From its beginning as a modest offshore market, the
international capital market with Europe at its heart
has grown into a broad and deep market of around
10 trillion serving the needs of governments,
supranationals and corporates from all over the world. From
year to year and decade to decade, the market has expanded
dynamically across all geographical and product areas. This has
helped the free movement of capital across borders and the
integration of economies, removing obstacles and building
bridges linking the different national markets together, and
enhancing structural reform and monetary integration.
Onset of financial crisis and the initial response
The dynamic development of the international capital market
and accelerated globalisation has led to ever-more complex
markets with many new asset classes. These pose market-related,
legal and practical challenges to market participants as well
as to supervisory and political authorities. Added to this has
been the experience of the international financial crisis of
the last two years. This has highlighted many respects in which
more work is needed for a robust regulatory environment,
designed to meet the challenges of today's financial market
place. The period of the crisis has been marked by massive
intervention by the financial authorities, particularly in the
US and in Europe, in an attempt to restore orderly markets
through the recapitalisation of banks; the provision of
government guarantees on interbank lending; and in some cases
government purchases of toxic assets, all accompanied by a
dramatic easing of monetary policy and selective fiscal
stimulus, country by country, but in a coordinated pattern. The
critical question continues to be whether this proves to be
sufficient to adequately revive bank lending to the private
sector, or whether further steps will be needed.
Conjunctively, in response to the crisis, the authorities
are already moving towards changes in the regulation of the
financial system. Globally, their starting point was the Group
of 20 (G20) Summit in Washington last November. This was
accompanied at European level by the February report on the
supervision of the financial system, prepared by a panel of
wise men chaired by Jacques de Larosière.
Following the subsequent G20 Summit in London on April 2,
the immediate priority remains to recover from the
international financial crisis by restoring confidence:
- There is a consensus that monetary easing and fiscal
stimulus are needed to end the global recession, though views
differ about whether enough has been done already or more
needs to be done.
- The second objective is to stabilise the financial system
through government involvement, where necessary, in
restructuring banks (by insuring or purchasing so-called
legacy assets to clean up bank balance sheets) and
recapitalising them (by providing sufficient equity to
withstand future losses if the market is not willing to
provide it), as well as by providing guarantees on future
lending until confidence is restored.
- The third objective is to devise an exit strategy through
the eventual sale of government-owned shares and tightening
monetary and fiscal policy again when economic conditions
But the longer-term issue is how to prevent another crisis
on a similar scale, in which regard the G20 work plan lays out
a lengthy list of tangible regulatory reforms. Progress reports
affirm that these are being swiftly advanced through the
ongoing efforts of various international fora, such as the IMF,
and standard setting bodies, such as the Basel Committee on
Banking Supervision. The September Pittsburgh G20 Summit
meeting continues to build on all of this. It is equally clear,
from both the de Larosière report, prepared for the
European Commission, the subsequent EU communications and
recommendations built thereon and the Turner review, prepared
for the UK Chancellor, that there will be a new approach by the
authorities in Europe working within the global context.
This will address each of financial regulation, the supervision
of financial institutions and the stability of the financial
system as a whole.
What can the market expect and what further issues need to
What can the market expect?
Details of the main elements of the new system of financial
markets regulation have not yet all been agreed, but as
things stand going into September 2009 the proposals
include the following:
- Prudential supervision will be more intrusive, in the
sense that supervisors will want to know in more detail what
is going on so that they can assess the systemic
implications, rather than, as in some countries in the past,
relying on a light-touch regime.
- There will be much more emphasis on the effective
regulation of liquidity.
- The regulation of capital adequacy will change. Banks
will in due course need more capital and of higher quality,
particularly against risk taking on the trading book (less
leverage will be permitted than in the past); and a maximum
gross leverage ratio may be imposed as a back-stop.
- A counter-cyclical capital regime is likely to be
introduced, with capital buffers being built up in good times
so they can be drawn down in difficult times.
- The authorities are seeking powers to collect information
on all significant unregulated financial institutions to
allow assessment of overall system-wide risks.
- Prudential regulation of capital and liquidity should
extend to "bank-like institutions" if they threaten
- Host supervisors are likely to rely less on home
supervisors, following the Lehman insolvency; and host
supervisors are likely to insist on having more control over
foreign branches, or to convert foreign branches into
subsidiaries, following the Landsbanki case.
- Banks are being encouraged to tie pay to long term
performance rather than short term profit where that
is not already the case.
- There is continuing pressure for more transparency
though there are many ways in which much of the financial
system is reasonably transparent already.
- Financial markets will become more resilient, for example
by increasing the role of central counterparty clearing
houses; and reducing reliance on credit rating agencies.
Delivery of European micro-prudential supervision will
remain the responsibility of national supervisors, but their
efforts will be supported both by colleges, to face the
challenges of cross-border groups, and a newly formed cohesive
body, the European System of Financial Supervision (ESFS). The
ESFS will draw upon the endeavours of three new European
Supervisory Authorities, formed through the evolution and
expansion of the three existing Level 3 committees: the
Committee of European Securities Regulators (Cesr); the
Committee of European Banking Supervisors (CEBS); and the
Committee of European Insurance and Occupational Pensions
Supervisors (CEIOPS). Flanking and supporting these revised
institutional arrangements will also be a series of
harmonisation measures, to deliver a single European rulebook;
consistency of supervisory powers; and equivalent
In addition a new European Systemic Risk Board (ESRB) will
be established. The ESRB will be established as a new
independent body, responsible for safeguarding financial
stability by conducting macro-prudential supervision at the
European level. The creation of the ESRB to work in
conjunction with the International Monetary Fund (IMF), the
Financial Stability Board (FSB) and third-country counterparts
seeks to address one of the fundamental weaknesses
highlighted by this crisis, which is the exposure of the
financial system to interconnected, complex, sectoral and
cross-sectoral systemic risks.
What further issues need to be resolved?
These proposals leave a number of important issues still to
be resolved. First, what is systemically significant?
Traditionally, there has always been an element of constructive
ambiguity about this. But since the insolvency of Lehman
Brothers, almost all significant financial institutions
and not just banks in trouble have potentially had
systemic implications: in a crisis, they are too large or too
interconnected to fail. Some part of the solution lies in
improved resolution frameworks, allowing for the orderly and
rapid administration of failing institutions, but this is
particularly challenging when faced with the complexities of
cross-border entities and the associated divergence of the
legal frameworks under which they operate.
Second, how should the authorities deal with financial
institutions that are too large to be rescued by the small
countries in which they are based? In the current crisis, as
the Governor of the Bank of England has pointed out, financial
institutions which have been global in life have become
national in death. This is a particularly difficult issue in
the case of banks operating cross-border in the euro area,
where there is a single central bank, but national ministries
of finance are the effective lenders of last resort, and it is
not agreed how the burden is to be shared between them.
Inter-related questions, such as the valuation of legacy assets
and the continued divergence in accounting standards between
the EU and the US, present further complicating issues.
Third, how can effective counter-cyclical policies be
devised to allow regulation of the growth of the financial
system? If it does become possible to rely on counter-cyclical
policy as a "third leg of the stool", alongside monetary policy
and fiscal policy, then financial crises may be less likely in
future and economic recessions less severe. But are the
authorities in practice prepared to lean against the wind in an
economic upturn? After all, some regulators and central banks
warned in advance about the risk of the current crisis (though
none foresaw its scale), but they were not able to agree on
what action to take and might have faced political resistance
had they sought to do so.
Fourth, how to marry the top-down assessment of systemic
risks with the bottom-up supervision of financial institutions?
This proves difficult enough between ministries of finance,
central banks and regulators at national level. But national
authorities cannot easily act alone, given that regulation of
the EU single market derives from European rather than national
level; and that the financial markets are global in nature.
Fifth, how quickly should proposed new regulations be
implemented? Banks may need more capital in future, but
imposing new capital requirements now is likely to limit their
ability to lend and delay the recovery.
Sixth, can the market play a role by regulating itself? The
de Larosière report draws attention to the opportunity
for the market to play such a role, so long as it implements
its own proposals and supervisors are able to verify this. The
crisis has clearly highlighted questions related to the value
of self-regulation, but it undoubtedly still has an important
role to play as an integral component within a broader
Finally, is it sufficient to assume that all financial
crises are essentially the same, or could the next one be
different? That risk is not a reason for failing to do what we
can to learn the lessons from this crisis in an attempt to make
the next one less severe than it otherwise might be.
In its activities ICMA has very often been the frontrunner
in creating the framework of cross-border issuing, trading and
investing, and has constantly helped to build the relationship
amongst all market participants. In its dual capacity as a
self-regulatory organisation and a trade association, ICMA has
initiated numerous sets of standard practices to help develop
efficient and well-functioning markets. ICMA is and always was
a strong voice, in the promotion of free capital flows across
borders and all other efforts on the long road to integrated
capital and financial markets.
In this crisis, ICMA continues to play a major role,
particularly due to its unmatched geographical and
institutional diversity. As a cross-border association, ICMA
sponsors and brings together sell and buy-side, works on the
improvement of the legal framework and continues to see its
mission to service the market as a whole. ICMA will continue to
represent general market matters and views to those monetary
and regulatory authorities vested with the responsibility to
create the appropriate framework for a national and
international financial system. In stressing that
self-regulation can help to solve problems more efficiently,
ICMA sees itself operating as a partner to these bodies.
David Hiscock joined the International Capital Market
Association (ICMA) as Senior Advisor, Regulatory Policy
in November 2008. He coordinates ICMAs policy work
on various initiatives undertaken on behalf of its
members and the international capital market,
particularly in response to current global market
Having initially qualified as a UK Chartered Accountant,
prior to this appointment Hiscock spent over 20 years at
JP Morgan, where he had a variety of roles most recently
that of Managing Director and European Head of Hybrid
International Capital Market Association (ICMA)
Tel: +44 20 7517 3220