Sharon Bowles MEP

EU financial and Economic Regulation – do they pull in the same direction?

Thank you for inviting me to speak here today and for your kind introduction.

As you mentioned, my career before politics was as a European Patent Attorney, and I recall once sending a long letter to aUSattorney on a case explaining three key points. He came back to me with the quote that "all good things come in threes -Gaul, Witches and the Trinity". These last couple of weeks you have had three good things here inIrelandwith visits from the British Queen, theUSPresident and now - I hesitate to say me - but I will suggest, my European Parliament delegation.

As chair of the European Parliament's Economic and Monetary Affairs committee I have been leading a delegation this week on a fact finding mission and have had meetings with Minister Brendan Howlin TD, the Governor of the Central Bank - Patrick Honohan, members of the special 103 committee in the Dail, and key representatives of institutions and stakeholders relevant to economic and financial matters in Ireland. Overall we are impressed, and I consider that due to its open economy, of the three countries in EU recovery programsIrelandis performing best in class.

As you know from the media coverage I have said a few things about interest rates being charged toIreland, which is a matter I have been pursuing for some time. My position is that I believe interest rates to countries in recovery programs must be sustainable because recovery is in the best interests of the Eurozone and the EU. Further, I have also said that if interest over cost is charged as a buffer in case of default, then it should be treated as a returnable deposit when there is no default, which would aid return to the capital markets.

Now, this fact finding delegation was part of the background work of the committee which covers financial services, competition, tax and economic and monetary affairs - which right now means the Euro crisis and the various surveillance measures - or economic governance as it is now called - that aim to keep Member States on track with their obligations. In fact all areas of our work are running at a high pace and we have something like 10 times the workload of during the last mandate.

The two areas of greatest activity are financial services and economic governance. These are dealt with by separate parts of the commission - financial services is part of the Internal Market and comes under Commissioner Barnier and economic governance is part of the economic and monetary affairs portfolio under Commissioner Rehn. At this point in time it is quite a pity that there is not more day to day engagement between these issues, as perhaps the title of this talk indicates, or as I have recently put it they are Dr Doolittle's push me pull you which is a difficult beast to manage.

So I thought it would be interesting today to give a flavour of some of the issues that are mixed up in the push me pull you problem.

First let's have a quick look at financial services. If I were to go through everything that is lined up for legislation I'd have no speaking time left, but what is happening is that the Pittsburgh G20 agenda of 'regulating everything' is being gone through at the same time as the reviews in the original EU financial services action plan fall due.

In the realm of banking we have already addressed some of the issues that were left undone fromBasle2 and the past - matters like large interbank exposures and putting capital requirements on the trading book. It would have been helpful if they had been in place before the crisis so there would have been less bank interconnectedness and less incentive to hold risky positions on the trading book.

We also adopted the 'skin in the game' principle for securitisations - the slice and dice and sell on procedure that spread sub-prime mortgage problems around the world - so that issuers of securitisations had to retain 5% of what they issued. This was a highly political move and done in some haste as a signal of earnestness about safety. Unfortunately it was not done in a way that took enough account of the different types of securitisation and lost sight of the fact that securitisation is not all bad as long as you know what is going on. This is now having a depressing effect on recovery of the good securitisation market, in particular for long term investment where the yield is low.

Following on we have the emergence of the new internationally negotiated capital rules of Basle 3 which will be enacted for the EU in CRD4 - and which features on the front page of today's Financial Times with fears theEuropemight go soft. I have to admit this is a fear I share, but I also have had problems with some ofBasle3. A lot of emphasis has been put not just on more capital in banks but on its liquidity. Initially the suggestion was that 100% of core capital should be sovereign debt. Along with others I thought that was totally stupid and was relieved when that was changed so that up to 40% can be held in high quality corporate bonds. But overall the new arrangements are acknowledged as taking banks out of the game for long term investment.

This has been recognised by the Commission and just a few weeks ago Commissioner Rehn launched a consultation of project bonds saying "there is drying up of project finance through banks" and put forward proposals to use the EU budget and EIB as a way to front load returns for long term infrastructure bonds aimed particularly at institutional investors such as insurers and pension funds.

While I was able to confirm to the Commission in my keynote speech at the consultation that the European Parliament was behind such an approach in principle, it unfortunately fell to me to explain that it was not quite as simple as they outlined and the phrase that sprang from my lips was 'read our financial markets regulation agenda and weep'. The reason I said this was because of the sameness of our prudential regulations across sectors, one of the issues I had been berating finance ministers and central bank governors with at the informal ECOFIN the previous week.

True the commission had spotted the problem ofBasle3 removing banks from the long term investment picture, but they had not noticed that the insurance directive Solvency 2 created similar problems and we already have the fact that insurance companies are bailing out of equities and corporate bonds because of a similar emphasis on liquidity. Coming down the track we have revision of the occupational pension's regulation where there is pressure for more of the same ideology, and other asset managers are also caught up due to the Alternative Investment Fund Managers Directive.

There was this ongoing implication in the Commission proposal that insurers and others would buy things that were in a project bond wrapper - just like they used to with securitisations plus monoline insurance - blissfully unaware that regulation from another part of the commission meant that all kinds of retention and due diligence requirements had been pasted into every sector of regulation.

Meanwhile other costs for investors piled on through the regulations on derivatives, collateral posting and hedging also present challenges and detract from long term investment. For good measure I also reminded them about the lack of business model approach in accounting standards which did not treat making loans and collecting interest as different from trading in loans that required mark to market.

There was other stuff too about reliance on ratings, liquidity and correlation that I mentioned and by then there were glum faces from the Commission, but relieved faces from investors who told me afterwards they had been trying to explain their problems but were being met with some disbelief.

I like to think I was being cruel to be kind and there has been some change in rhetoric since then. The very next week I spoke at the Financial Stability and Integration Conference and was on a panel that included Commissioner Barnier and Mario Draghi. We had all been together at the informal ECOFIN and other places too so I think they knew some of my points and Michel Barnier said he was going to look more at growth and the interaction with regulation and Mario Draghi said that while he did not see how we could back off from the internationally agreed Basle 3, he did not think all sectors had to take the same approach.

Of course the crisis did bring with it a recognition of the interconnection between the macroeconomic and micro prudential, but until now legislators focus has been all one way - seeking financial stability through micro prudential regulation and keeping watch at the macro prudential level for harmful things like asset bubbles and build up of undesirables - whatever that might turn out to be. The European Systemic Risk Board, part of the new European Supervisory architecture is specifically charged with looking out for the kinds of activities or cumulative positions that might cause a problem and new legislation like that for clearing and reporting of derivatives will feed aggregate positions into that body.

Meanwhile we are also putting in place the Economic Governance Package, six pieces of legislation that keep much closer surveillance on Member States budgetary positions, monitoring the return to within the stability and growth pact and - in the future - giving tools for earlier prevention. This is yet another set of rules that will certainly help in making it less likely that we fall into the same kind of hole again, will monitor whether or how we get out of the current hole but it does not of itself lift us out.

So the next step is to look for the way to get out of the hole and make sure we are not still digging.

The crisis has had three phases - the financial crisis, the economic crisis and the sovereign crisis and it seems to me that in response we must also seek three things: stability, integration and growth. Two out of three will not do.

Plenty of work has been addressed to stability when it comes to prudential regulation.

Better integration is a requirement forEurope's place in the global market but the EU still lags on competitiveness in several areas because we have not properly integrated our own single market in financial services. If we are not careful some of our new regulation will bring more near monopolies and stifle competition, while others seek ring fencing solutions in preference to tackling the elephant in the room of proper cross border crisis resolution and insolvency regimes.

Growth is what will get us out of the hole, but it will be lost if we get the balance of measures aimed at stability and integration wrong - and the current economic and sovereign situation demonstrates that we ignore the connection at our peril. And one of the essential elements for stable growth is long term investment.

So as far as I am concerned the top agenda item now is long term investment for both infrastructure and other aspects of the real economy.

By no means am I saying we have to turn from a proper financial regulation agenda - but achieving growth and taking that into consideration is a 'right now' issue that must be integrated into our regulatory deliberations. If it is done as an afterthought or on the hoof with last minute exemptions the chances are it will sow the seeds of the next round of problems.

We already have experience of unintended consequences of regulation. I have already alluded to is the sameness of prudential regulation over different sectors and in particular the concentration on sovereign debt for liquidity. The sovereign debt crisis makes one question this in various ways, will it be as liquid in the future, should we even be encouraging it anyway and is there enough to go round if banks, insurance companies and clearing houses and central counterparties are all driven towards it? Will this emphasis on sovereign debt perpetuate erroneous assumptions such as zero risk weighting for sovereign debt within a currency union when you can not print your own money? What has happened to diversity?

It all looks rather like a congested motorway where a single accident brings it to a standstill and all the relief roads have been legislatively blocked off. To me that is a systemic risk and just what we are supposed to be avoiding.

So it is good that in these last few weeks some realisation is dawning and that the dangers of sameness may also have started to be recognised. However that has yet to materialise in the drawing up of legislation.

To finish I will mention a few places where I have tried to help things along.

For example, I return to the issue of zero risk weighting on sovereign bonds. This comes fromBasle, and is really based on the assumption that there is no nominal risk because you can always print money. In a currency union this falls down and the presence of this flaw in our banking regulation created some perverse incentives during the crisis for banks to purchase higher yielding sovereign bonds, and long before the crisis contributed to the market slumber where there were narrower bond spreads than there should have been, and so no corrective discipline on sovereigns.

This should be corrected in CRD4 in my view. But also more interestingly, we can look at using the risk weighting as a tool for macroeconomic discipline. Unfortunately this is another of those matters that will be of more use in the future than now, because to change it now would be pro-cyclical. However it is now that we are doing economic governance legislation and in the parliament texts my amendments have been voted through suggesting use of varying risk weighting as a macroeconomic tool. It could for example be used as an alternative or addition to fines deployed at a warning stage for the stability and growth pact or for macroeconomic imbalances. My bet is that the potential for such measures would keep the markets on their toes, probably meaning they would never need to be used because market discipline can be faster and more effective than any fine that the Council would ever impose.

On the matter of integration, as I have said, we must not lose competition. A lot has been said about race to the bottom in standards and quite rightly attention had been given to setting appropriate standards, but that does not mean eliminating competition. Competition is essential to avoid complacency; it promotes choice which leads to diversity and liquidity. We have several pieces of legislation where it is essential to bear this in mind - in the derivatives legislation, in the review of MiFID - the Markets in Financial Instruments Directive and in clearing and settlement. It would be wrong to reckon that open market principles will win the day without a fight.

It is permanently necessary to remind that the benefits of the single market must be seen in the context of the external competitiveness of the EU, not simply as an internal club. I know thatIrelandunderstands this as an open economy but not all Member States are of the same view. Indeed, you can tell the mindset from whether the expression 'single market' is used, which usually means the external competitiveness dimension is well understood, or whether the choice of phrase is 'internal market' where the emphasis is more often on the level playing field within, and - dare I say it - protectionist tendencies on the external front.

The Commission recently had a consultation on the revival of Single Market, following on from the report by Mario Monti, and I remember looks of both alarm then delight when I said that adhering to single market principles should be an integral part of economic governance and I would be looking for ways to make this specific in the legislation. So I was also very pleased when subsequently the 'competitiveness' part of the Eurozone pact developed into a more comprehensive statement of pursuing completion of the single market. However, just in case - because the Parliament does not trust the intergovernmental procedures - there are several places where the Parliament has embedded the single market principle in its economic governance amendments.

So, these are just some of the issues that we are facing. Perhaps the message is that we live in push me pull you times - not just in regulation versus growth but also in the austerity versus stimulation debate, similarly linked to the search for growth. Maybe lateral thinking and learning to step sideways was never more needed - more progress may be made by teaching the push me pull you beast to walk sideways.