Today, I attended a CMU event organised by Bruegel and HM Treasury at Westminster. The keynote address from the City Minister Harriet Baldwin was followed by a panel with market participants (the buy side – asset managers and insurers – and a credit rating agency), a Commission official and a Treasury official. The view from the government: UK a staunch supporter, celebrating the CMU as an excellent initiative of the type that Brussels and the EU should be generating more often. Having a UK Commissioner in charge of CMU clearly helps. Beyond the consensus ‘CMU is a good idea’ and between the lines, I noticed three issues.
- ‘It is our strong belief that institutional change is not required to achieve the objectives of the CMU. Single supervision would not add anything’
This is one of the sensitive points in CMU, and a lot of energy spent in documents and meetings to pretends that’s not the case. Although the Commission and several member states (see the 5 presidents report) would prefer to create a supranational regulator for integrated capital markets, UK opposes it strongly. According to this view, ESMA – the candidate for a pan-European regulator – is best placed to ensure that national regulators implement supervision effectively. In the context of the Brexit referendum, ‘the last thing we need is institutional change’ captures well the British politics of the CMU.
Is there a danger that European states repeat the pre-crisis mistakes with cross-border banking? The banking crisis demonstrated that the prevailing regulatory nationalism was ill suited to deal with the coordination issues between home and host regulators. Ask any Eastern European banking supervisor.
The pessimistic British response to this question points to the foot dragging on the institutional architecture of the Banking Union. The hesitations and compromises there are steadily eroding (market) confidence in the ability of European politicians to create strong pan-European regulatory bodies. The optimistic view is that supervisory convergence that harmonizes rules would be enough to put the CMU on strong foundations.
One of the panelists questioned the premise of the optimistic view that for a single market it is enough to have common rules (and I would add, a rather fuzzy notion of ‘convergence’). In accounting, the application of rules (international standards) is not uniform – the fragmented enforcement of rules effectively entrenches the type of cross-border barriers that CMU aims to remove. The Commission recognises the validity of this point but is prepared to put the question aside because it wishes to avoid politically divisive topics.
So instead of calibrating the regulatory architecture to integrated markets, CMU envisages as next step a comprehensive review of post-crisis regulation. Given the complaints from the industry on the post Lehman ‘regulatory tsunami’ (loud and clear at this event too), expect this ‘proportionate regulation’ agenda to accelerate the process of watering down regulation that is already unfolding.
Recall this argument when your UK pension fund with exposure to German SME securitisation takes a massive hit due to large defaults in a market illiquid during crisis. And pray that ECB has normalised ABS purchases.
- ‘CMU will not harmonize borrowing costs for SMEs until there is a mechanism for rebalancing sovereign risks in Europe’
Market participants typically focus their CMU interventions either on deploring ‘regulatory tsunamis’ or identifying CMU areas that would improve synergies of their business model. In an unusual departure from the script, one panelist sought to make constructive criticisms. And it picked the elephant in the CMU room: government bond markets.
It is surely a measure of the creative genius of European regulatory politics that a project on furthering the integration of debt markets manages to say nothing about the largest debt markets in Europe (in Eurozone, EUR 6.8 trillion out of EUR 14 trillion outstanding in August 2015). Before Lehman and the sovereign debt crisis, the European agendas for financial integration used to stress the critical role that government bond markets play in financial markets, as proxy for risk-free interest rates, benchmark and hedging instrument for positions in other fixed income markets, and reserve ‘safe’ asset. The ECB made the integration of sovereign bond markets a priority, and used its lending collateral framework to accelerate it (by treating all Euro sovereigns as identical in terms of credit risk). The 2002 Collateral Directive was designed with the same ambition in mind – to allow private financial institutions to raise funding cross-border regardless of what sovereign collateral they use.
So can we have integrated capital markets with fragmented government bond markets? One of the panelists argued that securitisation performance across countries reflects credit differences between sovereigns (the graph below, in a rather bad photo, mea culpa). So much for reviving the European securitisation market.
Yet the CMU authorities have tended to fudge this question because answers are as politically divisive as the issue of supranational regulator. If CMU was to make government bond markets a priority, what would concrete policy measures look like? Put differently, if CMU is about persuading German savers to give money to Portugese corporations without a bank in between*, what would it take to persuade that German saver to give money to the Portugese government? Or even more complicated, how much would a Portuguese SME need to pay a German saver to borrow when that saver is reluctant to lend to the Portuguese government?
Here the CMU official supporters answer the usual European way – not a priority to think about it.
- ‘ As public policy makers we have to deal with competing objectives, and balance them carefully. The FTT / CMU is a good example’
Private finance agreed that the FTT plans are at odds with CMU. Putting the FTT genie back in the bottle has been a priority, particularly for the European banking lobby**.
Yet the FTT genie has proven more resilient than many expected. Recent statements suggest a new impetus to finish negotiations, as France independently decided to extend its own FTT to intraday trades. This raises interesting questions of coordination between DG FISMA, that is designing CMU, and DG Taxud, that designed and (still) defends the FTT in the working groups of the 11 member states. The best that the former can do is to follow negotiations closely and ensure that member states are aware that the tax should minimize impact on market liquidity and NEVER EVER include the repo market.
The repo market has always enjoyed a privileged position in the minds of European regulators – particularly the ECB***. The Green Paper on CMU made some oblique references to it, stressing the importance of collateral fluidity to ensure that securitization activities can be funded in cross-border repo markets. ‘Fluid’ collateral appeals to the pre-crisis image of the repo market as an engine for financial integration that led European regulators to endorse the creation of a market architecture governed entirely by private rules. Since the crisis, we know that private architectures creates systemic vulnerabilities – this is why the FSB has identified repo markets as markets systemic to shadow banking. Yet so far the only reform European regulators are prepared to contemplate has been increased transparency of repo transactions, despite warnings from the ECB that ‘The interaction between CMU and shadow banking reform needs to be addressed. This interaction is not addressed in the Commission’s Green Paper, but it is relevant.’
The priority remains funding for SMEs. Repo, shadow banking, government bonds, and supranational regulation, are not a priority of CMU. The art of political compromise in Europe rests precisely on that ability to postpone critical questions. If we try very hard to ignore these questions they may go away.
* best translation I’ve heard of the CMU ambitions.
** the EBF response to the CMU Action Plan stresses that ‘ If European lawmakers are indeed serious about CMU, they also need to recognise the importance of liquidity in financial markets. Proposals such as the Financial Transaction Tax (FTT) and Bank Structural Reform (BSR) are at odds with the objectives of CMU. Dropping these proposals will greatly enhance the chances of success for CMU’.
*** for those interested in the FTT on repo markets, you can read more here: A step too far? The European FTT on shadow banking. Journal of European Public Policy