1. DISCUSSION PAPER EUROPEAN COMMISSIONG20+G20+ TASKSCAPABILITY ISSUES By Robert McDowellRevised 3 times through to December 2009RMCDBASIC@aol.com

2. CONTEXT 1: making this an effective reality? 3. Argument All competent authorities lack macro- macro- financial models at both state & EU levels!NOTES To regulate at EU level requires tools, Central banks & competent state authorities have models, data, that build on EU laws (CRD, conflicts of interest in carrying out different objectives Solvency II & finance sector data etc.) We have (macroeconomic stability, prudential supervision, the laws, not tools for analysis & reportinginvestor protection or competition). required by EC & G20 agendas. Worse (in EU) if those objectives are only those of state As various measures of governments, policy makers (national interest, bailing-out of a big bailing- central banks impact all kinds of intermediary). Hence importance of EC rules, laws & intermediaries (commercial & investment banks,guidelines. investment & hedge funds, pension funds & insurers):Financial systems traditional 3-way division into 3-States & EC coordination can be cumbersome, withbanks, capital markets, & insurance washundreds of bilateral & multilateral memoranda ordefeated by events;colleges of supervisors etc.Defeating also VaR & capital adequacy models,Level 3 Committees (e.g. Cebs, Cesr & Ceiops), in& exposing equity values (200% of banks total spite of excellent if limited permanent staff, dependcapital wiped out gross & more in share value of banks)wholly on their constituents members/authorities &Asset swaps & capital injections reminded allhave rigid tripartite competences (banks, securities &that macro-bailouts are responsibility of states, macro-insurance) - an obsolescent framework.only assisted/ adjusted by EC authorities;Bail-Bail-out decisions are by central banks, In spite of progress, the system is unable to respond toregulators, governments, who were supervisingchallenges of integrated inter-linked markets (no over- inter-over-the impaired entities; arching models exist). 2 urgent demands:No lender of last resort or government had Much better cyclical protection for investors, citizens, &liquidity on scale needed but could create it bymacro-economyrelatively limitless power to grow a states short- short- Dramatic improvements in regulation to redirect role,term off-budget balance sheets (less so by ECB foroff-culture & flexibility of the financial industry.Euro Area where states gave money market operationsto ECB). ECB). 4. CONTEXT 2: EU-wide agreement without EU-wide forensics?EU- EU-To contain an earlyBut, who iswarning system onSpecifyingmacro-economic &Macro-model macro-financialtoolset & dataprudential for this?developmentsThe Big PictureIncluding legally But, who isbinding mediation Specifyingbetween national Micro-datasupervisors & formatregulatoryfor this?authorities.The Small Details 5. COMPREHENSIVE ACTION PLAN Is there a project management office for ECs G20+ comprehensive action plan Note: G20 tasks Short- Short-term immediate + longer medium term taskslisted grouped by immediate & medium term & byterminformation & actions.Two keys: (our phrasing) keys: (ourImmediate tasks are mix of X A new global financial architectureTechnical, regulatory & supervision infrastructure new Bretton Woods system (addressing global imbalances), Economic scenarios for economic capital models & Reporting to G20 & from G20 to G192 UN, Doha)Policy Audits of/by national & international bodies. set up quickly by IMF (purpose: financial stability) include emerging & developing economies (in FSF & IMF) Medium term tasks are Macro- Macro-prudential oversight of global finance Reviews of effectivenes of all work done & remainingtasks to be done by all bodies Y Auditing regulatory supervisory regimesOver-Over-arching role for Commission especiallycoordination & new directives based on assessments counter- counter-cyclical finance (measures & standards)& other G20 Commission tasks etc. asset derivatives clearing & transparency (financial markets measures) liquidity measures (instilling macro-prudential risk mgt.)macro- 6. FINANCIAL RISK REGULATION AT EU LEVEL This will change in EU an enormously responsible task (at EC Current crisis exposed poor organisation of level) to oversee how regulators & central banks roles swing financial supervision (central banks, EUbetween fiscal & lender of last resort to policy-maker, & ministers, & treasury authorities) even if they all strategic implementer (of what CRD & Solvency II & other risk responded better than anyone expected!. management in EU ultimately mean in a financial & economic crisis). Crisis questioned efficacy of horizontal allocation of micro-prudential competencies micro- across states (fragmentation in US or single regulator in many EU countries) & vertical distribution of macro-prudential (systemic & macro- global liquidity) competencies, where only national entities appeared to be in charge of policy responses & of supervision (media comment scarcely mentioned CRD or C-ebs).C- US - a mix of federal & state competencies while only states supervise insurance; EU - states led policy & agencies are (in popular mind) only at member state level; Euro Area - response was slower than in UK & relatively smaller (where short-term treasuries short- off-budget source of states short-term funding off- short- are vested in multi-national ECB).multi-ECB). 7. ECOFIN TASKS (1 of 2) delegated to Commission until financial stability has been fully restored, actions related to resolution & management of financial crisis remain the top priority within the EU ECOFIN Nov. 08MACRO- MACRO-PRUDENTIAL Actions & InformationImprove European supervisory & regulatory framework, amending, &updating existing roadmaps where necessary (most vital are roadmaps for Pillar II)Improve supervisory framework & enhance Lamfalussy process (Mar 2009)Strengthening risk & crisis management frameworkUpdate recommendations on functioning of EU committees of supervisorsConsider legislative actions by end 2009Pro-cyclicality (re. prudential & accounting rules) outline by end 2008Pro-Pro-cyclicality first report by March 2009 (finalised no later than mid 2009)Pro-Work to keep critical role at international level, in wake of G20 Summit/sReview guarantee schemes & recapitalizations & submit recommendationsModify national mandates of supervisors to take account of EU financial stability(foreseen in CRD & Solvency II - Strengthen CRD & SolvII Supervisors tasks)Ensure EU positions on new international financial architecture are well founded. 8. ECOFIN TASKS (2 of 2) delegated to EU CommissionMARKETS STABILITY & MICRO-PRUDENTIAL MICRO- Actions & Information Put into place a European oversight of credit rating agenciesLegislative proposals of Commission: gaining agreement s on these?Improve transparency to restore confidence in financial markets (needs massive consultation)Mitigate counterparty & op risks & improve transparency in CDSs market (bring on-market?)on-With CEBS report progress on transparency of fin. firms?Executive pay system: member states to implement EC recommendation ?Safe & sound European post-trade infrastructures to prevent systemic risks ? post-Increase transparency on the OTC derivatives markets (bring on-market?) on-Strengthening prudential rules (CRD & Solvency II) (needs road-map models & datasets) road-Definitive adoption of 2 directives before end of Parliament mandate ?Modify decisions on Cmte Supervisors so as to assign next tasks? 9. ECOFIN TASK ISSUES MACRO-PRUDENTIALMACRO- EU supervisory & regulatory framework (needs amending for Pillar II & III to provide detailed worked economic templates with empirical constantly updated stress models.)models.) Roadmaps (most vital in Pillar II, more than of CRD, but only 5% of advice! Major Gaps!) Improve supervisory framework & enhance Lamfalussy process (Mar 2009) (This depends on issues some of which are not immediately urgent for financial stability) Strengthening risk & crisis management framework (Commission has taken steps here need to survey all states current crisis response processes to learn lessons first issues are definition of systemically important market or firm event, then define KRI advance warnings e.g. what did supervisors know but did not flag & instead left issues as confidential part of supervisor Pillar II challenge dialogue?) Update recommendations on functions of EU Committee of Supervisors (College need for cross- cross-border combined research of EU-wide resilience with stability awaiting per-review data efforts EU-per- required to abstract multi-bank data in a systematic reporting format)?multi- Consider legislative actions (Additions to CRD & Solvency II that should be law not principles of guidance only. Must distinguish hard from flexible data. IFRS could be specified within CRD & Solvency II plus standardisation of FinRep/CoRep accounting information report format?) FinRep/ Pro-cyclicality (prudential & accounting rules) (IFRS/CRD on judgment areas) Pro-(prudential rules) Banks are not continue to act pro-cyclically; deleverging and raising credit margins!) pro- Pro-cyclicality (Major unsolved issues in correlating banks & markets to economy, E-Cap) Pro-E- Critical role in wake of G20 (Internal & External embrace of emerging economies into process) Review guarantees & recapitalizations (Detailed modeling, monitoring & refinement needed) Mandates of supervisors for EU fin. stability (Needs Central Banks models & oversight) EU on new G20 Fin. Architecture (EU study of global imbalances & EU systemic risk role?) 10. ECOFIN TASK ISSUES MARKETS & MICRO-PRUDENTIALMICRO-Mkt Transparency (OTC FX, MM, BD bring on-exchange and/or ensure regular reporting? on-Currently FX is surveyed every 2 yrs by BIS, but MM & Bonds trading not reported! Need transparentmeasures of market liquidity by instrument class and marketplace.)CRAs reform (need to be far better defined - conflict of interest charging, model quality, validation &transparency, TTC/PIT, new sub-AAA grades, & individual v. portfolio, cycle economics listing &sub-checking all CRA-type data sources incl. indexes & aggregate spreads data. CRAs are major story in CRA-factors leading to present crisis should be interrogated. Scope for new European CRAs out of firmsthat do similar analyses)CDSs market (netting standards available, but not full trading & clearing standards?)Executive pay (regulatory checklist under appropriate risk categories + extending risk policies &independent risk unit oversight of bonus levels & risks risk authority checklist?)Clearing (Quality of Market data, gross not just net, are not reported? More needed on Oprisk. Too Oprisk.much emphasis in past on commercial competition & not regulatory quality. Clearing should be regulatedlike banks (possible project to extend Basel II principles to Exchanges as appropriate? they hold largemargin collateral c/p risk same applies to in-house investment bank clearing/netting & prime brokers. in-Attention to stock lending?)OTC derivs (OTC instruments non-standard and/or customers excluded from X access, & degree ofnon-CFDs, & derivs Xs driving the cash market price discovery needs rethinking) 11. NOTES 12. Note: Contextual matters of public opinion? DG ECFIN history as a watchdog for EC/EU core principles, but not yet expressed in tools & models? now adds responsibility for wider econ role (EU in global structure) not at all easy to be held responsible in critical manner for EU/Eurozone economyEU/Eurozone Now loaded with tasks from ECOFIN in respect of G20 - not fully coordinated in central plan?Regional context to ECFINs work may be embraced in G20 tasks?EU is in fragile position (hence European Recovery Programme) even before melt-down. Programme) melt-down.Too much poverty around its borders (and some bad history)Critical issues e.g. include how to make a deal with RussiaEU may be going green but how to maintain borders etc.?Does G20 statement offer basis for wider problem resolutions?"G20" statement rich countries need support of worlds major non-OECD countries non- rich countries best effort at reform of international financial institutions + framework to maintain "level playing fields" (globalisation programme) programme) risks rejection by countries where most of world's population live but, a surprising number of poor countries are implementing Basel IIUseful blueprint (or not?) for 21st C, for at least next decade (Best result may be obtained by focus on modeling of external economics of EU as Europe Region & then integrating with UN global models before informing into IMF models. All currently lack detailed finance sectors.) 13. Note: ECOFIN welcomed fair value (fV) guidance by IASB(fV)Accounting rules for fV between trading & banking books, on & off B/S are critical, but ECOFIN sees urgency to improve real economic market valuation when assessing government schemes & cases but more to be done by IASB & BIS.G20 decision: ECOFIN will examine progress & need for action re. IASB governance reform (accountability to public authorities).ECOFIN states, Banking institutions have made progress to release states, exhaustive & comparable financial information related to their exposures, losses & write-downs arising from the financial crisis. Nevertheless, qualitative write- disclosure on valuation techniques still has to be improved. The Council encourages the industry to pursue its initiatives regarding the improvement of investor information & transparency in the securitisation market. market.is debatable. Progress is limited & problematic, not exhaustive or forexhaustive comparable financial information banks are obfuscating, but they also needinformation guidance on flexible judgment calls (e.g. in stress-testing of e-cap models).stress- e- Qualitative disclosure needs improving, yes, but also standardising, & standardising, quantitative definitions e.g. of market turbulence adjustments also improved! adjustments Precise relationship (mapping) between IFRS & CRD Pillar II is key! 14. Note: EFC to work on:Review IMFs resources & loan instruments for short-term policy IMFshort- IMF relations with other fora & IFIs Assess progress of key short-term prioritiesshort- Assess causes & lessons of present & previous financial crises Take account of financial stability in all markets (no model expected before 2012!) Propose updated short-term & long-term work priorities short-long- Standard setting & surveillance of financial institutions at global (G20) & Ecofin roadmaps: progress in sharing information with non-cooperative jurisdictions; non- strengthening IMF surveillance how IMF should develop early warning mechanisms build on swift identification of systemic vulnerabilities stronger integration of bilateral & macro-financial surveillance macro- strengthen joint IMF/World Bank Financial Sector Assessment Programs review mandate & governance of IFIs. 15. Macro- Macro-models 16. Bank of England Model This model is illustrative & was never realised by central banks or regulated commercial and investment banks? 17. MACRO- MACRO-MODEL issues in summary All authorities lack macro-models with detailed finance sectors (which must include,macro- alongside national sectoral & regulatory data & calculations as per CRD & Solvency II law) ECFIN task has over-arching approvals regime & policy initiatives role in coordination over- & collation of EU-wide responses regarding G20+ agenda.EU- Key primary G20 & prudential focus is to link financial stability with economics (macro- (macro-prudential tier) is CRD (& Solvency II) in Pillar II (e-cap modeing): (e-modeing): least complete parts of CRD & Solvency II (& of IFRS); that Banks (& insurers) have greatest practical problems with; Understanding market shares accurately & in context of national financial sectors quality Unless solved they cant calculate or monitor cyclical behaviour! can EC, with supervisors & central banks could specify macro-financial-economicmacro-financial- models, with USA + EU-wide & Euro Area dimensions - complicating national sectoral EU- models & should monitor with BIS cross-border obligations: cross- Various techniques missing, but can be advised, explained & summarised; Pillar II & IFRS framework, data sources & model structures & harmonising these for IFRS, SolvencyII & CRD are critical; To take account of full range of G20 tasks & results usefully feeding into macro-models. macro-models. This could be single biggest contribution to financial stability & The only basis for analysing & determining many pro- and anti- cyclical issues pro- anti- Current projects indulge too many short-cut assumptions to avoid processing allshort- available date (& game theory + asymptotic single factor macro-economy variables for those who cannotmacro- understand macro-economy accounting models or dont want to!)macro- 18. G20 TASKS IN EU 19. G20 tasksImmediate tasks Immediate tasks + Medium Term(TAKING FAR LONGER THAN FIRST EXPECTED) tasks (timescale n/a)financial technical, regulatory & supervisorypolicy infrastructure action plan mandated on relevent authoritieseconomic scenarios generation for economiccapital models & divided into groups of tasks & issues: policy assessments of measures by national & 80 Immediate (SHORT TERM) international authorities.tasks & issues 57 Medium term tasks & issues Medium term tasks distinguished as information orassessment of the effectivenes, adequacy &action tasks.qualities of all the work done & remaining to be done by all bodies involved. appropriate role for Commission includes coordination & application of this assessment at EU level similar to a Basel II ICAAP applied to individual banks except done by, or on behalf of, regulators & supervisors & central banks as monetary authorities, & of governments as fiscal policy-makers regarding financial system. 20. Immediate priority: A. Regulatory RegimesA. Regulatory RegimesPro-cyclical behaviour by banks (credit cycle exactly matching the economiccycle) is biggest single unresolved issue of Basel II banking & Solvency IIrecommendations toinsurance regulations (EU CRD law).mitigate pro-cyclicality,pro-Hitherto, banks have been late in deleveraging (withdrawing credit) into aby reviewing howdownturn & late in expanding credit in the early quarters of a recovery.valuation & leverage, This is central to Basel II Pillar II economic scenario stress tests, but canbank capital, executive only be addressed looking at all of financial sectors, not by bankscompensation, & individually.provisioning exacerbate BIS published papers as guides to banks to correlate their experience to thecyclical trends?underlying economy. None succeeded. Too little academic literature on thefinance sector to general economy relationship. Banks lacked precisetemplates how to do this.BIS & regulators told banks to make their own solutions. This proved to betoo intellectually difficult. 3rd party solution providers could not help either!Regulators issued some indicators for stress tests, but all banks stress-tested much too weakly; none to the extent of what needs to happen to wipeout their capital. In aggregate, credit crunch + recession are each wiping outall bank capital by 200%. Governments are supplying 100% & debtrecoveries 50%. The remaining 50% has to be replenished in other ways.______________________________________________________________Note: Cyclical trends are subject to retrospective revision e.g. US recession now officially beganDec.07! UK&I may revise recession data to having begun in mid-08. EU current officialrecession may be revised up to positive growth until 2010 when US is in recovery & UKfollowing soon after! Perception is as important to confidence factors as fundamental actuality.Economic patterns are mixed across trade surplus (e.g. Germany) & deficit states (e.g. Greece),& across credit-boom (e.g. UK) & credit-limited economies (e.g. Italy), with some (e.g. Spain) amix of both. But, principles & common features can be established! 21. Immediate tasks (1 of 10) B. Prudential Oversight B. Prudential OversightIn EU 10-13 are in hand, all else is unresolved. 10-.3 ensure credit ratings agencies (CRAs) meet IOSR standardsCRAs operated faulty models until June 07 &.4 & CRAs avoid conflicts of interest,accepted commercial conflicts of interest. But,CRAs occupy a role more central & essential to.5 provide greater disclosure to investors & issuers, financial valuations & markets, as risk drivers &.6 differentiate ratings for complex products, & ensure quantifiers, in banking & insurances than.7 CRAs role is to deliver superior unbiased risk assessments economic indicators, auditors or stock (but under legal risk/ solvency threats & cant prove if superior models)? exchanges. IOSR to reviewCRAs are essential, but must be regulated,.8 credit rating agencies standards andqualified & reformed. Credit crunch deepened.9 mechanisms for monitoring compliance.dramatically when ABS issues, banks &Monolines were downgraded, or subject to Supervisory Authorities to ensure potential downgrades, & share prices crashed.10 financial institutions maintain adequate capitaltriggered by CRAs once they fixed their models..11 in amounts necessary to sustain confidence. But, problems remained in grey areas between International standard setters to set out TTC & PIT risk grades, single & p/f ratings..12 strengthened capital reqs. for banks structured credit andreqs. More model transparency needed, or banks &.13 securitization activities.insurers (less so) cannot create their own IRmodels. All IR models currently rely on CRAs. Supervisors & regulators to Internal models only extend to unrated SME &.14 build on launch of CDS clearing services in some countrieshousehold loans (using score-cards) & calculate score-.15 speed efforts to reduce systemic risks of CDS & OTC derivsfor collateral & sureties..16 insist market participants support exchange-traded or exchange-Efforts to create exchange clearing for illiquid &.17 electronic trading platforms for CDS contracts; OTC instruments = very important. But, currently.18 expand OTC derivs market transparency; &standards are available only for netting CDS..19 ensure OTC derivs infrastructure supports growing volumes.CRAs are not yet producing hold-to-maturity risk hold-to-gradings for TTC ABS valuations.A few new CRAs are emerging to do this but thereis an oligopoly & insufficient quality validation. 22. Immediate tasks (2 of 10) C. Risk Management C. Risk ManagementIn the EU, regulatory supervisors are already doing Regulators to develop & implement implement20-29 as adequately as possible in current .20 enhanced guidance to banks risk managementbanks turbulent conditions. 30-37 are outstanding .21 in line with international best practices, &problems. .22 financial firms to re-examine internal controls &re-Liquidity risk, concentration risk & stress-testing .23 strengthened policies for sound risk management.are ill-defined despite recent new guidance = .24 policies & procedures for fin. firms to manage liquidity risk currently inadequate for detailed assessment. .25 Including by creating strong liquidity cushions.All banks failed to include one or more essential factors in their liquidity analyses. As with Supervisors to ensureensure economic scenario stress tests, banks want much .26 Fin. firms develop processes for timely & more precise templates. .27 comprehensive measurement of risk concentrations & This is a hard-to-change culture in which CRD is .28 large counterparty risk positions across products & treated as a regulatory overhead = not yet as .29 across geographies. central & core to how banks manage & operate. Financial Firms to to Liquidity risk used to be treated as relatively .30 reassess risk models to guard against stress &simple, predictable, easy to understand, trsy mgt .31 report to supervisors on their efforts. operation, now a crisis!? .32 have clear internal incentives to promote stability & Credit crunch dramatically exposed liquidity .33 have necessary actions for this in placeignorance, but banks boards & senior officers lack .33 avoid rewarding excessive short-term returns / risk taking. short-confidence how to take a precise or firm view of .34 exercise effective risk management &the issues. .35 due diligence over structured products & securitization.Ideally, it would help if they had more precise Basel Committee to to standards with worked examples & a liquidity .36 study need for improving firms stress testing models &firms health measure. .37 provide help to firms stress testing models, as appropriate. firms 23. Immediate tasks (3 of 10) D. Promoting Integrity in Financial MarketsIn the EU, regulatory supervisors are co-operating in 38 & 39above. 40-47 all in need of research & data & by central D. Promoting Integrity in Financial Marketsbanks with ECB. What they do not address is issue of post- National & regional authorities to promote & ensure MiFid fragmentation away from EUs major stock exchanges. .38 working together to enhance regulatory cooperation Ensuring cooperation among banking & insurance regulators .39 between jurisdictions on a regional & international level? in applying CRD is main function of C-ebs. .40 information sharing about domestic threats & National supervisors have right to challenge each other & .41 cross- cross-border threats to market stability & host country supervisors can examine banks home country .42 national (or regional) law is adequate to address theseregulatory submissions.threats?Degree of such co-operation was most clearly evidenced in .43 review business conduct rules to protect markets & failures of Fortis, Dexia, & others, whether funding problemsinvestors? (new Company Law standards?) or error-ridden failure to comply in detail with CRD legal .44 especially against market manipulation & requirements. .45 fraud &New liquidity risk reserve ratios, other cyclical buffers & .46 cooperation to protect Intl. fin. system from illicit actions. much more template detailed Pillar II analytics are in train, .47 appropriate sanctions regime for misconduct. but much remains to be detailed.Issues of cross-border financial stability threats includingstock-lending & short-selling as well as shadow-banking,how securitization issues were packaged & sold (between fin.Firms & between banking & trading books, & between proprietary &customers portfolios) & fair value issues are capable of beingresolved, but only if firm principles are enforced = notcompromised to please or disappoint everyone equitably.Operational risk issues of fraud & cross-border cooperation,44 -47, are variously in hand in EU. Differences remain &cannot be ironed out soon. 24. Immediate tasks (4 of 10) E. Reinforcing International Cooperation In the EU, CEBS is in process of standardising supervisortraining = a form of supervisory college. But, this does not E. Reinforcing International Cooperationextend to level of detail required by G20. CEBS is not designed Supervisors to collaborate to strengthen...for this with culture or skill-set to act at this level. .48 supervisor colleges for major cross-border fin.firms,cross- fin.firms, EU Commission could devise such a process? There is a process .49 surveillance of cross-border firms cross- in place for supervising cross-border financial institutions, but .50 regular meetings with major global banks for not yet a formal or regular meeting between systemically .51 comprehensive discussions of firms activities & important cross-border institutions to meet with a college of .52 assessment of the risks the firm faces.supervisors from each jurisdiction involved. Regulators to take all steps necessary toThis could be devised on an EU-wide (& non-EU partners) basis .53 strengthen cross-border crisis management, cross- beginning with template example of FSAs ARROW reviews = .54 incl. cooperation & communication with each otherinterrogatory challenge system.Regulators may co-operate on cross-border crisis management, .55 with appropriate authorities, &but does not yet fit in all regulators national remits. .56 develop comprehensive contact lists &Only central banks are strictly responsible for fin. sector system .57 conduct simulation exercises, as appropriate.stability. Regulatory arms or separately constituted supervisoryauthorities are responsible for resilience of individual firms, notsystemic risks directly. Finance Ministries (and ECOFIN) havecoordinating responsibilities. Therefore, 53-57 could be anappropriate coordinating role for Commission as in case ofpricing of national government & central bank support for banks& also European Economic Recovery Plan (November 26th 08),plus Regulation setting up European Globalisation Fund? 25. Medium-Medium-term tasks (6 of 10) G. Regulatory RegimesG. Regulatory Regimes CRD is half-completed towards ensuring most of All G-20 members commit to undertake Financial Sector G-above. Self-assessment or external assessment is a Assessment Program, report & support transparentvery significant undertaking for EU & a major assessments of natl. regulatory systems.natl.contribution to single market policies & perceptions. Each country or region pledges to review & report:Essentially it is EU-wide audit that Commission has .81 on structure of its regulatory system & much experience of in economic & social programmes .82 principles of its regulatory system using external auditors. Asessment is almost identical .83 ensure it is compatible with a modern & to principles of Basel II ICAAP, except applied to .84 increasingly globalised financial system. regulatory regimes. EU is a single market, a meta- Authorities review & report on differentiated nature of:economy above national economies, & with an .85 regulation in banking, securities, & insurance sectors &international single currency & monetary zone. .86 outlining the issues &Thus cross-border comparisons are economically .87 making recommendations on needed improvements important & cannot be satisfied by individual national .88 scope of Fin. Regs for unregulated firms, instruments, &reports. markets C-ebs is co-ordinating on CRD & related regulatory .89 appropriate regulation for all systemically-importantsystemically-supervision & announced cutting down of national institutions. exceptions. But, there is more than this. National & regional authorities to review Commission could scope an appropriate study & then .90 resolution regimes &put this to tender in whole or in parts. One weakness is .91 bankruptcy laws in light of recent experience & to ensure that with 93 & 94 there is not a reference to a 95 to be .92 orderly wind-down of large complex cross-border wind- cross-some standardisation of economic-capital models financial firms.definitions & implementation = more critical than Definitions of capital to be be capital adequacy. .93 harmonized, in order for .94 consistent measures of capital & capital adequacy. 26. Medium- Medium-term tasks (7 of 10) H. Prudential Oversight There are calls for creation of one or more European CRAs - a logic, notwithstanding globalised nature of financial markets. & there are H. Prudential Oversight nascent European-based firms with potential to Supervisors & central banks togrow into fully-fledged CRAs on a par with S&P, .95 register CRAs that provide public ratings Moodys & Fitch. .96 develop robust & internationally consistent approachesBut, 95 is a task to define who are & who are notfor liquidity supervision, (including) ofCRAs, & then what are all credit ratings data .97 central bank liquidity operations for cross-border banks. cross-sources & providers & then validation checks & certification or some regular regulatory audit. Indexes should be included. 96 is partly also an index issue, as liquidity risk can be dictated by credit risk gradings. This, & central banks liquidity windows are complex issues that require considerable research by financial experts working with economists & practical mathematicians. There is no single institution or standards body that can address all of the above. Hence this again seems a place for EU Commission to coordinate. 27. Medium- Medium-term tasks (8 of 10) I. Risk ManagementIn official G20 text, in 98 economists must also be implied here - an important point since economists have generally I. Risk Managementbeen left out of standards setting for banks & insurers. International standards bodies to work withwithThey have much to contribute centrally to Basel II, .98 broad range of economies & other appropriateSolvency II (EU CRD) Pillar II. bodies, But, over & above this they are important in navigating the .99 to ensure regulatory policy makers are aware &current economic cycle. Pillar II requires banks & insurers .100 can respond rapidly to evolution & innovation in to stress test for a 1 in 25 set of market & economic financial markets & products. shocks, in effect a severe recession. Undertaking this Authorities should monitormonitor today is changed obviously when in the middle of such a .101 substantial changes in asset prices &set of shocks. It should surprise no-one that banks .102 their implications for macroeconomy &internal models & systems are not attuned or designed or .103 for financial system.capable of determining recovery strategies & short term implications in next few years. Economists now, by force of circumstances, have a critical role to play, more than designers of Basel II imagined. EU authorities could address this issue with the same application applied to economic analysis of the introduction of the common currency. At that time, external economists were not much employed, but it should be different this time in addressing 102 & 103, but quite possibly will not be given the cultural resistance within banks to empowering their macro-economists? 28. Medium-Medium-term tasks (9 of 10) J. Promoting Integrity in Financial Markets J. Promoting Integrity in Financial MarketsItems 104-107 have in mind off-shore financial centres National & regional authorities should implement & tax-havens. They can also apply to unregulated .104 natl. & internatl. steps to protect global financial system shadow-banking types of firms generally. .105 from uncooperative jurisdiction & We do have views & analysis that can be contributed .106 from non-transparent jurisdictions thatnon-here as to all previous tasks, but not on items 108-114. .107 pose risks of illicit financial activity. On eve of Credit Crunch & during it, various attempts to Financial Action Task Force to continue work againstextend transparency & regulation fell before legal &political obstacles. .108 money laundering &What we do not yet have is comprehensive assessment .109 terrorist financing, &of the scale of issues involved. This would seem a .110 support efforts of the World Bank proper study for Commission DGs. .111 UN Stolen Asset Recovery (StAR) Initiative. Tasks 108-111 are in hand within EU & while more Tax authorities to draw on bodies such as OECD to coordination may be called for, these are not isssues .112 continue efforts to promote tax information exchangewe are able to comment on with authority & that applies .113 on lack of transparency & also to 112-114. .114 failure to exchange tax information. 29. Medium-Medium-term tasks (10 of 10) L. Reforming International Financial Institutions Underlying these are global (& Commission) questions relating to how trade & payments imbalances respond L. Reforming International Financial Institutions to & raised a demand for spectacular growth of Bretton Woods Institutions must bebestructured credit or debt instruments. Theories about .126 comprehensively reformed so that they can better savings, with export-led or endogenous growth, .127 reflect changing economic weights in world economy & shortage of government bonds, credit-boom bubbles, .128 be more responsive to future challenges, withcommodity booms etc. .129 emerging & developing economies given more voice & This is an area for global & multi-regional macro- .130 representation in these institutions.empirical economists. Bretton Woods model has a IMF to conduct vigorous & even-handed even-handedspecial interest for EU & Commission as within EU .131 surveillance reviews of all countries, arguably ECB (in conjunction with Commissions .132 giving greater attention to financial sectors &external development programmes) may become more .133 integrating reviews with IMF/WB financial sector like an EU IMF (except for UK objection). This is high- .134 whereby macro-financial policy advice is strengthened.macro- politics that has a long history since Delors Plam, OECD economies, IMF, & other international bodies for...European recovery Plan & current debates over if 2% or .135 capacity-building for emerging & developing countriescapacity-8% reflation is needed & if Commission should have .136 formulation & implementation of major new regulations,regulations, borrowing rights to issue large quantities of long term .137 consistent with international standards. debt to support cross-border transfers within EU. These matters will have more light shed by coordinating with IMF to remain close to shape & formal processes a new Bretton Woods could be. In current context it is key to EUs near term external policy & global role in financial matters & in terms of global economic recovery. Currently, we surmise, there are more published papers (if not many) with interesting ideas & analyses on what EU, Commission, could do. 30. Thank you for your attention