Summary “Financial and banking international regulation: A post-crisis new deal”

It is hard to sum up an entire conference, especially one featuring so much input and expertise, in a few paragraphs. The opening speech, which presented the post-crisis banking and financial scene and the role that regulation can and will play, set the tone and paved the way for the day’s two sessions. The first explored the theme of “Regulating Regulators” and the second dealt with “Regulating Actors and Activities”.

It is hard to sum up an entire conference, especially one featuring so much input and expertise, in a few paragraphs. The opening speech, which presented the post-crisis banking and financial scene and the role that regulation can and will play, set the tone and paved the way for the day’s two sessions. The first explored the theme of “Regulating Regulators” and the second dealt with “Regulating Actors and Activities”.

Eddy Wymeersch chaired the first part, during which Tajinder Singh discussed a post-crisis New Deal, presenting IOSCO’s position on the various principles and objectives that regulators need to follow to be more effective in preventing crises.

He was followed by Martin Merlin, who took a closer look at those principles and objectives by discussing the reform of financial supervision in Europe. Mr Merlin described the new organisational structures, as well as the powers and jurisdiction of the European supervisory authorities. Then came the regulators’ turn, with Thierry Franck speaking for the securities regulator, Autorité des Marchés Financiers, and Danièle Nouy for the banking and insurance supervisor, Autorité de Contrôle Prudentiel.

The second session was as stimulating as the first. Chaired by Ariane Obolensky, the theme of “Regulating Actors and Activities” was approached initially from the standpoint of the French Banking Federation. Next, Joseph A. McCahery described recent US banking reforms, notably the Dodd-Frank Act and the changes – some of them radical – it will bring about. Guido Ferrarini then addressed the issue of executive compensation and corporate governance, its relationship to the crisis and its consequences. Anouar Hassoune discussed the position of credit rating agencies, which, according to him, ought not to take all the blame for the crisis.

Next, Daniela Weber-Rey, Gérard Hertig, and André Prüm took part in a panel discussion chaired by Jean-Paul Gauzès of the theme of whether Europe was heading for “a levelled or unlevelled playing field”.

Alain Pietrancosta brilliantly summed up the day’s discussions and raised still more questions, since regulation is not a topic that can be exhausted in a single day — even one as successful as the 29 October 2010 conference.

Mr Hubert de Vauplane, Chairman of the AEDBF and Head of Legal and Compliance at Crédit Agricole S.A., stressed that while the crisis may have a number of causes, it has also brought to light the shortcomings of the banking and financial system and its regulators. This new crisis has drawn attention to the need to examine the system in its entirety, as much from a financial and monetary standpoint as from an economic standpoint.

The upcoming reform will therefore have to deal with a number of issues, the most pressing being rating agencies, pro-cyclicality, the overhaul of accounting standards and the recognition of phantom financing. It is set to be all the more delicate as the legislator and the regulators will have to work together under the eagle eye of public opinion and powerful lobbies.

It should also be borne in mind that this global crisis calls not only for national measures, but also a European and international effort that will have to rethink both the role of regulators and that of the sector’s players and activities.

Professor Eddy Wymeersch spoke about the new European financial authorities. After lambasting the complexity of the current regulatory system in Europe – mainly the result of the numerous regulatory sources – and describing the current European set-up that resulted from the Lamfalussy process, Professor Wymeersch presented the new European prudential structure. Following the Larosière report of February 2009 and the adoption of the proposed regulations, the structure of pan-European prudential supervision changed in order to meet the objectives set by the regulations, the most important being the creation of an internal financial market in which the operators would be subject to a single set of regulations and circumvent national barriers. The new European regulatory authorities (European Systemic Risk Council and the three supervisory authorities for the markets, banks and insurance: ESMA, EBA and EIOPA) will thus have the legal and normative capacity required to supervise national action more effectively, together with the power to mediate and regulate products and services, and the authority to supervise certain players in the sector. The manner in which these authorities are to be governed and financed should guarantee their effectiveness and independence. Professor Wymeersch concluded his message by saying “We have the tools, we just have to use them”.

Mr Tajinder Singh, Deputy Secretary General of IOSCO, pointed out that the recent financial crisis has challenged the traditional role of regulators and questions have been raised about the effectiveness and efficiency of the regulators when confronted with the responsibility of crisis prevention. This is why the regulators are reviewing their roles and responsibilities, a task which IOSCO is helping to facilitate. It has done so by introducing international financial regulation standards, increasing international cooperation in the matter and, above all, setting objectives and following principles that ensure that the financial markets are properly regulated. The objectives are investor protection, market transparency and the reduction of systemic risk. The principles, currently 38 in number, aim to guarantee the regulators’ political and financial independence so that they can regulate the markets efficiently and effectively and also to foster greater cooperation between regulators.

Mr Martin Merlin, speaking on behalf of the European Commission, presented an overview of the new financial supervision structure which is based on two pillars. The first, the European Systemic Risk Council (ESRC), comprises the Board of the European Central Bank and the chairmen of the EBA, the EIOPA, the ESMA, the European Commission and the scientific advisory committee. The ESRC operates on the principle of exchanging information, recommendations and warnings with the second pillar. The second pillar consists of the European Banking Authority (EBA), the European Insurance and Occupational Pension Authority (EIOPA) and the European Securities and Markets Authority (ESMA). These European authorities are supported by the national banking, insurance and financial markets supervisory authorities.

The European supervisory authorities have the power to ensure the coherent application of EU law, settle disputes between national authorities, deal with crisis situations and supervise rating agencies and trade repositories. They can also assess national supervision systems, promote consumer protection, prohibit and restrict certain products, contribute to managing systemic risk and attend regulators’ meetings.

Mrs Danièle Nouy, Secretary General of the French Prudential Supervisory Authority (ACP), explained two post-crisis measures: the creation of the ACP and the strengthening of the regulatory framework.

The French supervisory framework was recently strengthened with the creation of the Prudential Supervisory Authority (ACP). This new agency, created by the merger of the CB (French banking commission), the ACAM (French insurance and mutual insurance undertakings regulator), the CECEI (French credit institutions and investment firms committee) and the CEA (French insurance companies committee), is entrusted with two major tasks: ensuring financial stability and protecting bank and insurance customers. The ACP is also much more active in the international fora with the aim to promote the French model and to represent France on the various European bodies. To do so, the ACP has the necessary resources and the backing of the Banque de France. The Authority is governed by a Board chaired by the Governor of the Banque de France and composed of 19 members. The decisions of the Authority are made by the Board, which meets in different specific compositions (sectoral banking or insurance sub-committees, etc), so that it has a general view on the banking and insurance sector while being able to address issues specific to each sector or institutions.

Furthermore, a stronger regulatory framework is being implemented in order :

  • to strengthen solvency via the requirement for a larger amount of better quality equity capital. Capital requirements were also increased for risky assets;
  • to improve liquidity;
  • to cap excessive leverage;
  • to reduce pro-cyclicality, mainly with the implementation of forward-looking provisioning, and to minimise systemic risk;
  • to strengthen corporate governance and internal control. The new regulation puts special emphasis on consistency, integrity and ethics, strict risk management procedures and genuine transparency as regards corporate governance matters;
  • to review remuneration policies so that they contribute to controlling risk.

Ms Daniela Weber-Rey, Partner Clifford Chance and Member of the German Government Commission for the Corporate Governance Code, highlighted the need to define the level playing field. Do we wish to create a level playing field solely amongst the members of the European Union or don’t we have to look at the European Union in relation to other core financial markets, such as the US, the new Asian financial centres, Hong Kong, Shanghai and Singapore, and also Zurich. While the financial world is global, legal systems are national, at best European. It is thus difficult to meet the challenge for the creation of a level playing field in the financial sector. The improvement of governance is at the heart of crisis prevention and the EU Commission wishes to install sustainable growth, which may come short-term as a competitive disadvantage but may provide long-term advantages. Can we do without a level playing field?

Different regulatory regimes, in different regions, in parallel, contradictory, and intersecting were created in the political environment of our post-crisis world. This created an unlevel playing field as of the start. On top of this, the new regulation is a burden to all banks in all countries, those who contributed more to the crisis and those who contributed to a much lesser degree, those who survived with the help of state funding and those who came well through the crisis. This again creates inequality as of the start.

We also see the new phenomenon of infiltration of legal rules created at one place and in one area and yet becoming applicable in other places and other areas, without being mandatory. An example are the FSB Principles on remuneration, which infiltrated the various legal systems by way of soft law or hard law, interim solutions or mere submission, creating in this area more of a level playing field than would have been conceivable in the pre-crisis world. This was only possible due to a general understanding that something needed to be done, certainly giving way to some political pressure but better than a slow process of creating mandatory rules in parallel and in all of Europe. We thus quickly obtained a level playing field in some areas, at least to a certain degree.

While more has been achieved in the European Union than was to be expected pre-Lehman, the main difference still lies between Europe and the US, let alone the Asian financial centres. That is where the real challenge lies. Creating a certain level playing field in this respect is a pre-condition in the view of Daniela Weber-Rey for Europe not having too much of a competitive disadvantage in the financial sector.

Mrs Ariane Obolensky, Chair of the European Banking Federation (EBF) Executive Committee and Director General of the French Banking Federation (FBF), assessed the regulatory reform.

In September Basel III proposed a new 7% solvency ratio, comprising 4.5% of common equity and a 2.5% buffer. Unlike the system in place in the US, these measures largely depend on the banks. This observation calls for two comments. Firstly, Mrs Obolensky pointed out that banks should not be overburdened with the new liquidity ratios and systemic institutions’ new requirements. Secondly, it should be borne in mind that crisis prevention can be centred around other measures, such as broader supervision (hedge funds, rating agencies, etc.), the adoption of a new mechanism for resolving crises and market regulation via increased transparency and better systemic risk prevention.

Professor Joseph McCahery of Tilburg University explained the reform of the US financial system: the Dodd Frank Wall Street Reform and the Consumer Protection Act. Following the onset of the financial crisis and the analysis of the different factors behind it, we noted shortcomings in the existing financial regulations and the need for a more global approach. The Dodd Frank Act will tackle – or at least it will attempt to tackle – these deficiencies by adopting both macroprudential and microprudential regulations and by trying to limit systemic risk. Professor McCahery outlined the different points contained in the Dodd Frank Act. Some of the points relate to new regulations, while others concern the modification of existing regulations following the adoption of this legislation on 21 July 2010.

Thus, the Dodd Frank Act contains provisions relating to systemic risk prevention, notably via the Volcker Rule, the notion of “too big to fail” and the beefed-up role played by the different market authorities (and the SEC in particular), provisions concerning hedge funds, the concept of professional investor and corporate governance. It also imposes the need for derivative products to pass through a clearing house and be traded on a regulated market.

However, Professor McCahery was forthcoming about the drawbacks that could accompany these new measures, such as, for example, the substantial cost created by clearing. So, despite the many advantages of the Dodd Frank Act, some reservations as to its content and application have been and should be expressed.

Professor Guido Ferrarini focused on the issue of remuneration. Professor Ferrarini’s presentation was actually a summary of a book he wrote with a colleague: “Economics, Politics and the international principles for sound compensation practices”.

One of the thorny issues that surfaced during the financial crisis concerned the remuneration of directors, particularly that of banking chief executives. Did this remuneration, which was essentially paid in the short term, constitute excessive risk-taking by banks?

Studies have revealed that it is not the concept of “corporate governance” that is in question, but rather that of “good governance”, and that there is no evidence that short-term bonuses constituted excessive risk-taking. Furthermore, many banks hit by the crisis motivated their directors with benefits in kind.

So, while it is true that the introduction of international and European standards in order to better regulate the “Significant Financial Institutions” and the remuneration awarded to them could be beneficial, rigid, extensive regulation may not be the best solution that could be adopted. Lastly, regulation is necessary but it cannot replace a board of directors.

Mr Anouar Hassoune talked about the role of rating agencies. Quoting Leo O’Neill who said: “a rating is the shortest financial editorial on the planet”, Mr Hassoune – Vice-Chairman and Senior Credit Officer at Moody’s Paris – defined a rating as being an independent opinion on a debtor’s ability and willingness to honour its commitments (in the short and medium term). Having outlined the types of rating, he touched on the usefulness of rating agencies, which provide information rather than act as financial intermediaries in order to reduce inconsistencies as regards market information, while also explaining how these agencies operate and the different scales they take into account when awarding their ratings.

He then responded to certain criticisms levelled at rating agencies by clarifying the part they played in the 2008 crisis. He thus stated that conflicts of interest are much less prevalent than is believed due to the “Chinese walls” that exist between the different business areas in rating agencies. He also admitted though that the error committed by rating agencies was that of focusing on debt (and the countless securitisations they entailed) from a mathematical and legal standpoint while ignoring the economic considerations.

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