Financial Stability Board, Secretary General
European Commission, Director General, DG for Financial Stability, Financial Services and Capital Markets Union
François Villeroy de Galhau
Banque de France, Governor
BNP Paribas, Chairman
Bank of America Merrill Lynch, President Europe, the Middle East and Africa
1. The outlook for global financial regulation following the US elections is uncertain
1.1. The priorities of the FSB for 2017
A public authority representative stated that their organisation is reaching the end of the policy work to address the fault lines of the crisis and are seeing progress in implementation in many of the finalised areas. Their attention increasingly turns to evenness and assessments of the effects of the reforms. Meanwhile, they are focused on a number of other emerging risks and vulnerabilities, some of which the G20 has asked them to address.
The speaker’s organisation’s priorities for 2017 are: to conclude Basel III; finish their work on the CCP; and to have the recommendations issued on asset management activities operationalised. There is business to do to complete guidance on internal TLAC, and the speaker’s organisation is looking into regulatory and supervisory issues that merit the authorities’ attention in fintech. The policy work of covering large areas is drawing to a close.
1.2. The difficulties in pre judging what the new US Administration will do
A public authority representative pointed out that their organisation has not yet seen, in their work processes, the issue of the US retrenching from international cooperative activities. The US administration had the opportunity to signal if it wanted a break from all of that at the recent Baden Baden G20 ministers’ and governors’ meeting. Whilst the US made it clear that they have differences from previous commitments regarding trade and climate related issues, all of the elements that relate to financial reforms remain in place and were not contested.
The US remains in the process of putting in place its review under the new executive order, and it would be wrong to speculate on the output of that. Much of the focus is on a number of US specific issues, and global regulatory reforms are not the primary focus of that review. Caution is advised on speculation over what may happen now.
A representative of another public authority responded that they have participated in two international gatherings since the new administration took office, in Cape Town and Baden Baden. In both cases the US told Europe to take time, take precautionary positions and not to prejudge what the new administration will do.
The new administration has been extremely cautious but is clearly backtracking from the position of the Obama Administration. However, they made it clear that they wanted to leave room for their authorities to decide on the course of action, once settled. At the same time, they insisted that they would maintain the regulatory dialogue that was meant to take place last week. It took place and was very engaged and productive but It is too early to draw definitive conclusions about any positions that the new US administration will take at international fora.
The moderator questioned whether there ought to be concern that in the last G20 discussion, the US was unable to accept any terms formulated against protectionism. He asked whether it was a passing phenomenon or a serious retrenchment from global multilateral institutions. He reminded the audience that the WTO dispute settlement process is a vital piece of the global multilateral system.
A public authority representative emphasised that the US delegates made it clear that the changes they have requested to various documents were precautionary. However, the representative confirmed that they are concerned, have questions, and think it would be disastrous for the US to retrench.
However, when an individual has access to power, they tend to realise that issues are more complicated than they thought; Donald Trump could currently be learning that. The biggest power in the world may think that multilateralism is not in their best interests, but it offers other advantages. There are positive externalities in that, to which the US may be awakening.
An industry representative agreed with other panellists that it is too early to say what the new US administration is going to do. The media speculation will be misguided, exaggerated and flawed. They will not do away with all regulation. More harmonisation with level playing fields for global businesses is better because it makes the lives of regulators easier. A single set of rules is easier to establish, implement and manage.
The representative was also pleased to hear that the WTO rules are useful because the UK, alarmingly, may need to fall back on WTO rules for its future existence.
1.3. Global business needs global rules
At the 2009 G20 summit, following the global financial crisis, governments agreed to support a vision of greater regulatory harmonisation and co-operation across the world’s financial sector. Eight years later, most of the regulation intended to prevent similar financial turmoil occurring again is now either in place or close to implementation. These positive initiatives have undoubtedly helped financial stability, notwithstanding that there could have been greater efficiencies in their delivery. A banking representative stated that unfortunately one theme that comes through in everything that has been discussed is potentially the greatest missed opportunity in the post financial crisis world: the failure of global harmonisation of rules and regulation. Global businesses require globalised standardisation of rules. Not having them increases complexity, lack of consistency and the costs of doing business. The extent to which those rules continue to fail to harmonise will only exaggerate that missed opportunity.
The comments about America against the UK and Europe are alarming thoughts in terms of achieving an appropriate degree of convergence and harmonisation, and that applies to Basel. It is critical that, as much as possible, the EU should ensure international consistency and adoption of those rules. Failure to do so risks significant unintended consequences.
Ultimately, global rules make the financial system safer, and they underpin the level playing field that is needed for free trade, competition and growth. Financial stability has been created and it is critical that that should be maintained. The concern about a race to the bottom is real, but is unlikely to pose a great risk. It is the responsibility of everyone to ensure that the achievements made over the last decade are reinforced, maintained and preserved.
1.4. Consistent implementation of global rules is crucial
The moderator explained that they did not want to rely solely on the WTO, but stated that it being a multilateral institution is useful in itself. It has the precious jewel of a disputes settlement system, which has provided a vital safety valve during periods of economic stress. The WTO can take a great deal of credit for the lack of overt and deliberately protectionist measures. A rules based system like that has an important role to play.
The moderator had tried, whilst previously working for a public authority, to tighten the decision making and make it more obligatory. The representative had not seen, nor did he expect to see, support from the US. The representative noted that the FSB have no legal powers to enforce. If the EU does not apply the Basel rules as intended, there is little the FSB can do, which is a major problem in global financial markets.
A public authority representative stated that the solution is unknown. The pressure comes from where the shoe is felt to be pinching. The institutions operating internationally feel the pressure of a lack of harmonisation of rules. However, the market needs to be realistic and to distinguish where harmonised rules are absolutely needed. A piece of infrastructure that operates across borders clearly needs international governance and clear rules that everybody commits to observing.
In other areas the market needs to accept that it begins with a correct understanding of the principles that all should abide by in regulating the system and/or achieving levels of resilience in that system. In banking and other areas, the traditions of corporations have lasted longer, gone further and achieved more. In other spheres, it is still developing. There is the capacity for other regulators in the conduct, market oversight and other areas to progress, and it is hoped that that will happen over time.
A representative of another public authority stated that peer pressure is important. The representative recalled when adopting Basel III that there was a Regulatory Consistency Assessment Programme (RCAP) by the Basel Committee with which the European Union was found materially non compliant. That prompted a healthy reaction from the European Parliament to say that it is fine, that it is important to have global standard setters, and they have been elected to make rules in that jurisdiction. It is never good to deviate from the rules because it means that the case was not approved in the first place. Sometimes it is necessary in pursuit of common standards, but the structures of financial markets in general, and banking sectors in particular, are very different.
It is difficult to have common sets of rules that make sense everywhere. It is possible, but requires good will and also that everybody should understand that standard setting is not an offensive arm in terms of trying to boost the competitiveness of one’s players against the others.
A representative of a public authority agreed that it is important that the work be implemented, and done so consistently. It would be a travesty to step back from what has been achieved. The speaker remains optimistic that that it will remain in place and that its value will be recognised increasingly strongly over time.
An industry representative suggested that the inconsistencies could be resolved by an international treaty, but that is unlikely to happen. Instead, everybody should support the global standard setters by giving them as much authority as possible within the different political systems. A representative of the banking industry is not convinced that that will happen.
1.5. Europe knows what they want
A public authority representative stated that the EU’s position is clear. It is crucial that the degree of international commitment should remain strong, particularly for the biggest players. The EU has seen how instrumental G20 standards and the Basel Committee have been in fighting the crisis and recovering, and these standards are only good to the extent that they are widely and faithfully implemented across the world.
They are also important because there are the sole basis for what Europe calls ‘equivalence’ and others call ‘difference’ or ‘substituted compliance’. It provides a benchmark upon which Europe decides whether they can trust a foreign jurisdiction to manage part of, sometimes important, risks. The same goes for foreign jurisdictions vis à vis Europe. Without global standards, there would likely be no meaningful equivalence or substituted compliance policy. It is essential for the industry to work in an environment that is not too fragmented. There are enough sources of fragmentation; individuals ought to avoid adding more.
A national public authority representative noted that although Europe knows what they want, they do not yet know what America wants. It would be unrealistic to expect any decisive breakthrough before next fall. Europe needs time for friendly and difficult discussions aimed at transatlantic clarification.
Europe has three clear wishes: first, to stabilise banking rules; second, to progress decisively with non banks; and third, to preserve the existing international rules. Everyone should agree with the first wish. The need is urgent and also requires the completion of Basel III, if possible. It would mean two conditions: first the agreement should be without a significant increase of overall capital requirements ( this is clearly written in all the G20 communiqués); and second, Europe wants to keep a system that is models based on risk sensitivity. The purpose of the completion of Basel III is to reduce the unwarranted variations of the models based result; but should not to introduce a standards based approach. They have to accept an output floor, but it must remain a backstop and must not be the general rule. Amongst the stabilisation of banking rules, the November banking package from the Commission is globally thought to be appropriate, so should be implemented as quickly as possible.
The second wish, on progressing decisively on non banks, is mainly for the FSB. There are two priorities: first is asset management. Rules are needed for asset management (especially on liquidity) that differ from the banking sector. Second, there are CCPs, which clearly belong to Europe’s FSB priorities in quarters to come.
Regarding the third wish, on preserving existing international rules, everyone no doubt agrees for two reasons: first, that although better and more could be done, international and domestic regulators have delivered an impressive and fairly consistent job; and second, that the US going backwards on international standards would be bad news regarding their implementation, due to the level playing field and the probability of the next financial crisis in the US.
It would be wrong to conclude from such a situation that Europe should begin to dismantle their existing regulations. The common good as Europeans is to have financial stability first, so long as it does not hamper growth. Financial stability regulations in Europe have not hampered growth by any measure; at present there are no credit constraints in Europe. There is significant growth in credit volumes and low interest rates, so financial stability must come first.
2. Making Basel rules work for Europe is very challenging
2.1. Wait and see the US decision
An industry representative advised giving the US the benefit of the doubt on trade issues, but feels it needs to be monitored closely. One issue on which there is no agreement yet is completion of Basel III. The representative asked how to find agreement and whether the debate is going in the right direction or whether there are major concerns over competitive and implementation issues.
A banking representative agreed with the wait and see approach. Basel III has already been largely implemented. The question is currently whether to go further and renew those standards. The representative emphasises that the full Basel IV package would be a complete change from what has been done until now.
The representative agreed with other panellists that they ought not to speculate on the US implementing those changes, but felt that it would be perhaps even more speculative to anticipate that they will implement all of the changes. The wiser thing is to wait and not implement in Europe until the US clearly states what they intend to do. The world is in front of a new US administration who openly says that compliance with Basel is not their first priority. America is the first priority for America. The UK is the first priority for the UK. Europe’s top priority should be Europe.
The representative also supports not stepping back. However, Europe should not continue going forward in the same way as they have because there is no certainty from the other side that any new Basel package will be implemented.
There are differing banking systems, especially as far as mortgages are concerned. Delinquency rates on European residential mortgages have small variability, at around 1% in France while it is 5% in the US. Putting a same floor on the standard method for those types of loans, with so many different types of lending practices, is not harmonisation. The industry needs to aim for consistent impact from the regulation, but not necessarily the same regulation applied to differing underlying systems.
In the context of nascent recovery in Europe, creating jobs is also important. The European economy needs to be taken care of. Recovery is there, but it is fragile and needs care. Thus the balance between the two policy objectives financial stability and supporting the economy, must clearly be on the side of the economy and jobs.
A recent EC paper published by DG ECFIN stresses that the Basel IV package would hamper the European recovery. Stability is needed. The rules of the banking business have recently changed almost every year, which does not help to manage a business or help lending. It obliges the creation of much homework, permanently, in order to adjust to new regulations. For that reason the Basel IV package ought to interrupted and postponed which means another overhaul of the current rules in credit, operational and market risk. Postponing that would allow for better recovery in Europe.
2.2. Finding an agreement in the Basel Committee that works for all jurisdictions is not an easy task
A public authority representative stated that a key dilemma Europe faces is how to achieve consistency in implementation across the world whilst ensuring that the agreement reflects certain unique characteristics of regional financial markets and institutions in their particular diversity.
The agenda of the Commission is clearly stability and implementation. Globally, the rules adopted in implementing financial standards are good. Unintended detrimental effects should be repaired, but very logically. Stability is key. In order to encourage market participants to take strategic decisions and invest long term, the rules cannot continue to change and a signal should be given that they should not change, in principle.
That does not mean that Basel should not be completed. The mandate given to the Basel Committee to reduce excessive variability is appropriate: currently, the same hypothetical bank with the same risks is dealt with completely differently in one jurisdiction than in another, and that simply cannot be. The problem is that it is not what the Basel Committee delivered. The first proposal of the Basel Committee for finalisation pretty much came back to a standardised approach, which effectively means treating different risk the same way. That removes what is at the heart of a number of the reforms that have been made which try to incentivise market players to better manage their risks. Moving back to a standardised approach with any high level floor makes a risky bank balance sheet being treated the same as a non-risky bank thus removing this incentive and this remains the biggest problem.
During the current negotiations on the finalisation of Basel III, the importance of the issue from a European perspective has often been illustrated by reference to residential mortgages. Compared to many other jurisdictions, banks in Europe hold a large amount of low risk mortgages on their balance sheets, which can attract relatively low risk weights in particular if internal models are used, and they often are, to determine the risk weights. In principle, the low risk weights are justified by the low underlying risks.
As the current discussions are driven by concerns about unjustifiably low risk weights that may result from internal models and proposals revolve around putting in place constraints around the use of such models, there is a high risk that these constraints will prevent banks with low risk mortgages from reflecting this low risk in the capital charges they apply. Such an outcome would clearly be undesirable, as it would limit the risk sensitivity of the framework, creating the wrong incentives and resulting in increased capital requirements, all of which to a larger extent for European banks than for many others. In other words they would miss the initial target for the whole exercise that was to treat similar risks in the same way across jurisdictions, and would instead end up treating similarly very different risks across jurisdictions. A key objective from a European perspective is thus to ensure that the Basel framework remains risk sensitive enough to accommodate that key concern.
Furthermore, any backtrack for international standards, in any jurisdiction, is the basis for deferrals. If a jurisdiction for which the EU has recognised equivalence were to backtrack significantly in that field, that determination of equivalence would have to be reassessed. Of course, there is value in having everybody implement the same standards in terms of level playing fields, but standards are implemented in Europe because they are good for financial stability.
Finally, European banking specificities should further be taken into account by the Basel Committee where that is not yet sufficiently the case.
The moderator thanked the panel for their contributions. They summarised that the FSB and international institutions have done a remarkable job over the period, since 2009. Everybody needs to support implementation of what has been agreed, and not the unravelling or complete overhaul of what has taken the world into a much better place.