Almost exactly three years ago the then US president George W Bush stood shoulder-to-shoulder with his French counterpart Nicolas Sarkozy in Washington and declared: “We need to improve our regulations.”
Time has moved on; the White House has changed hands; and some of the instant unity and passion that drove forward the regulatory agenda in the wake of the failure of Lehman Brothers has evaporated.
But the process that the French and American presidents began in the dark days of 2008 is nearing the end – or at least the beginning of the end. Proposals on a whole new financial regulatory framework will be high on the agenda when leaders from the Group of 20 nations gather in Cannes.
Expectations are high that Sarkozy this time will stand alongside US president Barack Obama and British prime minister David Cameron to unveil a new regulatory system that will affect how business is done in New York and London, the world’s largest financial centres.
This will have been the result of innumerable meetings of regulators, policymakers and central bankers – a process that has unleashed a tidal wave of protest and dire warnings from the banking industry.
Some of the changes have already been approved and are starting to bite. Chief among these is Basel III – the demand that banks must raise the amount of capital they need to hold as a share of their risk-bearing assets from 8% to 10.5%.
NEW LOADS
However, there is a whole raft of further regulations that will come up for approval in Cannes that will impose fresh burdens on the financial industry.
Last month, G20 finance ministers and central bankers approved measures proposed by the Financial Stability Board (FSB) to curb the risks posed by banks deemed globally systemically important financial institutions (G-Sifis) – or ‘too big to fail’ in popular parlance.
They will have to bear higher requirements under proposals going to Cannes. The G20 has said 28 institutions will have to hold an extra share of Tier-1 capital, ranging from 1% to 2.5% depending on their systemic importance – although there is speculation the total could rise to 50 institutions.
In a closely related move, the FSB will also present its proposal that all large international institutions be required to draw up “resolution and recovery plans” – so-called “living wills”.
It has set a tentative deadline of December 2012, while other international regulatory bodies are working on new rules for accountancy issues such as mark-to-market, trade in derivatives and commodity futures. The International Institute of Finance (IIF), which represents the major global banks, accuses regulators of adding extra rules on to what the G20 has agreed.
PERILS OF UNCERTAINTY
Josef Ackerman, outgoing chairman of the IIF and chief executive of Deutsche Bank, says that there is a “danger” that the financial industry’s ability to provide finance to business will be “severely hampered” by uncertainty over regulation. “Our hopes now rest on the G20 to step forward and act decisively to ensure that it will be fully restored,” he says.
Critics point to the recommendation by the UK’s Independent Commission on Banking to ring fence retail banks and impose requirements of 17–20% as an example of national regulators engaged on “mission creep”.
But regulators are standing firm. Stephen Cecchetti, economic adviser to the Bank for International Settlements (BIS) that hosts the FSB, said last month that “too big to fail is too big to exist”.
“It is imperative that we not only cope with the too-big-to-fail problem, but that we also deal with it effectively. The capital surcharge for [G-Sifis] is a significant step in the right direction, and the same is true of the progress on improving recovery and resolution planning.”
During a visit to Europe last month Gary Gensler, head of the US Commodity Futures Trading Commission (CFTC), was confronted by a banker who said he was “worried” financial institutions would be scared away from anything but low-risk activities.
Gensler hit back saying: “I worry that if we don’t get this right, the American and European publics remain at risk. The financial systems failed and eight million Americans are still out of work.”
He acknowledged there was a “trade-off” between the ambition for international cooperation and the need for nations to draw up their rules. “I think it’s better if we can get at least a minimum of standards, at a uniform level. There will be some differences, and there’s room for innovation, but we need some minimums.”
CAPITAL RAISING
BIS’s macroeconomic assessment group (MAG), also chaired by Cecchetti, looked at the cost of raising capital requirements by an extra two percentage points over eight years.
It claimed the impact would be “quite small”, reducing GDP by a peak of 0.34% relative to its baseline level. Roughly 0.04 percentage points are subtracted from annual growth during this period, while lending spreads rise by around 31 basis points (0.31%).
BIS says the benefits will outweigh those costs many times over. Raising capital ratios on G-Sifis may produce an annual benefit in the order of 0.5% of GDP, while the Basel III and the G-Sifi proposals combined contribute an annual benefit of up to 2.5% of GDP.
The IIF disputes this, claiming that the proposed reforms will leave GDP 3.2% lower than it would otherwise have been. It forecasts economic output will be 5.5 percentage points lower as a result. It warns bank lending rates will be 3.6 percentage points higher, bank capital requirements will amount to $1.3 trillion while 7.5 million fewer jobs will be created.
While the G20 is likely to rubberstamp the G-Sifi and living will proposals and other elements formulated by the FSB, the fight over the issues will move onto the implementation, following the battle over capital requirements.
The financial industry believes that G20 national regulators are moving at different speeds and with different agendas. The multi-speed implementation is inevitable, given that parliamentary processes vary across the G20 membership.
In the US the all-encompassing Dodd-Frank Wall Street Reform and Consumer Protection Act has been in place for a year, while Europe is using a number of directives that are moving through the parliamentary process at different speeds.
The last month has seen the CFTC approve sweeping new constraints on speculation in food, energy and metals by imposing caps on the size of traders’ positions. However, attempts by the EU to put in place a similar regime may be blocked by the UK. France will push for a global agreement this week at the G20.
But will the G20 achieve its ultimate ambition of making sure the banking system is safer and that the risk of a repeat of the collapse of Lehman has been substantially reduced if not eliminated?
As President Bush put it three years ago: “The question is, how do we establish good regulatory structures without destroying the incentive to innovate, without destroying the marketplace?”
Peter Hahn, a former managing director at Citibank who now teaches at the Cass Business School in London, says it will take several years of stable performance for the banking system to re-establish confidence and stability.
“In large part this will be accomplished through simpler business models – reducing activities will reduce size,” he says.
But as Gensler points out, achieving regulatory reform will not be an easy task. “The 21st century of finance knows no boundaries. Effective reform cannot be accomplished by one nation alone. It will require a comprehensive international response.”