Including updates on shadow banking and mortgage directives


Large Swiss banks face tough capital requirements

In a move that could trigger similar proposals elsewhere, an economic parliamentary committee of the lower house of the Swiss parliament has approved huge capital requirements exceeding Basel III requirements for its two largest banks, UBS and Credit Suisse, but rejected proposals to require banks to jettison and at least shield risky investment business from their core retail and investment business operations.

Given the massive size of Swiss banks relative to the size of its economy, the economic committee backed plans to force UBS and Credit Suisse to hold 19% of their equity in tier one capital (CT1), to buffer the banks against financial shocks and the necessity for bail-out. However, the final 9% of capital will be allowed to consist of contingent capital bonds (CoCos), and the committee agreed on changes to the Swiss tax system to facilitate banks issuing these instruments in the future.

The parliamentary committee rejected changes which would require both banks to cap bonuses to no more than half of fixed salaries, noting that the Swiss markets regulator already had procedures in place to make sure bonus plans did not lead to banks taking too much risk.

The proposals, which have already been approved in the upper house of the Swiss parliament, will go for final approval in the lower house in September, meaning it could come in to force in 2012 with a transition period until 2018. Swiss banks have reacted coolly to these proposals according to Reuters. However, both banks have been reassured with government promises that regulations will be continually benchmarked against international standards.

The Swiss proposals are likely to feed into current debates which are raging in the EU, namely around whether Basel III should be a minimum or maximum standards and what type of instruments should be included as part of CT1. Moreover, the committee’s decision not to force UBS and Credit Suisse to change their structures or ring-fencing certain retail operations could feed into national debates, like in the UK, where governments are planning significant reforms in the coming years.


FSB examines Shadow Banking

The Financial Stability Board (FSB) is making swift progress in its efforts to strengthen supervision and regulation of the multi-trillion euro shadow banking system. A data and information sharing exercise between supervisors over this summer will form the basis for data collection from 2012 onwards. The FSB has also undertaken a mapping exercise of national regulation and internal initiatives against its April 2011 scoping paper. In a press release issued on 1 September, summarising its progress, the FSB indicated it will now establish work streams to examine whether or not regulated lenders hold enough capital against their transactions with all players in the credit intermediation chain.

Other work streams will focus on assessing the risks and possible regulatory reforms required in relation to money market funds and to non-regulated entities in the credit intermediation chain. Additionally, the FSB will probe the regulation of securitisation, in particular with regard to retention requirements and transparency. A final work stream will investigate the regulation of activities related to securities lending/repos, including possible measures on margins and haircuts.

These work streams will accelerate the FSB’s aim of developing a supervisory framework on the shadow banking system in the coming months, with a view to presenting more detailed recommendation at the G-20 summit in October.

Supervisors have long raised concerns that “shadow banking entities”, such as structured investment vehicles, hedge fund and money-market funds, could be used by financial institutions to evade attempts by authorities to mitigate excessive risk taking in the global financial system. Regulators have varying views on how best to regulate the activities of shadow banking entities — directly or indirectly via the banks that supply credit. The FSB, for its part, agreed a number of high-level supervisory principles to address systemic risk and regulatory arbitrage in July with a view to, monitoring non-bank credit intermediation by examining:
  • maturity transformation
  • liquidity transformation
  • imperfect risk transfer
  • leverage.
Laudably, the FSB calls for supervision which is “flexible, forward-looking and regular”, emphasising the need to share information among national supervisors given the international dimension of transactions. Recognising that authorities will have to continually adapt to changing market trends and therefore create a regulatory framework which is fluid and dynamic is a good first step in difficult task of effectively supervising shadow banking.


ECON presses for greater flexibility in mortgage contracts

Further measures to protect retail mortgage customers could be on the way according to the draft report released by the European Parliament’s Economic and Monetary Affairs Committee (ECON). The European Commission’s (EC) proposal on residential mortgage credit, released on 31 March 2011, aims at greater flexibility in post-contractual phase of mortgage agreements, allowing customers to make early repayments, switching lenders, and the right to convert a foreign current mortgage into the lender’s national currency.

The EC has been studying possibilities for legislation at an EU level in relation to mortgage credit over the past decade but there was little appetite amongst Member States for such a move. The financial crisis, however, has provided the impetus for it to put forward concrete proposals focusing on the retail property market. Indications are, though, that this may just be a first step and future proposals will consider the mortgage market more generally.

ECON’s recommendations, which will be published in full in the coming weeks, build on the EC’s legislative proposal, primarily in the following areas:
  • information: greater disclosure to customers prior to taking out loans
  • stable market: further measures to tackle remuneration practices of lenders to reduce bad incentives and conflicts of interest
  • competition: measures to increase competition and reduce market-share concentration.
ECON is also keen to stress the importance of diversity in the EU mortgage market, suggesting a “one-size fits all” is not appropriate, given the numerous cultural and economic differences across the Union.

While beneficial to customers and financial stability, the package of measures — particularly around post-contractual flexibility — will reduce margins for banks and other credit institutions as customers are no longer locked-in to profitable mortgage agreements. They also might make financial institutions less willing to enter the market, or incumbents to expand their residential mortgage lending books, as they see the opportunities to generate further returns elsewhere, particularly as capital becomes more limited (see our article on CRD IV).

These concerns will have to be navigated by Parliament and Member States over the coming months as proposals make its way through the EU legislative process. Mortgage credit represents a significant proportion of retail bank’s loan book; in 2009, residential mortgage lending amounted to just over €6 trillion in the EU, which is equivalent to 52% its GDP. Given the scale of the market, it is not surprising that regulators are keen to neutralise excessive risk taking and make customers more aware of terms and conditions attached to their loans. Hugh write downs, the subprime crisis in the US, and growing proportion of mortgage in arrears in the EU, is also testament of the need for robust regulations of mortgage credit.


Financial transaction tax to fund EC?

A financial transaction tax (FTT) could be used to fund the EU’s new multiannual financial framework, according to comments by the President of the EC, José Manuel Barroso. In a video message on the EC’s priorities for the autumn, President Barroso outlined he was “committed” to explore the Franco-German proposals of a FTT in great detail, and will be discussing this issue further with governments ahead of the G-20 summit in Cannes.

This is not the first time the EC has laid claim to the proceeds of a FTT. In its budgetary plans for 2014-2020, the EC floated the idea of using a FTT as a source of revenue, to make it less reliant on funds from national governments. Proceeds from a FTT could generate around 50 billion euros over a seven year period, equivalent to about one third of its overall budget. This envisages the imposition of a levy of 0.1% on the value of transactions involving stocks and bonds and a levy of 0.01% on derivative transactions.

However, the initiative will still face significant hurdles in Europe and elsewhere before it’s adopted. Jean-Claude Trichet, President of the European Central Bank, has been an ardent critic of such a tax and has called on European parliamentarians not to pursue plans, warning that the competitiveness of financial centres across Europe would be damaged unless the scheme was adopted internationally.

Ahead of last year’s G-20 summit in Toronto, the European Council took this on board suggesting that the EU should “lead efforts to set a global approach” for introducing an international framework for levies and taxes on financial institutions. While G-20 countries agreed that banks should have to contribute the current and future bail-out measures, there was no consensus on how this should be achieved. For its part, the IMF believes that there are more efficient ways of taxing the financial sector than a FTT, arguing that backward looking charges on financial instruments based on past balance sheet items is more effective.

The EC will be making detailed proposals on a transaction tax in financial services in the coming months. However, it is difficult to see how it will be able to build consensus amongst international partners, given the challenges it has faced trying to sell the merits of a FTT in Europe. Focus on the G-20 summit in Cannes might also be deflected away from long-term mechanisms to mitigate the costs of financial crisis, to dealing with more immediate concerns such as the slowdown in global economic growth and the sovereign debt crisis in Europe.