Christian Noyer: Evolution of the regulation in Europe and in the United
States - convergence or divergence?
Keynote address by Mr Christian Noyer, Governor of the Bank of France and Chairman of
the Board of Directors of the Bank for International Settlements, to the Paris-Europlace
Financial Forum, New York, 18 April 2011.
* * *
Strengthening financial regulation has been high on the agenda of the G20 since Pittsburgh
in October 2008. Much has already been achieved both at the international level especially
through the Basel Committee for Banking Supervision but also on national level with the
Dodd-Frank Act in the US and the pending regulation for market infrastructures in the
European Union.
It is fair to say that the evolution of the regulation in Europe and in the United States has not
always followed the same path in the past. At a time when our regulations are completely
revisited and when many restructurations are taking place in the finance industry, rigorous
consistency on both sides of the Atlantic is clearly needed if we want to avoid regulatory
arbitrages and uneven level playing field which would be the seeds for inefficiencies and
future disappointments.
In my remarks today, I will briefly discuss the achievements on reforms of financial
regulation. Then I will highlight some existing discrepancies between European and US
regulatory frameworks that should be addressed.
I. Regarding achievements in financial regulation: What has been completed so far?
Three main issues warrant specific attention:
- First, at the G20 level, the reform on OTC derivatives;
- Second, the Basel Committee work for banks (Basel 3);
- And third, the accounting reforms by the IASB and the FASB.
1.1 One of the most visible regulatory changes is the reform to address weakness
in OTC derivatives markets
Although they were not at the origin of the crisis, they certainly and conspicuously
aggravated systemic stresses in a weakened global financial system.
The forthcoming European Market Infrastructure Regulation - commonly called "EMIR" - as
well as the Dodd Frank Act is both of paramount importance in order to fulfill the Pittsburgh's
commitments made by G-20 leaders. I see as particularly important the increase in
transparency, the prevention of systemic risk, the promotion of financial stability.
In order to meet these objectives, both regulations do introduce mandatory reporting of
derivative transactions to trade repositories as well as mandatory clearing for eligible
standardized transactions.
Both regulations do take into account the fact that a mandatory clearing obligation may also
increase the systemic importance of clearing houses. Indeed, both regulations introduce
more stringent organizational, managerial and prudential requirements in order to ensure that
those clearing houses are safe and sound and comply at all times with those requirements.
The fact that both regulations are overall consistent and support the same objectives
is of crucial importance and it is a first achievement for financial stability.
Nevertheless, it is only a first step, and implementation measures have still to be elaborated
by European and American competent authorities and, as recalled by a popular saying: as
usual "the devil is in the details".
Therefore, it is of the uttermost importance to further encourage cooperation and exchange
of information between the European and American competent authorities. I will come back
on this issue later on.
1.2 Concerning the recent evolutions of the banking regulation, let me first point
out that, to me, the Basel 3 package constitutes a very significant advance that will in the
long run strengthen the prudential framework for banks. The main message I would like to
emphasize today is that Basel 3 is a balanced reform, in the sense that it is both ambitious
and cautious.
The scope of risks captured by the Basel framework has been enhanced very significantly.
Banks' capacity to absorb losses has been magnified by more than three times if, beyond the
higher level, you account for the improvements in the quality of capital. Some incentives
towards excessive risk-taking have been corrected, through higher capital requirements for
riskier activities, notably those related to re-securitization, and also through new rules for
compensation policies. A leverage ratio will be introduced that will act as a backstop, and not
a substitute, to risk-weighted regulation.
Besides, I believe that, with Basel 3, some important work of harmonization has already
been done. For instance, we now have a far more stringent and more harmonized definition
of regulatory capital. The need for common and internationally harmonized capital and
liquidity requirements has been broadly recognized and will be made operational in the near
term.
Basel 3 represents therefore an ambitious goal. At the same time, it has been set in a
cautious way in order not to impact the financing of the economy and the global growth.
Those latter points are the reasons for the rather long phasing in, that has been put in place
by the Basel Committee. This phasing in period should also enable countries that did not
move to Basel 2 - namely the US -, to implement Basel 3 at the same pace than European
banks.
As a matter of fact, I consider it essential that implementation of this new framework both
in Europe and in the US be concomitant - and exhaustive and I am far from being the
only one. As a matter of fact, experience shows that if a reform is not implemented globally,
weaknesses remain. The American administration is very positive and determined about it,
so I trust that can be done. Failure to implement Basel 3 in a globally consistent way would
lead to a competitive race to the bottom and may thus plant the seeds for another crisis.
1.3 Last but not least, another area in which significant progress has been made
since the crisis is the accounting framework.
Following the impetus of the G20 and the Financial Stability Board, there is a current trend in
accounting reform for reducing the scope for mark-to-market and for moving from an incurred
loss model to a forward looking model of provisioning. In particular, both the IFRS and the
US GAAP will include an amortized cost category for financial assets such as loans. In my
view, these types of changes in the accounting rules constitute the first, and to my mind the
most powerful line of defense to limit the procyclicality brought forward by the crisis.
I also want to point that even we if are witnessing some significant progress between the two
sets of accounting standards, I am convinced that further convergence is needed.
II. Indeed, when it comes to the sources of differences and discrepancies
between US and European regulation frameworks, I'd like to bring to your attention the
following issues:
- Regarding OTC derivatives, further consistency at technical and implementation
level is key in order to avoid regulatory arbitrage;
- The convergence between IFRS and US GAAP is particularly needed to allow for a
level-playing field implementation of some regulatory requirements, such as a
leverage ratio, over different jurisdictions.
Regarding the there is a great degree of parallelism in the
2.1 OTC derivatives reform,
EU and US approaches, but issues arise as the details are worked out.
First of all, regulators have been mandated to make important determinations, such as which
derivatives may still be traded over the counter or which participants could be granted
exemptions in clearing obligations. It is obviously essential that our regulatory efforts result in
similar solutions so as to avoid creating arbitrage opportunities.
Second, the scope of possible mutual recognition regimes for trade repositories and clearing
houses should be carefully assessed in order to obtain a fair reciprocal treatment. The basic
principle is fairly simple: a third country trade repository or clearing house could service
participants or markets of other countries provided that the legal and supervisory
arrangements are deemed equivalent and that international cooperation arrangements are
established. But equivalence is not really easy to assess and one could understand a more
conservative approach based on a systematic registration. Indeed, under such a regime, a
third country trade repository or clearing house servicing participants or markets of another
country would have to be registered by the competent authorities of that country and, once
registered, would have to be subject to regulations and to on-site inspections, in addition to
the domestic ones.
While, in order to decrease the risk of burdensome and inefficient regulatory overlap, the
position held in the European EMIR regulation proposal is to support mutual recognition
regimes, registration regimes do remain implemented in other major jurisdictions; in
particular, in the US as foreseen in the Dodd Frank Act that applies to activities outside the
US that have a "direct and significant connection with activities in, or effect on, commerce of
the United States." In practice this may mean that non-US entities would become subject to
the requirement of the DFA, unless an exemption is granted. In my view, the US regulation
and the subsequent registration to US authorities should not lead European entities to be
subject to a redundant or a double regulation.
The issue of access to the information stored in trade repositories is also particularly
sensitive. One can easily understand that if the national supervisory bodies keep both full
access to the locally registered TR and full control of the access granted to foreign
supervisors, we will rapidly conclude that we need one TR per asset class and per country,
which will clearly be sub-optimal from a supervisory point of view, since we need a
consolidation of the risks, and from an industrial point of view with an increased cost for
everybody.
Hence, it is crucial to continue our common discussions with the American authorities in
order to limit redundancies and inconsistencies, of information decrease the risks of
regulatory arbitrage or overlaps, whilst our common objective remains the safety and
soundness of financial market infrastructures. Constructive dialogue between rule making
agencies is essential.
2.2 In the field of regulatory and accounting standards, I would like to point out that
convergence is highly needed in order to allow users of financial reporting, especially
regulators, analysts, and market participants to draw relevant comparisons between banks.
- Firstly, let me say briefly that the largest European banks have strengthened
their robustness during the last two years and are, at least, as robust as their
US peers1:
• The top European Banks have seen their revenues increase by 8.6% on
average from 2009 to 2010 (up 2.5% for the main US banks over the same
period). All banks have benefited from a decline in their costs of risk (-43% for
US banks and -30% for European banks, from 2009 to 2010). But in absolute
terms, the cost of risks amounts to EUR 63 bn for the top 4 US banks, as
opposed to only EUR 58 bn for the 11 largest European banks.
• Solvency ratios have significantly improved in Europe, banks have retained
earnings and increased capital through various ways (new equity issues,
dividends paid in new shares);
• With comprised between 10% and almost 18% for the main
Tier 1 ratios
European banks, they are equivalent to the range of 11%-16% of American
banks.
• Regarding now the core Tier 1 ratios, which is the measure displayed by
banks for the markets, they are also pretty equivalent. Again, with ratios
ranging between 8.5% and 15.3%, the main European banks are as solid as
US banks (with ratios between 8.4% and 13.3%).
- Secondly, the differences in the leverage ratios levels mainly result from
accounting discrepancies that can lead to particularly misleading comparisons:
• If we observe the leverage multiples, it is true that the figures displayed by
US banks (between 10% and 14%) are lower than those of most of European
banks. For the latter, the range is much wider (between 15% and 25%).
• But we all know that the measurement of the leverage ratios is significantly
impacted by different accounting treatments, the main differences between
IFRS and US GAAP arising from the netting of derivatives and repos.
• The example of Deutsche Bank is a case in point to illustrate this impact. At
the end of 2010, the institution presented total assets of EUR 1,900 bn. But,
according to the bank, on an adjusted basis, which reflected netting of
derivatives and certain other balance sheet items, total assets were EUR
1,200 bn. In addition, according to some analysts, the grossing-up of
derivatives assets alone would create a rise in total assets comprised between
42% and of 129% for the largest US banks.
The discrepancies in the offsetting of transactions have been outlined by the Financial
Stability Board. As a result, the two leading accounting Boards have swiftly reacted in putting
this topic on their convergence agenda. I welcome this joint project and wish that the two
Boards, after the consultation period with their respective constituents, will be able to
publish a common standard that will facilitate the implementation of a global leverage ratio.
2.3 More generally, the differences in accounting standards between IFRS and US
GAAPs have been a matter of concern from the beginning of the crisis.
Since April 2009, the G20 has continuously asked the two Boards to converge towards a
single set of high quality global accounting standards and to complete their convergence
project by 2011 with the aim of remedying the major weaknesses identified during the crisis.
The standard setting Boards have made progress, but standards have still to be finalised
and this is not an easy path.
- Regarding the impairment of financial assets, the two boards have eventually
agreed on a joint project based on a forward looking model that should allow for the
building up of provisions at an earlier stage of the life of the portfolio. It is of the
outmost importance to have a converged standard to avoid any accounting arbitrage
across the Ocean and to facilitate international comparisons between global banks.
A balanced standard should be able to dampen the effects of an economic down
turn.
- Concerning the the importance given to the
classification of instruments,
business model of the banks has led to recognize an amortized cost category for a
broader range of instruments, and to reconsider the extensive use of fair value in the
IFRS standards. Nevertheless, convergence between the IASB and the FASB is
far from being achieved. Even if the US standard setter has recently set an
amortised cost category, the latter would have a narrower scope than in IFRS and
the overall architecture of the classification model is not yet finalised.
- The SEC is expected to give its decision on the adoption of IFRS by the end of this
year. Definitely, the easiest path to fill in the gap between the IFRS and the US
GAAPs would be the adoption of IFRS by the US.
*
* *
Let me conclude.
- The various G20 statements set clear directions and deadlines. Looking ahead, our
challenge is now to specify the rules and implement them. The main challenge for
regulators now lies in finalizing the rules and incentives that will be conducive to
reaching these targets. Thanks to the agreement reached by G20 leaders,
ambitious regulatory reforms and markets initiatives are now under way. I
recognize that the regulation of global finance is a considerable challenge: we have
to preserve innovation while setting the limits on the capacity of instruments,
markets or models to weaken the whole system.
- Our goal now is to ensure consistency across countries of the detailed
regulations while keeping the momentum of the reform. Indeed, OTC
derivatives are a global market, large banks are not local players and accounting
standards should be a common language. Any discrepancies in the regulatory
frameworks would be easily arbitraged, creating loopholes in the system. In that
perspective, we clearly need to strengthen our coordination.
Ladies and gentlemen, thank you for your attention.
ANNEXES :
1. Niveaux des ratios de solvabilité et de levier des principales banques
européennes et américaines
Ratios Tier 1 des principales banques européennes Ratios Tier 1 des principales banques
américaines
Source : Rapports financiers des banques
Ratios core Tier 1 des principales banques européennes Ratios common Tier 1 des principales
banques américaines
Source : Rapports financiers des banques
* Pour BNPP : common Tier 1 ratio
** Pour BBVA : core capital ratio
Si le est défini par la réglementation, le ne l'est pas.
Tier 1 ratio de fonds propre « core »
Selon les pays et même selon les banques, on parle de core Tier 1 ou de common Tier 1 ou
encore de core capital ratio. Ces termes ne recouvrent pas toujours la même définition des
fonds propres car il ne s'agit pas d'une mesure réglementaire mais d'un indicateur
davantage destiné au marché, sur lequel les banques disposent de plus de liberté pour son
calcul et sa communication.
A noter que même le core Tier 1 et le common Tier 1 ne sont pas toujours définis de la
même manière par les banques.
Levier des principales banques européennes Levier des principales banques
américaines
Source : Rapports financiers des banques (calculs Banque de France - SEMASFI)
2. Impact de la non compensation (netting) des opérations sur les dérivés sur le
total bilan et les leviers des banques US
Augmentation du total bilan si non Impact du netting sur les ratios de levier des
compensation des opérations banques
sur dérivés (hors repos)
Source : Risk.net (d'après Credit Suisse et Fitch)