A graphic tool by the Financial Times explains the existing framework and proposed changes to financial regulation in the EU, US and UK.
To my best knowledge, the UK is still an EU Member State. However, it is not part of the eurozone and London is the biggest financial centre in Europe. That explains the separate heading.
The European Council conclusions from the June 2009 meeting cover a couple of very important issues.
Treaty of Lisbon
A decision and a declaration are attached to the conclusions that address the concerns of the Irish government on the ratification of the Treaty of Lisbon. The document says that the decision is legally binding, does not require a new ratification, and will be attached as a protocol to the founding treaties during the ratification of the next accession.
The Heads of State or Government agreed unanimously on the name of José Manuel Barroso as the person they intend to nominate as President of the European Commission for the period 2009-2014.
Economic and Financial Situation
The European Council supports the creation of a European Systemic Risk Board which will monitor and assess potential threats to financial stability and, where necessary, issue risk warnings and recommendations for action and monitor their implementation. The European Council also recommends the establishment of an European System of Financial Supervisors, comprising three new European Supervisory Authorities.
Climate Change and Sustainable Development
The European Council considers that all countries except the least developed should contribute to the financing of the fight against climate change in developing countries on the basis of a universal, comprehensive and specific contribution key.
The European Commission has adopted a Communication on Financial Supervision in Europe and has invited all interested parties to submit their reactions on the Communication before 15 July.
The financial supervision package proposed in this Communication involves two key elements.
– a European Systemic Risk Council (ESRC) to monitor and assess risks to the stability of the financial system as a whole (“macro-prudential supervision”).
– a European System of Financial Supervisors (ESFS) for the supervision of individual financial institutions (“micro-prudential supervision”), consisting of a network of national financial supervisors working in tandem with new European Supervisory Authorities, created by the transformation of existing Committees for the banking securities and insurance and occupational pensions sectors.
The Communication follows directly the recommendations of the de Larosière report.
In its communication to the European Council summit on 19-20 March, the European Commission sets out proposals for coordinated European action to fight the economic crisis.
Regarding the financial system, the Commission endorses – and asks EU leaders to endorse – the key principles set out by the de Larosière Group.
In terms of the support for the real economy, an annexe summarises 500 national measures and concludes that they are broadly in line with the principles that recovery action should be timely, targeted and temporary. The Commission calls on EU leaders to endorse clear principles for further action, in line with the single market, with open trade worldwide, with building a low carbon economy and with returning to sustainable public finances as soon as possible.
According to the EC The EU should make a united push to improve the global financial and regulatory system, focusing on:
• better transparency and accountability;
• appropriate regulation of all financial actors;
• tackling difficulties caused by uncooperative jurisdictions;
• boosting international supervisory cooperation;
• and reforming the IMF, Financial Stability Forum and World Bank.
The High level Group on Financial Supervision in the EU has published its long-awaited report. The group is chaired by Jacques de Larosière, and includes Leszek Balcerowicz and Otmar Issing, among others.
The report first analyses the causes of the financial crisis. One of the main reasons in the report is that “very low US interest rates helped create a widespread housing bubble“.The report claims that “the credit expansion in the US was financed by massive capital inflows from the major emerging countries with external surpluses, notably China”.
The HLG believes that there have been fundamental failures in the assessment of risk, both by financial firms and by those who regulated and supervised them. The members of the group believe that insufficient attention was given to the liquidity of markets. An important point of the report is that regulators and supervisors focused on the micro-prudential supervision of individual financial institutions and not sufficiently on the macro-systemic risks of a contagion of correlated horizontal shocks.
The report suggests some counter-cyclical regulation measures:
– introducing dynamic provisioning or counter-cyclical reserves on banks in “good times” to limit credit expansion and so alleviate pro-cyclicality effects in the “bad times”;
– making rules on loans to value more restrictive;
– modifying tax rules that excessively stimulate the demand for assets.
The HLG believes that the Basel 2 framework nevertheless needs fundamental review. The report suggests that:
• the assets of the banking system should be examined in terms not only of their levels, but also of their quality;
• stricter rules should be applied for off-balance sheet vehicles;
• the EU should agree on a clear, common and comprehensive definition of own funds.
As for credit rating agencies (CRA), the report suggests a fundamental review of CRAs’ business model, its financing and of the scope for separating rating and advisory activities should be undertaken. More, the report demands that the use of ratings in financial regulations should be significantly reduced over time.
Some of the other important ideas include:
• at least one well-capitalised central clearing house for credit default swaps in the EU;
• the assessment of bonuses for should be set in a multi-year framework, spreading bonus payments over the cycle;
• Deposit Guarantee Schemes (DGS) in the EU should be harmonized and preferably be pre-funded by the private sector.
The HLG states that “while the Group supports an extended role for the ECB in macro-prudential oversight, it does not support any role for the ECB for micro-prudential supervision“. The report suggests a new group, replacing the current Banking Supervision Committee (BSC) of the ECB, called the European Systemic Risk Council (ESRC) should be set up under the auspices and with the logistical support of the ECB. Its task would be to form judgements and make recommendations on macroprudential policy, issue risk warnings, compare observations on macro-economic and prudential developments and give direction on these issues.