Speech Eurocommissaris Charlie McCreevy: hervorming financiële reguleringen (en)

Mr. Charlie McCreevy

European Commissioner for Internal Market and Services

Supervision, solvency and capital requirements

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Financial Risk Solutions 10th Anniversary Dinner

Dublin , 28 September

Ladies and Gentlemen,

It is my pleasure to address you at this 10th Anniversary Dinner of Financial Risk Solutions. Let me first congratulate our hosts on the ten years in business and the tremendous international success they have achieved during this time – thanks to their entrepreneurship and innovativeness.

Tonight I would like to share with you a few thoughts on the reform of the European financial regulation. I will speak about the Commission initiatives on supervision, the new solvency rules for insurers and capital requirements for banks.

I do not need to tell anyone here how damaging was the financial crisis for Europe. An enormous effort by the governments was necessary to save financial institutions, restore confidence in the financial markets, and keep the economy going. We all have to draw lessons from this.

One thing is clear. The financial sector will not be the same as before. We want it to be more viable and to better fulfil its vital role. Therefore, since spring of this year the Commission has been working a comprehensive financial market reform.

Last Wednesday the Commission proposed a package of measures to reform financial supervision in Europe. For the first time in history certain supervisory powers will be given to European authorities – to safeguard financial stability across the Single Market and enhance competitiveness of the EU financial industry.

The new financial architecture will have a macro-prudential and micro-prudential dimension.

On the macro-prudential side, the European Systemic Risk Board will monitor the macroeconomic trends with a view to detecting any threats to financial stability in Europe as early as possible. Backed by the analytical resources of the ECB and national central banks, it will examine the potential risks and – if necessary – issue warnings to relevant institutions. This will help us avoid being taken by surprise again. The ESRB will be an innovation in the European macro-economic policy landscape, but it responds to the latest global trends.

As for micro-prudential supervision, we have proposed the creation of three new European Supervisory Authorities. They will be built on the basis of the current Lamfalussy Level 3 Committees and will take over all their tasks. In addition, they will have the powers to adopt harmonised supervisory standards for all EU Member States and resolve conflicts between national supervisors – in the areas strictly defined by law. So far we have had informal – and not always effective – cooperation between national supervisors in the CEBS, CEIOPS and CESR. Now, the new Authorities will seek solutions and act as a broker to reconcile diverging national interests. It is important to emphasise that in the new European System of Financial Supervisors the bulk of the day-to-day supervisory work will remain at the national level.

I am convinced that this reform can be a giant leap for the construction of a Single Financial Market. We have now entered a phase of difficult negotiations with the Member States and the European Parliament. If the actors in this game are short-sighted and concerned only about their own interest, we may fail. If – on the contrary – they can look at today's horizon and are open for compromise, we will win.

Along with the new general architecture for European financial supervision, we also need updated rules for banks, insurance undertakings, securities and other players in the financial market.

Solvency II

I am very happy to see that the Solvency II Project is continuing to mobilise much energy and enthusiasm from the wide variety of stakeholders involved.

The Framework Directive, on which political agreement was found between the EU institutions in April, is now being finalised by the lawyers and the official text should be published before the end of the year.

At another level work is continuing at a very active pace on the preparation of the future implementing measures, for which the Commission intends to present the necessary proposals in the Autumn of 2010. These measures will cover a wide variety of topics, many of them fairly technical, and CEIOPS have been working very hard to develop its future advice to the Commission.

CEIOPS have released over recent months a large number of draft papers for public consultation. I know that a number of solutions proposed by CEIOPS in their draft advice are perceived by some stakeholders as not in line with either the principles or the fundamental characteristics of the Solvency II Framework Directive and would, taken together, result in a solvency regime that would be excessively prudent and complex.

In this context, it is crucially important that stakeholders comment constructively on all key aspects of the draft advice and that they also suggest concrete alternative solutions if they do not agree with what CEIOPS are proposing.

The industry has a particular role to play in this respect, and I would urge financial services firms to seize all opportunities to engage in an active discussion with CEIOPS at technical level whenever you feel that the tentative direction taken would be deviating from the political agreement embedded in the Framework Directive.

Once the final advice from CEIOPS has been received on the numerous issues on which the Commission has requested advice over the coming months, we will start drafting the implementing measures. The Commission will do so in close co-operation with experts from Member States, who will see to it that the substance of what they have agreed in the level 1 text is well preserved.

I can assure you that, in developing the level 2 measures, my services will be careful to actively consult stakeholders and prepare a thorough impact assessment. Of particular importance here will be the Fifth Quantitative Impact Study, which will provide evidence on the likely impact of the draft implementing measures and will help ensure that their final version is properly calibrated.

Prudential requirements for banks

Now let me turn to banking regulation. As you may have noticed, amendments to the Capital Requirements Directive seem to be a regular event these days. The season turns and the Commission adopts a new proposal to ratchet up regulatory capital.

In October 2008 we proposed the first set of changes – 'CRD 2'. These measures aimed to set the right framework for robust supervision of cross-border banks, and to tackle head-on the perverse incentives, needless opacity and shamefully lax standards of a hyper-active securitisation industry that caused so much damage to the global banking system. At the time my proposal to require banks to retain a percentage of their securitisations – to force them pay proper attention to the loans they generate for onward securitisation by ensuring they have some 'skin in the game' – were greeted with a barrage of criticism from the industry. But the proposal was adopted in July this year, and now it looks as if the US is going to follow suit.

Sadly however parliamentary and Member State amendments significantly diluted the potential effectiveness of the proposal and this is an issue which I hope will be put right in future revisions.

The proposal for CRD 3 was presented this summer. This aims its fire at three areas that contributed to the crisis: complex re-securitisations, risky trading book activities, and the skewed structures of remuneration that encouraged individuals to take unacceptable risks – to gamble in pursuit of short-term profits and huge bonuses.

First, [the proposals for complex re-securitisations build on the requirements for thorough due diligence that we introduced in CRD 2. It is simply not acceptable that banks should invest in arcane structured products without understanding the risks. The people who are capable of economically analysing a CDO2 must be a rare – in my view non-existent species – certainly in respect of many asset classes. I have asked my services to ask Member State supervisors how this can be done and am still waiting for an answer. More generally, the capital requirements for re-securitisation products will be raised to reflect the additional leverage that is created by re-packaging one securitisation into another.

Second, the proposal addresses the shortcomings of the capital requirements for the trading book. Recent experience has shown us all too clearly that when times get rough the risk from the trading book is just as great as the risk from the banking book. So the capital requirements for risky trading book activities will be increased. Positions will have to be backed by capital, just as they are in the banking book.

Third, remuneration practices within banks will be brought under the supervisory spotlight. We are all aware of the public anger at bloated pay packages for short term financial success based on excessive risk taking, and the outrage at huge personal rewards for institutional failure. There is now international consensus that this situation cannot continue. And in the EU we have already set the ball rolling with the proposals in CRD 3. Banks will be required to have sound remuneration policies that comply with balanced principles about the calculation and payment of bonuses, or else face supervisory sanctions. I do not have a problem with good people who create value being properly rewarded. But I have a real problem if perverse incentives motivate behaviour that destroys shareholder value and leads to huge bail outs from the public purse.

CRD 3 is currently being negotiated by Member States and the Parliament. We hope for early agreement – every one agrees in principle that these measures are needed.

And finally, we are looking forward to a possible CRD 4. One of the ideas we are exploring is 'dynamic provisioning': the requirement for banks to build up extra reserves when times are good to help them survive the lean periods. We all know that the Spanish already required this, and that their banks have been better able to withstand the shocks that have shaken the global banking system. We need to find ways of taming the procyclical tendencies of our capital requirements, and this is one of the possibilities we are exploring.

We are also considering further measures to help constrain the build-up of leverage in the banking sector, supplementing the present risk-based capital requirements. The risk sensitive approach of Basel 2 was an advance on Basel 1, but there is also a strong argument for a simple approach that cuts through the complexity and gets to the heart of the matter. A simple metric - such as a leverage ratio – could be a valuable additional measure for determining acceptable levels of risk. Of course, this work will need to progress in tandem with the efforts at G20 i level and we need to be conscious of any potential unintended adverse consequences.

So do all these changes mean that we got it wrong with the CRD? I would say yes. Improvements were certainly needed. Some weaknesses were highlighted by the crisis. Others represented unfinished business and were in the pipeline anyway. While the regulatory shortcomings in Basel 2 – implemented in the EU by the CRD – were not the cause of the crisis they did not help. I would also stress that I believe it is in accord with good practice that when officials or supervisors have spent too long on a particular project – as some have on Basel 2– it is time for them to move on and for fresh eyes to be brought to bear on the problems. .

Financial regulation needs to ensure sound prudential standards and investor protection without unduly fettering business and stifling innovation. This is a very difficult balance to strike, and the pendulum may swing too far in either direction. The outcome will never be perfect – financial markets are too complex for that. But we need to keep trying. If that means a Solvency 3 or CRD 4, 5, and 6, so be it. (Though that will not be my problem ..!)

Thank you for your attention and let me wish you an excellent evening.