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Good afternoon Ladies and Gentlemen,
I am delighted to have been invited to formally open the European headquarters of Wachovia bank here in Dublin today. It is, I know, an important milestone in Wachovia's development.
I obviously was not privy to the decision making process that brought Wachovia to Dublin. But I am sure that the success of other international banks in developing successful pan-European businesses from here, the growing pool of skilled expertise in Dublin, and the favourable fiscal and regulatory environment were all important factors in the decision making process.
I am sure also that the regulatory framework we have created in Europe over the past decade will facilitate Wachovia as it moves forward to develop markets for its financial services across the Member States.
Over the past decade the financial services industry has had to put in place an expensive and extensive regulatory framework to stimulate competition, to underpin financial stability, to deliver an appropriate level of investor protection and to strengthen the integration of European markets. In most respects it has been a great success and points up the value of open consultation and principles based regulation.
But the financial turbulence of the past four months has provided salutary lessons for everyone involved in global financial markets. It is especially – indeed sometimes only - in turbulent times that regulation and its effectiveness gets tested. And we cannot, and should not, bury our heads in the sand or ignore the fact that there have been some aspects of our regulatory framework – both at Member State and European level - that are likely to need improving. There are lessons for us all. For regulators, now is a time for humility, not for ambition.
Transparency requirements have many dimensions within the financial market regulatory framework. Clearly in the aftermath of the recent financial turmoil there is a case to look at various aspects of transparency afresh. In appropriate circumstances transparency has a useful role to play; for example, when it comes to dealing with opaque financial instruments.
But I have always been of the view that when the stability of a financial institution is at risk, the situation is best resolved behind closed doors. Unfortunately, in recent weeks, gold-plated transparency rules stood in the way of the quiet resolution of a problem before it became a crisis: The result was that transparency rules that were intended to underpin investor confidence, when put to the test, actually promoted investor panic. Panic that culminated in a bank run - averted only by a central bank lifeboat which in turn spread moral hazard throughout the system. It would surely be irresponsible for regulators not to reflect on this experience and not to draw the appropriate lessons. Clearly transparency that culminates in panic, followed by a rescue, followed by the proliferation of moral hazard is transparency that we would be better off without.
The principles underlying Basel 2 have considerable merit in terms of the underlying framework that they establish for facilitating a more risk sensitised approach to capital allocation. I have however indicated before that there are certain aspects of Basel 2 that must be further developed. The recent financial turmoil presents a good opportunity to further develop the framework going forward in a way that enables more attention to be given to liquidity issues. The lessons since last summer will be useful to draw on in this regard. It is instructive to note that as recently as 25th July - just weeks before Northern Rock had to be rescued - the company was demonstrating to shareholders how the combined pillar 1 and pillar 2 capital allocations required for its mortgage lending business, together with some asset disposals, could facilitate significant share buybacks over the ensuing three years.
Since then, in the aftermath of the liquidity problems, questions have begun to be asked as to what, if any, real value can be attributed to the company's shareholder equity given the cost of liquidity to the business now. In this regard the fact that Northern Rock's stock market capitalization stood at one third of its book equity when I checked it earlier this week and represents less than 0.7% of the book value of its total assets tells its own story.
Which brings me to another contentious issue - accounting. The recent tightening in market liquidity has brought into greater focus the practical effects in times of stress of a small number of the new accounting standards on the valuation of assets – and liabilities - which produce consequences that might be considered bizarre. The move towards marking assets to market - or where the assets or contracts are opaque or illiquid - to "marking to model" is throwing up some disturbing anomalies, not least where "marking to model" can see the counterparties at both sides of a transaction booking a profit – because, as with all models, the value that comes out is a function of the assumptions that are keyed in. So perhaps it is not surprising that some have referred to this latest accounting practice as "marking to myth".
In similar vein we need to ponder further the "mark to market" convention now applied to liabilities where for example an institution whose credit risk is deteriorating - and therefore the market value of its bonds is declining - can get a boost to its net asset value by virtue of the mark to market discount on those bonds – despite the fact that the underlying liability is due to be honoured at par on maturity.
So, Ladies and Gentlemen, these are certainly issues for accounting standard setters and regulators to ponder in the time that lie ahead. But reflection and self-examination isn't just for them.
Irresponsible lending, blind investing, bad liquidity management, excessive stretching of rating agency brands, defective value at risk modelling pose questions for a much wider audience. Now that the tide has gone out, the state of undress of many participants in financial markets is there for all to see: Bare bottoms all over the place. Nobody can be proud of some of the ugliness that this credit crisis has exposed.
Clearly we would be failing in our duty – at both European and Member State level – if we did not use the fall out from the turmoil in the credit markets to review parts of our regulatory framework. I personally may have conceived very little of it; I am certainly not responsible for gold-plating any of it. But as Commissioner for the Internal Market, I am the guardian of all of it, and the step-father of some of it. And in that context I believe that a review of aspects of it is appropriate. I have warned before, however, that rushing to legislate afresh is not the sensible answer to a crisis. Some of the excesses that have happened will be self-correcting.
Take for example credit ratings: Trust in the rating agencies' stretched brands has dissipated. This is evidenced by the illiquidity and the current, apparently unprecedented discounts on much AAA rated paper now in the market. This surely tells its own story about the dissipation of trust in the AAA brand. If the credit rating agencies are to restore trust in their franchises and if their securitization rating business is to have a worthwhile future they must themselves take - and be seen to take - effective corrective action that strengthens confidence in their governance. They must create a framework where conflicts of interest are properly and more effectively managed. I have, as you know, asked CESR to report to me on their conclusions by Spring of next year. I am not going to be prescriptive at this stage. But perhaps a governance structure that involves a direct reporting line from fully ring-fenced rating assessment functions to a supervisory rating sub-committee of independent directors of the rating agency boards - on similar lines to the way the relationship between internal audit functions and audit sub-committees of boards works - might be a starting point. I hope – and expect - that the rating agencies will give serious thought to this and other ways that will help to restore trust and to do so as quickly and as effectively as possible.
When we come through tough and challenging times it is the strong who survive and the weak who go to the wall. Out of this downturn in the credit markets will come some good - and much opportunity for banks with strong franchises and that are well capitalized. I know that Wachovia is such a bank. That's why this is an opportune time for you to be embarking on the expansion path that you are announcing today. I don't doubt that you are very well placed to take your business forward in Europe, and to be as successful as you have been for more than a century in the United States.
I wish you well, and thank you very much indeed.
