GIVEN its history of financial meltdown and subsequent recovery, Sweden, which assumed the presidency of the European Union on July 1st, is the ideal country to orchestrate the reform of Europe’s financial landscape. Its reputation for levelheadedness will come in handy too. The EU remains riven by two deep divides on the regulation of finance.
The first is an ideological one over the degree of freedom that should be afforded to markets. It pits a weakened and distracted Britain, whose appeal as a financial centre in less troubled times was enhanced by its “light-touch” regulation, against countries such as France and Germany, which feel their long-standing distrust of freewheeling markets has been vindicated.
“There is a large body of people who say that the Anglo-Saxon model has failed,” says a person involved in the new regulations. “Now they see the chance to bury it.” Tougher regulations may also peg London back in its rivalry with other European centres such as Frankfurt or Paris.
The second divide is between countries that want large cross-border banks to be overseen by a single European supervisor and those that want them to stay under the control of home regulators. The question of who is in charge cuts to the heart of Europe’s problems. Its banks operate in a largely borderless market but are often closely watched only at home.
The opening shots on supervision were fired on June 18th and 19th when European leaders agreed to establish a European Systemic Risk Board, which is intended to sound the alarm over the build-up of risk, and to create new European supervisory authorities to keep an eye on big cross-border financial institutions. The promise to create new European authorities was hailed by proponents of centralised regulation as a victory over Britain. Nicolas Sarkozy, the French president, called Britain’s agreement to their establishment a “complete change in Anglo-Saxon strategy” on financial regulation.
The new structures may not live up to his expectations. The risk board, for instance, has only the power of its voice. In good times its warnings may well be ignored and during a crisis it may have to hold its tongue for fear of sparking panic. Moreover, it seems likely to duplicate work being done globally by the newly christened Financial Stability Board, an international body which held its first meeting on June 26th and 27th.
The new supervisory authorities are also hamstrung. They cannot compel countries to do anything that might cost money (“burden sharing” in the jargon), such as propping up banks with more capital. Nor can they wind up cross-border banks in an orderly way to ensure that all depositors are protected, something that is needed to stop countries from simply grabbing what assets they can when big banks fail. The danger is that national supervisors in Europe could well end up ignoring the new authorities and erecting barriers to foreign banks instead. “If we stick with national supervision we will end up with national banks,” says Dirk Schoenmaker of the Duisenberg school of finance.
The other major regulatory proposal to have come out of Europe recently inspires even less confidence. The commission has proposed heavy-handed regulation of hedge funds and private-equity firms. The principle of bringing all important institutions into a regulatory net is sound. But the directive clumsily lumps together hedge funds and private-equity firms when imposing disclosure rules and limits on borrowing. The Swedes are well aware of the problems and are likely to ensure that what eventually emerges is acceptable for both industries. Yet the focus on alternative-investment managers, which played a small role in contributing to the financial crisis, suggests that rules are being drawn up to satisfy domestic audiences.
There is another danger. In general the wheels of European policy turn slowly. Proposals on the central clearing of derivatives and bankers’ pay, among others, have been twice delayed in recent weeks and are now expected to emerge later this month. Revisions to rules that will force banks to hold more capital will not be released for months and certainly not agreed before next year. Yet by the time Europe has agreed on a set of common rules, many countries will have already revamped their own.
Britain’s Financial Services Authority, for instance, has already proposed measures to force subsidiaries of big banks operating in Britain to hold more capital. It also wants to use a loophole in European law that gives it the power to impose liquidity requirements on the local branches of banks from elsewhere in Europe. These are moves that appear to undermine the principle of Europe’s single market in banking.
National governments have bailed out their banks in exchange for an explicit or unspoken promise to keep up lending to small businesses in their home markets (although some have supported continued lending in troubled eastern European and Baltic countries). The European Commission’s competition watchdog, which is policing the aid, also appears to be contributing to fragmentation, albeit unwittingly. Axel Weber, the president of the Bundesbank, Germany’s central bank, recently complained that it was forcing banks to focus their lending and borrowing in their home markets, a charge the commission has hotly denied. Those most keen to reform European finance may yet find their principal sin is tardiness. For even as they write new rules, the market they want to regulate is fragmenting before their eyes.