EU Plans Governance Advances for 2010

2010 is shaping up to be a year where the European Union will implement previously planned measures to tighten the screws of financial regulation. The question is whether those efforts will line up with reform plans hatched by the G-20 or be diluted under pressure from lobbyists—and so far, the answer is “who knows?”

McCreevy

One major factor is the appointment of Michel Barnier to serve for the next five years in the key EU position as the new commissioner covering financial services. The French national is replacing Irishman Charlie McCreevy who, during the pre-crisis period, was noted for his light-touch approach to business regulation.

Barnier has been described as the appointment to lead a shake-up of European banking. Hence, the center-right politician was initially regarded by London’s financial circles as a much-feared bogeyman. No doubt, he would prefer to describe himself as a pragmatist.

Barnier

He says he generally wants to follow G-20 recommendations, and adds that he wants to promote “capitalism for entrepreneurs” rather than “capitalism for speculators.” European Commission insiders, however, are waiting to see exactly what this means in the practical world of the Brussels legislative machine.

Monti

The insiders are also awaiting another viewpoint, expected in the spring, when former EU Commissioner Mario Monti is due to report on the problem of growing nationalistic forces in financial services in the EU. (Monti is now president of Bocconi University in Italy.)

One specific—and controversial—subject concerns the measurement of financial assets, or how accountants book assets according to fair-value rules. Last autumn, the International Accounting Standards Board published a revised set of provisions, International Financial Reporting Standard No. 9. But in November the European Commission took the unprecedented step of declining to adopt IFRS 9, at least until further notice. (Despite the Commission’s stance, some non-banking European companies have been booking 2008 results under the revised formula anyway).

Véron

The Commission’s withdrawal was attributed to pressure from banks in France, Germany, and elsewhere, fearful that the new spotlight on their derivatives holdings might subject them to higher capital-reserve requirements. The European Banking Federation repeatedly opposed pressures last year to boost capital reserves, with warnings that increased reserves could “have perverse effects on the real economy.” Economic experts such as Nicolas Véron, however, of Brussels’s Bruegel think-tank, have been recommending “a [comparative] assessment of the … long-term viability of … most key banks.”

The fight over IFRS 9 isn’t restricted to Europe. The U.S. Financial Accounting Standards Board promised just two months ago to accelerate convergence of U.S accounting standards and IFRS and to complete the project by June 2011. Delays in Europe over accounting for financial instruments won’t help. The Federation of European Accountants (FEE) has also promised to keep lobbying for fair-value measurement of financial instruments, as part of a larger commitment to a single set of global accounting standards.

CLASSIFYING OTC DERIVATIVE INSTRUMENTS

The following excerpt is from the Committee of European Securities Regulators: Call for Evidence on the Technical Standards to Identify and Classify OTC Derivative Instruments :

1.According to Article 25(3) of the Markets in Financial Instruments Directive (MiFID) , investment firms shall report details of transactions executed in financial instruments admitted to trading on a regulated market to their competent authorities.

2.OTC derivatives are used to take positions equivalent with positions that can be taken with financial instruments admitted to trading on regulated markets. Reporting of the transactions on OTC derivatives is not mandatory under MiFID, but some CESR Members have taken advantage of Recital 45 of MIFID to extend the scope of transaction reporting to OTC derivative instruments where the underlying is an instrument admitted to trading on a regulated market in the EEA. Therefore, some CESR Members require reporting, whereas others do not.

3.In order to allow CESR Members to exchange transaction reports on OTC derivatives, CESR is considering modifying its existing IT system, the Transaction Reporting Exchange Mechanism (TREM). Transaction reporting is a key element used in the detection and investigation of suspected market abuse. CESR Members have started to study the technical aspects of the project and launched (in December 2008) a work stream in order to study the inclusion in TREM of the features needed to facilitate the exchange of transaction reports on OTC derivatives among those CESR Members that are willing to participate in such an exchange.

4.CESR, at this time, expects to launch a project to adapt TREM by Q3 2009. The new mechanism would then be in place by Q3 2010. CESR notes that funding for this project has been discussed with the European Commission.

5.The aim of this call for evidence is to seek interested parties’ views on which classification and identification standards should be used for OTC derivative instruments.

6.At this stage, CESR is mainly interested in the scope of instruments that are currently reported in the Member States that have used Recital 45 of MiFID to extend the scope of transaction reporting. Therefore, this call for evidence is focused on OTC derivatives where the underlying instruments are securities admitted to trading on regulated markets in the EEA. The types of instrument currently collected are, for example contracts for difference, spread bets, credit default swaps, equity swaps, options, futures, warrants, etc.

Call for evidence

7. There are a number of issues that have to be considered before the eventual launch of the system. CESR has identified the classification and identification of the OTC derivative instruments as one of the major challenges of the upcoming project.

8. The ISO 6166 standard, called ISIN (for identification), and the ISO 10962 standard, called CFI (for classification), are available and widely used for shares and bonds admitted to trading on regulated markets, but do not currently cover fully OTC derivative instruments.

Source

Committee of European Securities Regulators.

Boutellis-Taft

FEE chief executive Olivier Boutellis-Taft says his group will also keep up pressure for EU member states to comply with the Statutory Audit Directive, which governs how auditing firms are regulated and spells out what services they can and cannot provide. The Directive should have been fully implemented in 2008, but FEE insists that some countries still have not yet complied.

Structural Reforms

de Larosière

The European Parliament is also slated to vote on a slew of reforms to its oversight regime, which would replace three existing agencies with new ones intended to strengthen financial regulation and to resolve disputes among national regulators in the EU’s 27 member states. The reform plan was originally proposed last year by a commission led by Jacques de Larosière, former governor of the Banque de France; it had been scheduled for implementation in 2010, but is now likely to become bogged down in legislative delays.

The three new regulatory agencies will be the European Banking Authority, the European Insurance and Occupational Pensions Authority, and the European Securities and Markets Authority. The three will work via a system of qualified majority voting instead of unanimity, which should put them in a vastly stronger position to resolve cross-border regulatory disputes in Europe.

The de Larosière plan also includes the creation of a European Systemic Risk Council (ESRC), to be charged with identifying risks to financial stability and “issue warnings … for action to address such risks.”

Another issue likely to come up in 2010 is the crucial “passport” system under the EU’s pending Alternative Investment Fund Managers Directive. The current draft wording allows any asset management fund based inside the European Union to market itself in all member states. The version now on the table in the European Parliament would curb that discretion for so-called “third-country funds” (money funds based outside the EU, including those in the United States), requiring them to get authorization from each EU member state before it can do business there.

Bassi

The European Commission, however, wants to “passport” all funds, including third-country funds, provided that “their rules are the same or equivalent to the EU rules.” Ugo Bassi, who oversees regulation of asset management funds at the Commission, has warned of risks of “fragmentation” and regulatory arbitrage if matters were left to 27 different member states.

Van Hulle

As for the Solvency II Directive (the principles-based framework legislation for the world of insurance), implementation of the measures will carry on. Commission official Karel Van Hulle says companies will have to continue preparing for full compliance with the Directive, which covers risk-based capital adequacy, by 2012.

Cronin

Looking at 2010 and beyond, an estimate from the Brussels office of the CFA Institute, foresees that during the next five years Europe will see at least 72 major rule-making initiatives affecting financial services. Charles Cronin, head of CFA Institute Centre, believes that 50 or so will affect the broader capital markets. The investor advocacy group also forecasts a growing role of international bodies, such as the Financial Stability Board, IASB, Basel, and International Organization of Securities Commissions.