the pace of financial regulation reforms. In areas where some agreements have been reached, such as in relation to global systemically important financial institutions (G-SIFIs), many of the most difficult issues, such as harmonising national legal systems, have been sidelined for a future date. In other and more nascent areas of regulatory focus, such as shadow banking and macroprudential supervision, regulators are finding it difficult to design rules, agree parameters and coordinate activities. Despite warnings from the European Stability Risk Board and other authorities about specific risks to the financial system, such as high frequency trading, structured UCITS and FX lending, regulations to address many of these areas are at an early stage of policy development and will take years to implement.
However, the G20 meeting made some progress in a number of important areas. The Financial Stability Board (FSB) put forward a list of 29 banks and some large investment firms that will be subjected to extra scrutiny under new G-SIFI’s measures, including 17 European firms, 8 US firms and just 4 Asian banks. These firms will be subjected to additional capital surcharges from 2016 onwards, to prevent public bail-outs. The G-SIFIs will be required to have additional loss absorption capacity ranging from 1% to 2.5% of risk-weighted assets (with an empty bucket of 3.5% to discourage firms from increasing their systemic significance), to be met with common equity. These rates are fluid and will change as firms shrink or expand their balance sheets. The G-SIFI list will be reviewed every November to add and delete firms. On the current list, several of the largest global banks by assets, such as Industrial and Commercial Bank of China, were excluded because their businesses were viewed as being less complex and risky than their peers. Also, the omission of some major European banks, such as Intesa Sanpaolo and BBVA, appears to be explained by the concentration of their activities in their respective domestic economies. This approach may drive other G-SIFI’s to consider retrenching to their core domestic businesses in the future, to avoid additional capital surcharges.
Each G-SIFI will be subjected to more intensive surveillance and will be required to prepare a ‘living will’ by the end of 2012, showing how the firm intends to wind-down its business in an orderly manner that reduces the impact on financial stability and minimises the need for government support. Specifically, the FSB warned that these firms will face stronger supervisory mandates and higher supervisory expectations for risk management functions in the future.
In terms of bank capital and liquidity, the G20 agreed the rules must be implemented in a co-ordinated and complete manner, including Basel II implementation where it has not previously been applied, enhanced capital requirements on market and securitisation activities (Basel 2.5) and new capital and liquidity rules and leverage ratios (Basel III).
On the controversial topic of remuneration, the G20 has asked the FSB to create a ‘dedicated surveillance instrument’ for the supervision of the standards regarding compensation, to be reviewed by bilateral regulatory reviews, and to draft more precise recommendations on the personnel to be covered by remuneration measures.
The G20 also addressed OTC derivatives, committing to ‘complete the reform of the financial sector and to align national arrangements to prevent risks of regulatory arbitrage’. New rules will focus on financial guarantee requirements applicable to non-centrally cleared derivatives and harmonisation of central databases and procedures for regulator data access. This measure was seen as a win for the US administration who was pressing for such harmonisation.
On market integrity and efficiency, the G20 has asked the International Organisation of Securities Commissions (IOSCO) to make recommendations to ‘enhanced transparency and oversight obligations for the new market technologies’. The G20 also decided to take action on credit default swap markets and to introduce a global financial counterparties ID system providing. Legal Entity Identifiers.
Finally, on commodity derivatives, in response to volatile commodity prices and the flash crisis last year, the G20 endorsed a common regulatory framework for commodity derivatives based on IOSCO’s recommendations, to be implemented by the end of 2012, including measures to improve market transparency, tighter oversight (reporting obligations) and greater powers for market authorities to set position limits.
FSB given further power to drive the international regulatory agenda
The G20 leaders have chosen Bank of Canada governor Mark Carney, a former investment banker, to replace Mario Draghi as head of the FSB, at a time when the global financial system faces its most difficult phase since the bankruptcy of Lehman Brothers in 2008. Carney comes with a strong CV, presiding over a country with a stable financial system that has successfully navigated the financial crisis pretty much unscathed and without resorting to public bail-out. He has consistently advocated more stringent regulations and aggressive fiscal and monetary policy in times of crisis, having helped spearhead the global response to the financial crisis in mid-2008.
In his first public speech as FSB chair in London, Carney indicated that shadow banking will be a top priority in the coming months. He is also keen to push forward with the current reform agenda, advocating higher capital reserves and tighter liquidity requirements.
In Cannes, the G20 leaders agreed to give the FSB a much more prominent role in monitoring and coordinating these requirements to ensure a level playing field is created and opportunities for regulatory arbitrage mitigated. Under new changes, the FSB will take on a legal personality with greater financial autonomy and resources under the Chairmanship of Carney. The global regulator will also be given additional powers to ‘name and shame’ non-compliant countries, in an effort to keep current agreed timelines on track.
Firms should take note of these institutional changes. The sub-prime crisis demonstrated that global financial markets are closely interconnected, even emerging markets which were previously thought to be decoupled. Recent actions to shore-up European banks, in the form of deleveraging and more robust loan-to-value ratios, are leading to tighter global lending conditions, according to Carney. Risks and weaknesses can spread effortlessly, through both regulated (e.g. securitisation), and non-regulated markets-(e.g. shadow banking), so global regulations are needed to ensure that risks are neutralised across jurisdictions and aren’t allowed to build up in any one country.
It is clear that the FSB, together with its sister organisation IOSCO, will be absolutely central to shaping the future regulatory agenda, driving global plans for recovery and resolution, measures to address systemically important financial institutions and regulations to curb high frequency trading. Thus, despite their disappointing failure to demonstrate leadership on the sovereign debt crisis, the G20’s efforts to strengthen the international framework for developing economic and regulatory policy may lead to a more uniform cross-border approach on key issues in future.
Barnier: G20 countries must deliver on regulatory reforms
Speaking on the final day of the G20 summit, Michel Barnier, the EU Commissioner for Internal Market and Services, suggested ‘we only have a small window of opportunity’ to resolve the current 'deep' financial crisis before irrevocable damage is done. Barnier warned that if G20 members stall on current market reforms and don’t work hard to finalise the remaining technical details to operationalise the new regulatory framework in the coming months, the already fragile recovery will evaporate, with catastrophic consequences on employment and output and the real possibility of greater social unrest. Barnier argued ‘there can be no return to business as usual in the financial sector’, echoing statements made elsewhere this summer by Jaime Caruana from the Bank for International Settlements and more recently by Robert Jenkins from the Bank of England. All of them believe that financial institutions and their investors will have to settle for more modest profits and lower returns on equity in the future.
UK and France lock horns on financial transaction tax
Days after G20 leaders failed to reach agreement on a global financial transaction tax (FTT), EU finance ministers (ECOFIN) clashed on the issue again in Brussels. Germany and France have both championed the tax in recent months backed by European Parliament and the Commission, believing that the tax is ‘technically possible, financially necessary and morally unavoidable’ and could be operational by 2012. However, the UK and Sweden only support the idea of levying financial transactions if it is adopted globally, which is ‘not going to happen’ according to George Osborne, the UK Chancellor of the Exchequer, and therefore, the proposal should now ‘be put to bed’.
A FTT could damage recovery in an already fragile EU financial system and real economy. The Commission estimate that a FTT could reduce European Gross Domestic Product by 3.5% and cost over 500,000 jobs across the continent but this will be off-set in terms of reducing the probability and severity of costly banking crises. Anders Borg, Sweden’s finance minister, questioned the Commission’s calculations, suggesting that it may be underestimating the cost for growth by not factoring-in secondary effects and overestimating the revenue gains from a FTT. Borg indicated that, for example, a FTT would likely reduce turnover on secondary markets for government bonds, thereby, increasing borrowing costs for sovereigns and furthering exacerbating the current debt crisis.
Achieving unanimous agreement among the 27 eurozone Member States is likely to be difficult and given that each country will be required to implement the FTT under its own local laws, there is a real prospect of inconsistent application, which would distort financial markets in the EU itself. The tax could be introduced at a eurozone level as proposed by the Belgian finance minister, but this would put eurozone institutions and domiciles at a disadvantage. Even achieving this will be difficult task, because some eurozone countries are skittish about the merits of a FTT, with the Italy delegation calling for more studies and research, and the Irish finance minister expressing fears that financial services business will flow to the UK if a FTT is only adopted in the eurozone.