Good morning Ladies and Gentlemen:
It is a pleasure to be here at the Euro Finance Week. In these turbulent times, the reflection and discussion that take place at this conference are extremely valuable.
I was invited to speak today on "Prudential supervision in an integrated market". This reference to an integrated market can no longer be assumed to be just the EU internal market. The current financial crisis has shown just how interconnected the global financial markets are. For that reason, the meeting of G20 heads of state this past weekend has been a highly significant milestone in moving towards a more appropriate financial architecture at the global level.
This leaders’ summit presented a shared understanding of the root causes of the crisis in which we currently find ourselves. Not least among these was the fact that regulators and supervisors did not fully understand the risks building up in the financial markets. They did not keep pace with financial innovation or give due attention to cross-sectoral propagation of risk. There was a lack of transparency and inadequate oversight of market players, particularly with respect to complex financial instruments. The G20 leaders also noted that the segmented nature of regulation contributed to inconsistencies, both domestically and internationally. These regulatory deficiencies contributed to the excesses in the market and ultimately resulted in severe market disruption.
At the European Commission, we support a comprehensive approach to international reform, in order to ensure that we never provoke a crisis like this again. We want to see a strengthening of international regulatory standards; international cooperation between financial supervisors; multilateral macroeconomic surveillance and crisis prevention; and a beefing up of international crisis management and resolution capacity. Both the Financial Stability Forum (on the micro-economic side) and the IMF (on the macro-economic side) should be strengthened in line with their respective expertise, and their effectiveness and their legitimacy must be improved. Also, they must be encouraged to collaborate more closely.
A strong element of the reform of the international financial architecture should be the consolidation of European representation. As one of the two biggest capital markets in the world, the EU must take a leading role in these crucial international reforms. Europe’s citizens expect no less.
We strongly endorse the principles for reform agreed at the summit. It was agreed that implemented regulation at home remains the first line of defence against market instability – but intensified international cooperation among regulators is absolutely necessary. Regulators must ensure that their actions avoid potentially adverse impacts on other countries, and support competition, dynamism, and innovation.
Within the EU, we need to do more. To go beyond these principles and turn them into immediate action. Our first priority must be to ensure the rapid adoption of the proposals on the table that will strengthen collaboration among supervisors in Europe (notably for large cross-border financial institutions). I will be speaking about the Solvency II proposal and the revision of the Capital Requirements Directive a little later. We also need to work on strengthening the cross border financial crisis resolution arrangements foreseen in the Memorandum of Understanding and Roadmaps. And we need to press on with conviction on other essential projects that will help us bring us out the other side of this crisis, such as the Single Euro Payments Area. SEPA will bring more competition into the payments market, bringing better service at better prices to consumers and businesses.
For over a year, we have been working alongside Member States to deliver the actions contained in a series of Roadmaps endorsed by the ECOFIN Council to respond, as a Community, to the crisis. In all, we have 40 measures on the Roadmap including Prudential Risk Management and Supervision, Crisis Management; and the Strengthening of Supervision and coordination.
Regulation on Credit Rating Agencies
Quite some time ago I made clear that the regulatory framework surrounding credit rating agencies needed to be changed. The Commission made its proposal for a regulation on CRAs just over a week ago. This regulation introduces a registration procedure for credit rating agencies to ensure that their credit ratings can be used by credit institutions, investment firms, insurance and assurance undertakings, collective investment schemes and pension funds within the Community. Credit rating agencies will have to comply with rigorous rules. We want to make sure that ratings are not affected by the conflicts of interest inherent to the ratings business. That credit rating agencies are vigilant as to the quality of the rating methodology and the ratings. And that they act in a transparent manner. We are also proposing that they be subject to an external surveillance regime. Of course, ratings by themselves did not cause the current financial collapse, but it is high time that we put a series of checks and balances in place to avoid some of the excesses we have seen in recent years.
Clearing house for OTC derivatives, Accounting
We need to take urgent steps to bring OTC derivative trading out from the shadows. We cannot let the OTC market continue without adequate counter party clearing. I have established a Working Party involving the industry on this issue. I plan to put a clear roadmap in place to ensure that Credit Default Swaps are cleared through a central clearing counterparty by the end of this year. More generally I also plan to have a systematic look at derivatives markets to draw on the lessons learned from the current turmoil.
Group supervision
Financial markets in the EU have integrated over the last years and we should welcome this since it brings many benefits for our citizens and businesses. But we also need to put the right supervisory structures in place for this integrated market. Where financial institutions are active across borders, it is essential that member states act in concert, not only with regard to their own interests, but acknowledging that what affects one can affect all. This is especially true when it comes to cross-border groups. Look at what happened with Fortis and Dexia! We have on the table at the moment two landmark proposals that will dramatically improve the supervision of insurance and banking in Europe. Solvency II and the revision of the Capital Requirements Directive.
CRD revision
Given the events of recent months, it is the regulatory framework for the banking sector that is uppermost in our minds. Last month, the Commission made a proposal for a revision of the Capital Requirements Directive.
This proposal recognises just how crucial it is to address the challenge of supervision in an integrated market. Two of its most important aspects relate to the establishment of Colleges of Supervisors to enhance cross border cooperation between supervisors and to the mandatory exchange of information between supervisors to help detect signs of stress. We are also imposing much clearer responsibilities on supervisors in respect of banks operating on a cross border basis. This should ensure that in each Member State where a bank has an operation it will be appropriately capitalized.
The proposals will strengthen oversight for the 40+ largest cross border banks, equipping the system to handle much more effectively the problems that could arise in the event of a cross-border banking failure.
It is vital for co-operation between supervisors to be enshrined in the regulatory framework for normal times, as well as in times of crisis. Rather than working in the sole interest of their own member state it is important that solutions for cross border groups are found in a collegial manner. The proposal on Colleges depends on co-operation and inclusion. But the arrangements need to be workable. We need to increase the stability of the system as well as the efficiency of supervisors regulating the system. Therefore, we have sought to balance inclusion and consultation with decision making powers where there is no consensus.
With regard to securitisation, we want to see rigour, discipline and risk sharing. It is important that in the "originate to distribute" model the originator and the investor, the seller and the buyer explain and understand what exactly is on offer. So the second important component of our proposal to revise the CRD relates to the due diligence that banks must perform in the analysis of risk assets that they invest in, and the net economic interest that originators of such assets must maintain in them.
One of the other main aspects of our proposal relate to placing limits on how much risk a financial institution can expose itself to with a single counterparty (the so-called "large exposures regime"). Our proposal will restrict banks in their lending to other parties, even to other banks. This may sound counter-intuitive when inter-bank lending is as slow as it now is. Of course we do not want to exacerbate the current situation, but we do want to ensure that no institution puts all its eggs in one basket. I know that some German financial institutions, particularly the smaller ones, have had concerns that a hard limit of 25% of own funds would have a disproportionate effect on them. This issue has been resolved by the inclusion in the proposal of an alternative threshold of 150 million euro applicable to these smaller institutions. You can see that we do take on board the concerns of stakeholders.
Solvency II
Although our Proposal on Solvency II was developed in quieter times, recent events only confirm the vital importance of these aims. The benefits of success will be even wider – we will set the global standards for insurance regulation – a huge prize. And one that is within our grasp.
I realise fully that the most challenging aspect of this project is the introduction of a modern regime for group supervision. Our Proposal is based on a clear and simple approach: EU groups manage themselves on an integrated basis, and supervision should therefore be organised as much as possible on the same coordinated and centralised basis.
The Proposal introduced a large number of significant improvements to the way in which supervisors involved in the supervision of a group will work. Intensive exchange of information, systematic consultation and effective coordination will take place within colleges of supervisors. It gives me great pleasure to note that these provisions have been widely welcomed.
I also decided to introduce the so-called "group support regime", for the benefit of those groups that are fully integrated. This Proposal has met with some scepticism. Some people fear that the changes proposed to the allocation of powers between the group supervisor and the local supervisors would lead to less efficient supervision and reduced protection of policyholders.
I continue to believe that these concerns are fundamentally misplaced. Recent developments on the markets have shown all too clearly that the only adequate response to more integrated markets is integrated supervision.
In the same vein, I firmly support the need for Solvency II to have a clear message on the European dimension of the mandate of national supervisors. The directive must make it clear that supervisors have a duty to foster cooperation and convergence within the EU.
De Larosière Group
The current market turmoil has thrown into sharp relief the need to have a supervisory system that corresponds to the integrated nature of EU financial markets. Next month, I will be putting forward proposals to strengthen the roles of the European Committees of Supervisors in the banking, insurance, and securities sectors.
But the current institutional set-up may not be adequate to operate in the new integrated reality. We need to think about how to achieve the right supervisory architecture in Europe – one that is suited to the realities of the single market, and in which supervisors can work together to meet the challenge of cross-border institutions. Last week, the first meeting took place of the High Level Group on Supervision chaired by Jacques de Larosière, which has been mandated to examine the possibilities for a revision of the supervisory landscape to meet these aims. This group has an intensive programme of work before delivering its recommendations at the end of February next year.
In the meantime we must make the improvements that are necessary. The colleges of supervisors set out in the CRD review and the Solvency II proposal is a pragmatic step.
So Ladies and Gentlemen, much has been done but there is more to do.
The Commission will continue to work with its global partners to bring about a new era in international cooperation and coordination among financial authorities. This is what the modern marketplace demands of us. More widely, it is not acceptable for us to simply look backwards and fix the problems of the current crisis. We also have to identify the potential sources of future instabilities and tackle them in order to put in place a robust, resilient and stable financial system.
Can we do it? To borrow a phrase from a certain President-Elect, Yes We Can!