Benoît Coeré: The reform of financial regulation - priorities from a
European Central Bank perspective
Dinner speech by Mr Benoît Coeré, Member of the Executive Board of the European Central
Bank, to the Association for Financial Markets in Europe (AFME), Paris, 6 March 2012.
* * *
I wish to thank Marco Protopapa, Johannes Lindner, Balázs Zsámboki, Jürgen Kirchhof, Giacomo Caviglia, Gábor
Gyura and Olya Ranguelova for their contributions to the speech. I remain solely responsible for the opinions
contained herein.
1. Introduction
Ladies and Gentlemen,
I am very pleased to be with you here in my new capacity as a Board member of the ECB. In
my remarks today I wish to focus on some regulatory initiatives which I regard as being
instrumental to a stable, well-functioning financial sector.
At the peak of the financial crisis, the Group of Twenty (G20) committed to an unprecedented
overhaul of the financial regulatory framework. As you may know, it assigned the Financial
Stability Board (FSB) a central role in developing and overseeing the concrete regulatory
initiatives as well as monitoring their implementation. Indeed, international coordination is
vital when dealing today's complex and integrated financial system. Three and a half years
after the collapse of Lehman Brothers in 2008, I can safely say that much has been done to
improve the resilience of the financial system, drawing on the lessons learned during the
crisis. Still, the overhaul of the regulatory and supervisory landscape is not complete: several
pieces of the puzzle still have to be fitted in.
Of the various areas that have been addressed by the FSB, I would like to focus today on
three main issues that I deem of special importance from the ECB's perspective. First, I will
discuss the timely and consistent implementation of the new Basel III framework, both at
international and EU level. Second, I will consider the ongoing work to address the "too big to
fail" problem, particularly within the specific EU landscape. Third, I will address some key
policy issues in the field of OTC derivatives, financial markets infrastructures and the review
of the Markets in Financial Instruments Directive, taking into account their importance for the
orderly working of financial market activities.
2. Timely and consistent implementation of Basel III
The new Basel III rules form the cornerstone of the new prudential regime for banks. In view
of the G20's commitment, a timely and consistent cross-country implementation of the Basel
standards as well as the subsequent enforcement of the new rules are clearly high-priority
issues which will pose significant challenges for the authorities and the banking industry
alike. I very much welcome in this regard the Basel Committee's decision to assess the
implementation of Basel III in parallel across major jurisdictions, namely the EU, the US and
Japan this year. This effort is instrumental for promoting an international level playing field.
In the EU, as we all know, the EU Commission published last year its proposal for a Capital
Requirements Directive and the Capital Requirements Regulation, which together constitute
the "CRD IV", the purpose of which is to implement Basel III in the EU. The ECB, in
accordance with its statutory task, provided its Opinion1.
Let me first and foremost stress that we acknowledge the leading role of the Commission
and welcome its commitment to a consistent transposition of the new capital and liquidity
rules into European law. One very important topic is the introduction of a single rulebook in
the EU. We consider such a rulebook as an important step towards establishing a single
market for financial services and enhancing financial integration in Europe. One of the
benefits of this rulebook would be a commonly agreed definition of regulatory capital. The
consistent application of such a definition would make it easier to compare eligible capital
instruments from bank to bank within the EU, thereby strengthening the confidence of market
participants in the loss-absorbing capacity of banks' capital and, more generally, in the
resilience of the EU's financial sector.
The ECB proposes in its Opinion the possibility for national authorities, within the framework
of a single EU rulebook, to adopt - with specific safeguards - stricter requirements in their
respective Member States for macro-prudential reasons. This is necessary because Member
States need to address country-specific financial stability concerns stemming from different
structural features of their domestic financial systems. It is key that the possibility for Member
States to apply these stricter requirements should be framed within the single EU rulebook
framework. To this end, specific safeguards should be put in place. First, definitions should
remain intact; only quantitative ratios and limits can be tightened. Second, the European
Systemic Risk Board could play a coordinating role in assessing financial stability concerns
and possible unintended consequences and spillovers to other Member States. Furthermore,
the European Banking Agency (EBA) and the ESRB should publish regular updates on their
websites of measures adopted by Member States and the underlying reasons for stricter
requirements. Third, where financial stability concerns that triggered the application of more
stringent measures cease to exist, the quantitative ratios and limits should return to a
harmonised level set by the regulation.
3. Towards a pan-European approach to the resolution of systemic financial
institutions
The FSB has adopted a dual approach to deal with the so-called systemically important
financial institutions (SIFIs), namely by targeting both tighter loss absorbency requirements
as well as improving the resolution technology available to authorities. A milestone in this
area is the international framework for global systemically important banks agreed by the
FSB and the Basel Committee on Banking Supervision. The framework proposes a
progressive capital surcharge, depending on a bank's systemic importance. This surcharge
system is necessary to provide banks with correct incentives to decrease over time their own
systemic footprint.
Even more crucial, and much less advanced, is the resolution approach to the "too big to fail"
problem. During the financial crisis, the failure of a large cross-border banking group was not
a credible option. As a result, governments had to resort to massive taxpayer-sponsored
bailouts, in some cases even the ring-fencing of banks' assets within national jurisdictions.
This was a clear sign of the lack of adequate resolution powers, which would have minimised
disruption to the financial system as well as the burden on public budgets.
This shortcoming was realised both globally and in the EU. Last November in Cannes, the
G20 endorsed the FSB's new international standards called "Key Attributes of Effective
Resolution Regimes for Financial Institutions". On the basis of this document, the European
Commission is about to finalise its legislative proposals for an EU framework for bank
recovery and resolution.
The consistent implementation of these Key Attributes at international level is clearly a
priority for the near future. How will all this work in practice for large cross-border banks in
the EU's Single Market? The Commission's proposals - which I fully support - will provide a
common language for domestic authorities for recovery and resolution planning, set up a
common toolbox of supervisory and resolution measures, and also establish some principles
for cross-border cooperation. All this already looks like a huge step forward from the status
quo, where national regimes are lacking the necessary resolution powers, and not
harmonised with each other, either. Moreover, we should not forget that in the Single Market
major banks operate in more than a dozen countries via branches and subsidiaries. When
Fortis was broken up in 2008, only three countries were involved directly in its crisis
management, but cooperation still proved to be difficult. That is why I strongly believe that
the EU needs to make progress towards a truly integrated resolution regime that adequately
mirrors the cross-border nature of its banking sector.
First, let me mention that bank levies have been already imposed in several EU countries.
Although they are undeniably a burden on the financial sector, I believe collecting ex ante
funds for resolution is ultimately beneficial for all parties, if the financial system becomes
safer in the long run. But having purely national financing arrangements would again present
the practical and political challenges of coordination and eventually sharing burdens among
several countries. A superior option would be to collect levies directly at EU level. Should this
prove politically unfeasible, we would still at least need to have rules on how the national
financing arrangements should together contribute to the overall resolution costs. Pooling
resources in a single pan-EU resolution fund would bring a number of positive elements into
the resolution framework of cross-border banking crises: it would reduce the amount that
would be subject to burden-sharing; it would increase risk diversification and additionally
provide the right incentives for cooperation. In any case, precise and transparent procedures
and balanced decision-making mechanisms relating to the activation and use of the funds
will be necessary to make it acceptable for Member States.
Second, I also think that a pan-European financing arrangement is the pre-condition for an
even more ambitious step forward, namely the establishment of a single European resolution
authority. Why would we need such a body? We have already learnt from past experience
that crisis management and resolution calls for incredibly quick decisions. This typically
means taking over a bank on a weekend and opening it for customers on the Monday, for
example in the form of a bridge bank. Considering all the legal and technical complexities of
such a move in a cross-border context, the only efficient way to do this is to have a single
authority taking the lead and relying on national resolution authorities as its agents.
Certainly, a lot needs to be done to set up an integrated European resolution regime like this.
But it is not something for the distant future. Recent events have underscored the need to be
more ambitious - now. During the recent financial and sovereign crisis in Europe, we have
seen the pernicious interaction between weaknesses in the financial sector and fiscal
imbalances. Many policy initiatives have been put in place to restore confidence in European
banks, despite concerns over their sovereigns. Low short-term interest rates in the euro area
should in the short term help to prevent a disorderly adjustment of balance sheets and
support the profitability of financial institutions, but they may weaken the incentives for
repairing balance sheets in the first place. A pan-European financing arrangement would be
one of the most effective measures to break the link between the creditworthiness of banks
and that of their sovereigns. Its establishment would also remove the need for ad hoc policy
measures in response to crises, such as the one-off EU-wide capital exercise conducted by
the EBA, which incorporated market valuations of sovereign exposures in times of stress. I
am also convinced that such an integrated resolution framework is likely to be the most
suitable for the industry as well, since it ensures a level playing field and that the relevant
rules are consistent throughout the EU.
4. OTC derivatives, market infrastructures, and the MiFID review
Let me now briefly comment on something that could be considered the "plumbing" of the
financial markets: namely, over-the-counter (OTC) derivatives and market infrastructure. The
reform of OTC derivatives markets has been a key part of the work to enhance the financial
system's resilience since the global financial crisis. Indeed, the limited development of
financial market infrastructures, weaknesses in bilateral risk management and the lack of
transparency regarding counterparty exposures in OTC derivatives markets contributed to
the financial market turbulence, as the cases of Bear Stearns, Lehman Brothers and AIG
have painfully demonstrated. These cases also illustrated the potential systemic
repercussions of malfunctioning OTC derivatives markets, particularly in view of their large
size and close linkages with the underlying cash markets.
To enhance the functioning of OTC derivatives markets, the G20 agreed that standardised
OTC derivatives contracts should be traded on exchanges or electronic trading platforms and
cleared through central counterparties by the end of 2012; in addition, OTC derivative
contracts should be reported to trade repositories.
I see two particular priorities at the current juncture. First, I have the impression that
international discussions in recent months have focused heavily on the implementation of the
mandatory clearing obligation and paid much less attention to objectives in the fields of
standardisation and trading. We should not forget that standardisation is a pre-condition for
centralised clearing. Second, as the EU and the US are moving to finalise the technical
details of their new legislative requirements for OTC derivatives, I believe that further efforts
are necessary to ensure consistent requirements. To this end, it will be essential that both
the final EU and US rules converge to fully reflect the substance of the updated principles for
financial market infrastructures, which the Committee on Payment and Settlement Systems
and the International Organization of Securities Commissions will release next month.
Let me briefly touch on the further development of financial market infrastructures for
OTC derivatives, focusing on the role of central clearing counterparties (CCPs) and trade
repositories. The rationale for fostering the use of CCPs is that a CCP reduces systemic risk
by acting as counterparty to every trade, applying multilateral netting, and particularly
stringent risk management practices. In this way, potential contagion risks in the case of a
default of a CCP clearing member are minimised both for the CCP itself and for the financial
system more broadly. On the other hand, trade repositories play a critical role in providing
centralised data record services for OTC derivatives transactions regardless of their degree
of standardisation. This enables a comprehensive overview of open positions and the
corresponding exposures arising from OTC derivatives transactions.
There is a longer-term trend towards global and offshore financial market infrastructures
which is linked to the economies of scale inherent in network industries and intensified by the
introduction of mandatory clearing for OTC derivatives. As a consequence, we are seeing a
growing concentration of systemic risks in a limited number of global CCPs. Such risks have
not yet been adequately addressed. In particular, cross-border oversight arrangements often
do not exist or are insufficiently developed, which implies that foreign authorities do not have
the appropriate information to assess possible risks to their jurisdictions and/or to take action
to reduce them. Furthermore, procedures and loss-sharing in the case of the default or
resolution of global/offshore CCPs have not yet been developed.
Let me also mention that, in parallel, an increasing number of jurisdictions are considering
the potential adoption of location policies for CCPs predominantly using a non-domestic
currency. I would like reaffirm that as a rule, the core infrastructures for the euro should be
located in the euro area. When they are not located in the euro area, they should comply with
the CPSS-IOSCO principles, and also with central bank-relevant policies so as to preserve
the integrity of the currency. Moreover, they should be subject to effective oversight by euro
area authorities. There can and should be no automatic granting of liquidity to offshore
CCPs.
Let me finally say a word on the revision of the Markets in Financial Instruments Directive
- the MiFID review. The ECB fully supports the European Commission's proposals, which
mark an important step towards strengthening investor protection and creating a sounder
and safer financial system in Europe. The EU regulatory framework needed a revamp to
adequately take into account financial innovation and the latest technological developments,
and to address the G20 commitments to tackle the less regulated and more opaque parts of
the financial system. With regard to the specific measures that are being proposed, let me
mention a number of key issues. First, the ECB welcomes the upgrade to the market
structure framework, which will extend the scope to a new trading platform, i.e. the organised
trading facility (OTF). Second, the ECB also fully supports the proposed extension of
pre- and post-trade transparency requirements beyond equity instruments, to include
structured products and derivatives. When properly calibrated, such measures would
enhance price formation and support the evaluation of financial instruments. Third, the
proposals to increase data consolidation are also crucial, both for investors and the
authorities. They would ensure efficient comparison of prices and trades across venues and
facilitate the monitoring of market abuse by the supervisory authorities. Finally, as regards
the proposals to tackle the development of new trading strategies, such as algorithmic
trading and high-frequency trading, the ECB supports these amendments insofar as they
would enhance the efficient functioning and integrity of markets.
5. Conclusion
In my comments tonight, I have attempted to give a brief overview of some of the themes
which I consider important for the creation of a stronger and more resilient financial sector.
International coordination has reached unprecedented levels thanks to the distinguished role
played by the G20 and the FSB. European integration has made giant leaps since the
Lamfalussy report of 2001 and the De Larosière report of 2009. But this is not enough.
The euro area is an Economic and Monetary Union, an "E-M-U". European governments
have strengthened the governance framework through the Six-Pack and the Fiscal Compact.
Their actions to address fiscal and economic imbalances are bearing fruit. They should
further enhance their efforts to boost the Single Market. So the "E" stands for "Economic".
The ECB has used conventional and non-conventional measures to support price stability. It
is striving to restore the transmission channels of monetary policy and make sure that the
impulse stemming from it is transmitted uniformly across the 17 economies of the euro area.
So the "M" stands for "Monetary". But the letter "F" - for financial - is missing: to operate
smoothly and to be more resilient to crises, the Economic and Monetary Union has to
become a true financial union.
I thank you for your attention.