By Michael Prowse
Don’t worry: I don’t expect Michel Barnier, the top European financial regulator, to come up with startlingly bold proposals this summer – proposals that would prove his critics wrong. But there is little doubt that the EU could, if it chose, take a tougher line than the US Treasury against what it calls “systemically important financial institutions” (SIFIs) – the likes of Goldman Sachs, Citibank, J P Morgan, Barclays and UBS.
The US has opted to rely on stricter supervision and higher capital requirements. Mr Barnier, in his recent speech to the European Institute in Washington, rightly noted that other options are possible: size limitations and/or prohibition of risky activities. If he advocated breaking up the biggest firms, he would win the enthusiastic backing of a large segment of the academic financial community in both the UK and US.
Mr Barnier is at least well aware of the economic inter-dependence of the US and EU. Forget China: the trade and investment links between these two economically advanced blocs are the most significant on the planet.
It follows that the US and EU have a huge incentive to coordinate reforms of their financial systems. They need to head off regulatory arbitrage (especially significant between New York and London) and level their portion of the global playing field even if the rest of the G20 fails to follow suit. Yet while the shape of the US’s regulatory response to the 2007-09 financial crisis is basically history (the final details await reconciliation of the House and Senate bills), the EU’s is still a work in progress. So what can we expect from Mr Barnier, the EU’s financial architect in chief?
Bear in mind, first, that France’s former agriculture minister is not part of that nation’s technocratic elite and not regarded as a man of ideas. He is known instead as a good-natured pragmatist – someone more comfortable negotiating deals than juggling abstract arguments. He is not a great admirer of Anglo-American capitalism but neither is he particularly hostile to it.
What is encouraging is that his personal skills give him as good a chance as anyone of building consensus among disparate European nations. And such skills are vital given the cultural, institutional and legal differences between British and Continental European financial capitalism. In any case what the world lacks is not so much ideas as the political will to confront the powerful banking lobby and implement reforms that are in the wider public interest.
So far the EU has agreed a new supervisory framework for financial markets and some modest regulation of private rating agencies. The ratings firms will now have to register and adopt more transparent methodologies. Tougher action is needed: it is far from clear that rating should be a private sector activity at all, given the conflict of interests when those rated pay for their ratings and can shop around for the best deal. Mr Barnier has hinted at a new pan European rating agency for sovereign debt. If publicly run, this would be good idea.
Meanwhile, new European Supervisory Agencies for banking, insurance and securities markets are to work in tandem with national authorities, and with a new European Systemic Risk Board. A transfer of regulatory functions from national capitals to Brussels is highly desirable and long overdue. But how these proposals will work on the ground remains unclear: London and Frankfurt in particular are accustomed to regulating themselves, and in different ways.
Mr Barnier expects to reach final agreement shortly on long-standing proposals for regulating hedge funds and private equity but is anxious not to put European based firms at a disadvantage relative to their American counterparts. And he has just announced proposals for a tax on banks to ensure that financial companies rather than taxpayers bear the burden of any future banking crisis. London andParis immediately raised objections, which suggests Mr Barnier will not readily achieve his longer-term goal of an integrated European banking resolution framework. But the goal is right nonetheless.
These relatively modest achievements aside, EU financial regulation is mostly a list of aspirations.
On derivatives the EU is dragging its feet. Mr Barnier supports US-style reforms aimed at bringing transactions onto regulated exchanges so as to increase transparency and protect the interests of consumers and non-financial users. Legislative proposals are due this summer. I hope the European proposals are at least as tough as those being discussed in the US.
On bank capital requirements, Mr Barnier also promises legislative proposals later this year. But he is cautious for two reasons. Given the fragility of the European economy he does not want to choke off recovery by announcing too stringent requirements. He is also waiting on the outcome of discussions still underway in Basel on the calibration of capital and liquidity standards, proposed new controls on leverage, and rules to link capital requirements with the state of the economic cycle. The Basel rules are a key element in the jigsaw and the proposed direct control on leverage is encouraging.
Mr Barnier is also promising action to strength the corporate governance of financial companies on the grounds that crisis prevention “starts from within”. The UK authorities are taking a lead here: they want to shift power to shareholders (who failed to curb the abuses of senior management in 2007-09) by making all directors stand for re-election at every annual general meeting.
On governance, the Anglo Saxons may have something to learn from the Continentals: why not give rank-and-file employees some influence too, by electing them to supervisory boards alongside representatives of shareholders? Most ordinary employees were appalled by the excesses of their senior management in the recent crisis, but were powerless to prevent their risky behaviour.
And, finally, what of those “systemically important financial institutions” (SIFIs) – those large financial companies with a finger in most pies that national authorities regard as “too big to fail”? After irresponsible risk-taking at such firms helped cause the worst recession since the 1930s and precipitated the biggest ever taxpayer bailout, one might have expected a Democratic Administration and Congress to break up such firms. Most financial experts agree there is little economic logic behind such conglomerates.
The task of regulators would certainly be easier if different firms undertook different tasks requiring different skills. And a larger number of smaller, more specialised firms would mean more competition, which would benefit consumers and non-financial firms. Yet in the event, the conservative Geithner-Summers approach seems to have prevailed: the US is relying largely on a combination of stricter supervision and higher capital requirements. It cannot be expected to work
Mr Barnier should put the US Treasury to shame and take on the SIFIs. He should recognise that size limitations and restrictions on multi-functionality do make sense. As pundits on both sides of the Atlantic have stressed, banks that are too big to fail are simply too big. It won’t be an easy argument to sell in Continental Europe, home of the universal bank, and where one-stop financial shopping is a way of life. On the other hand powerful voices in Europe – Mervyn King, the Bank of England governor, for instance – do favour a tougher line than the US has yet embraced.
If Mr Barnier were to take on the financial titans, he might influence the G20 and via the G20, the US. And there are precedents of a sort: the European Commission has always run an aggressive competition policy: it has never hesitated to take on the largest companies, including Microsoft, when it concludes that their way of doing business is contrary to the public interest.
But since no nation wants to be at a competitive disadvantage, size and function limitations in the financial sector will have to be imposed globally or not at all. This is Mr Barnier’s big chance to show that he is a capable of bold innovative thinking. Regrettably, I don’t count on him breaking out of the box.