EU regulations due to take effect later this year will require credit rating agencies seeking to operate in Europe to register and be supervised by the proposed European Securities and Markets Authority (ESMA). Concurrently with the significant work to strengthen the resilience of the financial system, important changes are also being considered to improve the regulatory and supervisory framework. Of particular significance is the creation, proposed by the de Larosière Report, of the European Systemic Risk Board (ESRB), which will exercise macro-prudential supervision and monitor systemic concerns, and, at the micro-prudential level, of the European System of Financial Supervisors (ESFS). This consists of a network of national financial supervisors working with the new European Supervisory Authorities, namely the European Banking Authority, the European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority. 2  BIS Review 67/2010  Complementary proposals emerged from the G20 London Summit of April 2009, which launched a global plan for recovery and reform and mandated the FSB to ensure the consistent implementation of the G20 road-map. Ongoing work, which is expected to be completed in the coming months, includes an impact assessment of the BCBS capital and liquidity proposals; the development of tools to reduce the probability and impact of failure of systemically important institutions; measures to reduce the potential of OTC derivatives markets to act as channels of contagion; proposals to restart securitisation on a sound basis; and promoting the full national implementation of the FSB Principles and Standards on compensation.

There were manifest conflicts of interest, originators and brokers had limited interest in ensuring continued monitoring of products and credit ratings were inflated, conveying a false sense of security. A euphoric bubble thus developed, based, in Alan Greenspan’s words, on “the complexity of the interactions of asset markets and the economy”, and which concealed a massive global under-pricing of risk. Market participants seem to have been aware of the growing risks but were unwilling to retrench. You might recall Citibank’s Chuck Prince’s memorable words during the onset of the crisis that “as long as the music is playing, you’ve got to get up and dance. We’re still dancing”. Market players failed to appreciate the speed at which demand could evaporate and risk aversion could increase. This soon resulted in record-high risk premia, seized-up interbank markets, acute liquidity and credit shortages, bank failures and a widespread loss of confidence. Meanwhile the high degree of financial market integration had created the premise for a simultaneous build-up of systemic risk. Financial institutions did not internalise the costs arising from the too-big-to-fail and too-interconnected syndrome. Central banks had been monitoring these trends, but it turned out that the regulatory tools were not designed to address systemic risk. Neither was the strength of the feedback loop between the financial  BIS Review 67/2010  1  system and the economy fully anticipated. Unfortunately, these all proved to be critical weaknesses.