Gertrude Tumpel-Gugerell: Beyond the turmoil - rules, supervision and
infrastructures
Speech by Ms Gertrude Tumpel-Gugerell, Member of the Executive Board of the European
Central Bank, at the opening panel at the SPIN 2009 Conference, Rome, 15 June 2009.
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Ladies and Gentlemen,
It is a great pleasure for me to participate in the opening discussion at this conference. The
organisers, in choosing the title of the panel, have given us the challenging task to look
beyond the current turmoil surrounding rules, supervision and infrastructures. This is
certainly not easy as we cannot yet speak of an end to the difficult period facing both the
financial and real sectors of the economy. However, looking beyond the turmoil and start
implementing the lessons we have learned is exactly what is needed at this point in time.
Against the background of the crisis up until now, we have to draw the right conclusions and
begin designing the future of the financial architecture, including new rules and improved
supervision and oversight. This needs to be done now before the window of opportunity -
which will not remain open forever - closes.
However, before looking beyond the turmoil let me take the opportunity first to examine the
performance of market infrastructures in the current crisis. Developments in the financial
markets and the fate of specific institutions have been at the heart of the public debate.
However, owing to the close interdependencies between financial markets, intermediaries
and infrastructures, the difficulties affecting institutions and markets have also had a
knockon effect on market infrastructures, putting the functioning of payment systems, central
counterparties and securities settlement systems under a real-life stress test. Fortunately, as
I will illustrate in a moment, EU market infrastructures have proven to be remarkably resilient,
thereby limiting the overall systemic risk. In the main this has been due to the successful
interaction between industry, regulators and overseers, just like - if I may - in the Italian
banking sector, which has also shown itself to be remarkably resilient in the current
circumstances.
In the second part of my intervention, I would indeed like to look beyond the current turmoil. I
will - despite the very positive overall assessment for infrastructures - point to three areas
that warrant particular attention for the future of market infrastructures. The first of these is
the enhancement of overall crisis management arrangements for market infrastructures. The
second involves strengthening market infrastructures for OTC derivatives. And third, given
the importance of retail markets to the overall stability and efficiency of the financial system,
there is the need to complete the Single Euro Payments Area (SEPA).
Performance of EU market infrastructures during the financial turmoil
The financial market turmoil has impacted on EU payment systems, central counterparties
(CCPs) and securities settlement systems mainly through intensified and more volatile
market activity. We have also seen some peaks in transaction volumes as well as more
frequent and higher margin calls. Furthermore, many infrastructures have had to cope with
the default of a major participant, notably in the context of the demise of Lehman Brothers in
September 2008 and the corresponding spill-over effects on its subsidiaries.
Fortunately, EU market infrastructures were able effectively to overcome these challenges
without any major operational disruptions. In particular, the Eurosystem's TARGET system -
which is not only the backbone of the large-value payment infrastructure for the euro, but
also plays a central role in providing settlement services for 36 retail payment systems and
33 securities settlement systems that are connected as ancillary systems - has proven to be
stable and resilient. Nonetheless, I would like to mention three key stylised facts which
illustrate the impact of the current turmoil:
First, the values processed in TARGET in the last quarter of 2008 showed an unusually high
increase of 13% compared to the first three quarters (see Chart 1). When looking at the
average values settled in different time bands during the day, the main difference
between the third and the fourth quarter of 2008 relates to the values settled in the last hour
of operations. This reflects the strong increase in overnight deposits made by banks with
national central banks as a consequence of the switch to the full allotment fixed rate tenders
in the ECB's open market operations, following the intensification of the crisis after the
collapse of Lehman Brothers in September 2008.
Second, not surprisingly from September 2008 onwards, we see a remarkable increase in
the number of sender limits along with a decrease in their value (see Chart 2). Nonetheless,
these changes had a marginal impact on the smooth flow of transactions and did not cause
delays to the timely submission of payments.
Third, the level of non-settled payments remained fairly stable in the second half of 2008,
amounting to just 1% or so of the total daily average value settled in the system (see Chart
3), indicating the overall resilience of the TARGET system in the face of the financial turmoil.
Crucially, market infrastructures continued to function robustly. In particular, by providing
stable networks despite the highly disruptive conditions in financial markets, market
infrastructures played an important shock-absorbing role and helped to maintain overall
public confidence in the financial system.
Since central banking overseers and financial regulators recognised long ago the critical
importance of the reliable functioning of market infrastructures for overall financial stability
and efficiency, they took action together with the service providers. Stringent requirements
ensure that EU infrastructures are adequately designed, effectively manage their risks, and
operate efficiently and reliably, both under normal circumstances and at times of crisis.
Recent experiences suggest that these measures were well-targeted. Nevertheless, some
areas for further improvement have also been identified. I shall now mention a few key areas
for further action.
Areas for improvement
As stated, I would like to focus on three areas: firstly, improvements related to the overall
crisis management arrangements; secondly, the strengthening of market infrastructures for
over-the-counter (OTC) derivatives; and thirdly, efforts geared to producing a more
integrated retail payments infrastructure.
Crisis management arrangements
One priority that relates to the overall crisis management arrangements is to further improve
notification procedures, particularly regarding the communication of insolvencies by public
authorities and infrastructure providers to market participants. Although this has generally
worked well during the current turmoil, some measures are in progress to foster the
exchange of standardised information.
In addition, further measures are needed to ensure close cooperation with the authorities
regarding the relationship with the defaulting participant and the coordination of measures to
limit the impact of the default. Moreover, it might be an advantage if infrastructures were able
to end unilaterally the contractual relationship with the participant (without waiting for the final
decision by the relevant judicial or administrative authority).
Furthermore, the current turmoil has reminded us that default rules need to be not only
sufficiently clear and comprehensive for the infrastructure participant, but also that they
should not cause any conflict between infrastructures. Therefore, as infrastructures are
becoming increasingly interlinked, more coordination in the implementation of the default
rules is vital for further mitigating risks at the systemic level.
Finally, the default of Lehman Brothers was a major showcase for the severe implications of
"institution-based interdependencies" between two or more infrastructures resulting from the
exposures of major financial institutions participating in each of these infrastructures.
Therefore, it is crucial for us to continue closely monitoring the interdependencies between
individual institutions in order to assess their impact on the stability of the infrastructure.
Infrastructures for OTC derivatives
Let me now turn to the need to strengthen the infrastructure for OTC derivatives. OTC
derivative markets have been very dynamic with a veritable explosion in outstanding contract
volumes primarily over the past decade. The basic problem, however, is that this very
dynamic evolution of OTC derivatives markets has outstripped development of the underlying
clearing and settlement arrangements. Indeed, as the post-trading of OTC derivatives
remained predominantly bilateral and non-standardised, the respective arrangements have
become increasingly inadequate for coping with the growing volumes and complexity of OTC
derivatives trades. This was highlighted in particular during the financial market turmoil, when
higher trading activity and market volatility further aggravated the existing tensions. [The
resulting processing backlogs and uncertainties about counterparty risk raised strong
concerns among policymakers, as highlighted in the Financial Stability Forum's April 2008
1
report on the lessons from the financial turmoil.]
The need to strengthen market infrastructures for credit default swaps (CDS) stems from the
importance of CDS markets for overall financial stability, for three reasons. First, the
systemic importance of CDS markets comes from the high degree of interconnectivity
between CDS markets and credit and cash securities markets, the embedded financial
leverage of CDS, and the significant level of CDS exposures in relation to the total assets
and capital cushions of the banks involved. Second, the associated financial risks, for
example when compared to interest rate and foreign exchange derivatives, are more difficult
to manage. This stems from the greater underlying complexity and the correlations between
different CDS exposures when market-wide strains occur. Third, specific risks to financial
stability stem from the high degree of market concentration where very sizable financial risks
are held by a small group of major market players. Therefore - as we have seen not only
with the default of Lehman Brothers, but also the earlier near-defaults of Bear Stearns and
AIG - the default of one major CDS counterparty can put these markets under very severe
strain.
A natural inference from our experiences during the current turmoil is, therefore, to improve
the resilience of OTC derivatives markets through a more widespread adoption of central
counterparty clearing or exchange trading. Central counterparties (CCPs), by concentrating
all outstanding derivatives positions of the participating buyers and sellers in one place,
enable a significant reduction in counterparty risk: firstly, through the diversification and
netting of risk exposures; secondly, through the application of stringent risk-based margining
procedures to ensure adequate management; thirdly, through collateralisation of outstanding
exposures on at least a daily or even intra-day basis. In addition, CCPs also contribute
significantly to market transparency and integrity and bring significant operational efficiency
gains, e.g. through the standardisation of risk management processes as well as via
multilateral netting and collateral management.
As a result, public authorities and industry bodies worldwide have embraced the
establishment of CCPs for CDS markets as a top priority and we expect a number of
solutions in both the EU and the United States to be up and running by the end of July 2009.
In view of the role of the euro for the derivatives market, I would welcome a CCP in the euro
area. The effective and timely implementation of the respective roadmaps and full dealer
commitment to making the maximum possible use of these facilities will be essential.
Looking ahead, it will also be vital to ensure close convergence between the requirements
and approaches of the overseers and regulators involved so as to maintain a level
playingfield between the different CCPs and pre-empt possible regulatory arbitrage. At EU level, the
forthcoming ESCB-CESR recommendations for central counterparties have already been
revised to include specific guidance on their application to CCPs for OTC derivatives. It is
now also crucial to achieve such a common understanding at the global level as well. In this
respect, we look forward to the recently initiated joint efforts of the CPSS and IOSCO to
review the CPSS-IOSCO recommendations for central counterparties issued in 2004.
Finally, I wish to reiterate that the introduction of CCPs will not be a panacea for addressing
all concerns regarding the resilience and efficiency of OTC derivatives markets. For instance,
we will need complementary action to ensure better risk management and transparency as
well for those products that are not yet sufficiently standardised to be eligible for central
clearing. Furthermore, sound post-trading needs to be complemented by enhanced trading,
pre-clearing and lifecycle management of OTC derivatives, e.g. via the greater use of
automated trading and confirmation, portfolio compression, the registration of all trades in
central data depositories, as well as enhanced risk management and disclosure
requirements for the financial institutions involved in OTC derivatives trading.
Towards more efficient and resilient retail infrastructures for the euro area
Let me finally come to the third issue we need to focus on beyond the current turmoil: the
vital role of retail infrastructures in terms of financial stability. The retail business facilitates
the bulk of payments related to the day-to-day lives and financial activities of both individuals
and companies. It represents the financial system's interface with the general public and is
crucial for preserving confidence in the financial system and, ultimately, in the euro as the
single currency.
Two issues relating to the retail business and the current turmoil are noteworthy. First, the
retail business - with its cornerstones of saving, lending, and payment services - has
successfully withstood the financial crisis. Second, banks with a balanced business model
have been best equipped to cope with the current challenges. Therefore, retail services offer
two major opportunities at the present time: first, to revive confidence in the banking sector in
the eyes of the general public; second, to strengthen banks' balance sheets.
However, one important - sometimes overlooked - issue seems a key prerequisite: in the
same way as the large value infrastructures mentioned before, stable and efficient retail
infrastructures are needed throughout Europe in order to alleviate systemic risk and
safeguard financial stability. However, despite 50 years of European economic integration,
Europe is still lacking an integrated retail payments market.
Therefore, the further realisation and completion of the Single Euro Payments Area project is
a crucial element for the retail banking and payments market beyond the turmoil. Without
doubt, SEPA is the largest payment initiative undertaken in Europe, following the euro cash
changeover. Major milestones have already been achieved: only recently, regulators have
addressed the uncertainties surrounding interchange fees and the reachability of the SEPA
Direct Debit. Nevertheless there are still a number of further topics on our common agenda,
e.g. standardisation in cards, payment innovations, a migration end date, and the
governance of payment issues at the European level.
Harmonisation in the field of retail payments is a natural area for efficiency gains. However,
the market is moving only slowly in this direction. Although SEPA continues to be a mainly
self-regulated project, some elements might need more regulator involvement. The
Eurosystem has emphasised that a realistic but ambitious SEPA migration end date is
necessary. Such a date would facilitate communication and provide more certainty for all
stakeholders. The most viable option for achieving an end date is through regulation by the
public authorities. Since an EU regulation is probably the most effective option the
Eurosystem appreciates the Commission's launch of a public consultation on this topic.
Only by tearing down the walls of fragmentation can we ultimately bring about harmonisation,
efficiency gains and a level playing-field. Such a development inevitably leads to increased
competition. I am fully aware that it is not easy - especially in a period of low growth and
higher credit risks - to change revenue models. However, those who invest early will benefit
and position themselves successfully. Corporates tell us that they would benefit from SEPA
services because they are internationally connected. Taking into consideration the renewed
relevance of retail payments, the key success factors in the years ahead will be
harmonisation, innovation and increased competitiveness. Banks and infrastructures will
successfully take up these challenges only by continuing to play an important role in retail
payments.
Conclusion
From the very beginning of the crisis, the ECB has acted in a decisive manner. It has taken a
number of measures unprecedented in nature, scope and timing. The ECB has provided
large amounts of liquidity support to banks. By making changes to its operational framework,
the ECB made sure that all solvent banks would have sufficient access to funding. When the
crisis intensified in September last year, we introduced a number of new measures. Most
importantly, we provided banks with unlimited access to liquidity at fixed rates for up to six
months. The ECB also expanded its list of assets eligible for use as collateral in the
Eurosystem's credit operations. Moreover, we recently announced further measures, namely
to provide longer term refinancing up to one year and to purchase covered bonds of up to
EUR 60 bn.
Looking now beyond the turmoil on rules, regulation and infrastructures, the current financial
turmoil has taught us one key lesson for the future: self-regulation is not sufficient for
systemically important markets, institutions and infrastructures. Maintaining financial stability
is in the public interest. Therefore, public authorities must take appropriate measures to
regulate, supervise and oversee systemically important markets, institutions and
infrastructures in order to prevent systemic risks spreading and safeguard the financial
stability of the system.
For market infrastructures, one lesson for the future is that, despite their remarkable
resilience in the current crisis, there is no room for complacency given their crucial role in
financial stability. On the contrary, overseers and regulators in future years need to increase
their efforts towards ensuring safer and more secure market infrastructures and also to
further strengthen EU market infrastructures. I have highlighted three specific areas for
enhancement. First, the general crisis management arrangements, particularly on
disseminating information and increasing awareness about default arrangements of market
infrastructures. Second, measures for building market infrastructures for OTC derivatives,
also in the euro area. And third - as in the case of large value payment systems - the need
for a more integrated and harmonised retail payments structure. Therefore, I regard
continued full support from all stakeholders for the effective and timely implementation of the
Single Euro Payments Area as a key priority for the period ahead.
Thank you for your attention.
ANNEX I: Charts
Chart 1 Values settled in TARGET per time band
Chart 2 Evolution of the limits on the SSP
Chart 3 Non-settled payments on the SSP