Abstract
The author argues that over the past few months, the political centre-right has become the most credible option in regards to future economic reforms. The proposed framework which balances competitiveness with rules to protect European citizens, while at the same time maintaining the core values of freedom and responsibility, is the best recipe for an effective economic recovery. The author underlines the importance of facing this first global economic crisis by adapting our values to the new era, suggesting that although faced by difficult times, the world has been offered powerful incentives to change. He argues that the single market is part of the solution and not the problem in this financial crisis. Only by working together, yet respecting the rules of subsidiarity at all times and avoiding protectionism at all costs, will the EU both overcome the recession and ensure that a similar situation will never happen again.
2009 will be remembered as the year of a worldwide recession which started with the collapse of a bank in the summer of 2008. All of a sudden people we knew, or even our own finances, were affected by the bankruptcy of Lehman Brothers and the general state of the banking sector. By now, many of us are feeling the effects of the recession.
However, 2009 should also be remembered as the year in which the solutions to the first global financial crisis were found. A crisis is one of the most powerful incentives for change. Europe and the world are seeing a dramatic change, a revolution of ideas similar to that which happened after 1929, when the Great Depression began, or of 1973, the year of the first oil shock. However, today's world looks quite different than it did before–-there is now a level of interconnection nobody could have dreamt of only a generation ago. Numerous experts are trying to find parallels with the past and the right approach, but it looks very much as if the current crisis is unprecedented and there is no easy fix available.
The crisis is the biggest challenge of our time, a challenge for the whole of society, for every single citizen and of course also for governments and the political class in general. These all have a duty to act. But how can we find the right approach? And in view of the upcoming European Parliament elections, what are the values we defend on behalf of our citizens in the face of grim reality? In general terms, one could say that some questions may lead to possible answers: Will stimulus plans only be burdens for future generations? What is the cost of non-action? And what is the result? Which measures are compatible with the single market and which have the best return? As the European political family of the centre-right, we have certain clear principles. I will come to those in the second part of this article.
If we want to draw a lesson from the beginning of the crisis until now, it is that problems can only be solved by working together. The reactions of the governments in the 1930s and 1970s were mainly to work against each other. Today, almost all countries in the world have been affected in the same way and they realise the extent of their interconnection. This gives reason for hope.
The European reaction
The quick reaction of the European Union under the French Presidency to the financial crisis in the second half of 2008 has greatly contributed to stability. The rest of the world witnessed the EU as a strong and credible global actor. The Member States acted immediately and with unity, which prevented financial catastrophes in the EU comparable to the bankruptcy of the Lehman Brothers. ‘Unity, Rapidity and Complex Actions’ was the motto of the moment. And that was exactly the right reaction at the time. In addition, the stability of the euro was a great asset, one which the EU can be proud of and which helped to prevent worse situations from developing in some European countries.
To counter the imminent threats of the crisis, the EU Member States decided in a coordinated way to guarantee the bank deposits of their citizens, to recapitalise banks at risk and to inject liquidity. This helped to avoid chain reactions with unforeseeable consequences.
Indeed, during the French Presidency we saw the beginning of a politically strong Union and the effects this had on other global partners. The French EU Presidency was also able to rally all Member States behind common approaches in other fields. I refer to the conflict between Russia and Georgia, as well as the decisions on common action to fight climate change as two important examples. In fact, in the field of climate change, the EU confirmed its role as a world leader, its willingness to move on and its intention to reconcile concerns about the economy with those about the environment. I would go as far as to say that Nicolas Sarkozy showed clear political action according to the principles of the centre-right forces in Europe.
Thanks to the French Presidency, we have understood the need for a European Union which is united, efficient in its decision-making mechanisms and politically stable. And to the eurosceptics I would like to say: yes, it is important that the European Union does not interfere in issues which are better placed under the competence of the Member States. This is the principle of subsidiarity, which our political family has always stood for and will continue to defend. And I do not deny that there are regulatory excesses on the part of the European Commission.
However, in the political arena, which is so complex that a common approach is needed, we still need more of Europe. If we go back to the nation states, as some would like to see, we would go back to the nineteenth century and we would be caught between existing and emerging global players.
The political centre-right in Europe–-what do we stand for?
In my view, the last months have shown that our European model of society, namely the social market economy, represents the only viable form. This system, which marries free market forces to solidarity and social cohesion in a sustainable form, has proven its worth over the past decades. Names like Monnet, Sturzo or Erhard, great politicians from our political family, are closely connected to this approach. We want a level playing field with enough competitiveness to ensure best practices but also with enough rules to protect our citizens.
We stand for clear values, not only as a general framework but also and very concretely for the economic sector. As a part of society, the economy needs to follow the very same values on which our societies are built: freedom and responsibility are two sides of the same coin. And this is the model of society we want to keep for the future.
I would like to present some of the priorities of the EPP-ED Group in the European Parliament in view of further action needed to tackle the financial and economic crisis, which will hold us in its grip for some time to come.
First of all, our priorities should remain focused. Measures that will yield long-term results and lay the foundations for genuine economic recovery are the only real solution. We have to safeguard state aid rules, and fair market competition should be central. The single market is part of the solution, not part of the problem, and should be protected as fiercely as possible.
We should take the lead in fighting protectionism and defending solidarity among Member States. Let me take the example of the European auto industry. It would lead to a large distortion of the single market if some countries were to put protection mechanisms in place and take individual decisions. However, a healthy level of coordination with regards to the European auto industry as a whole could be helpful. A crucial factor within the EU in general is the coordination of measures. European strength heavily depends on doing things together.
As the political party which advocated the creation of the European stability and Growth pact before the euro came into force, we deem it imperative to keep a tight control over public finances. Financial stability is essential to prevent the current situation from spinning out of control. The stability and growth pact in its existing form allows for all recovery measures. Reducing deficits in boom times is clearly in line with stimulating the economy during a recession. The needed flexibility exists, but great care should be given to the need to bring deficits back to zero as soon as possible after the recession is over.
Furthermore, small and medium enterprises are the powerhouses in Europe as far as the creation of jobs and growth go. My message to the EU Member States is that in the short and medium term, red tape for SMEs has to be reduced and faster access to new technologies be made possible. At the present moment, it is of the utmost importance that SMEs receive easier and faster access to liquidity. The liquidity obtained by public funding as well as through reduced interest rates has to be passed on to companies as soon as possible.
Indeed, the restoration of the credit market is an essential condition for ensuring that economies start functioning again. The importance of the banks in alleviating the economic crisis is a central issue, as is the importance of the inter-banking market and the restoration of trust. The European Central Bank has a key role to play in facing the crisis. I encourage the ECB to continue its efforts to restore liquidity in the banking sector using all the tools at its disposal. One aspect that has to be considered is that those banks which created the crisis in the first place should not benefit indirectly from public money, where bad assets may regain worth. Mechanisms have to be found so that this money flows back to the public.
Of course, we should not forget that the financial and economic crisis has led to a severe social problem within our societies. Softening the impact of this crisis on the most vulnerable has to be a primary objective. The need for solidarity should exist not only among the Member States of the European Union but also within each society. Additionally, we should not forget that a crisis can also be an opportunity. The current financial and economic crisis has ended a system of greed and opened a window on real values.
This present world did not exist five years ago. The intensity of changes occurring over the last few years has created a totally new framework. This is the main difficulty–-many changes but without the necessary adaptation of the government structures. We are facing the first crisis of the global world. Under these circumstances, we must adapt our values to the new era. Huge emphasis must be placed in finding global responses. In this respect, the decisions of EU leaders to push regulation on financial services is an important step in the right direction. (Berlin, 22 February 2009, meeting of the European G-20 nations in preparation for a common position for the next G-20 Summit).
European legislation to prevent similar crises in the future
While concrete stimulation packages as well as financial and liquidity aid can only be given by Member States, the European Union's strength now lies in a coordinated approach to trigger leverage effects and in new control instruments for the financial markets.
The European Parliament wants to pass a legislative package in a first-reading decision before the end of the legislative term. It will be of the utmost importance for the control of the financial markets. The package covers capital requirements, regulation for credit rating agencies as well as solvency law. A second package of the same kind, concerning better transparency in the financial markets, will be submitted by the European Commission in March/April of this year. It will be an important task for the new parliament that is to be elected in June.
An overview of the reports
Credit rating agencies
The current crisis has revealed weaknesses in the methods and models used by credit rating agencies. One reason for this may be that credit rating agencies operate in an oligopolistic market that offers limited incentives to compete on the basis of the quality of ratings produced. The poor quality of ratings of structured finance instruments has considerably contributed to the current crisis. In addition, shortcomings in communication between agencies and users of credit ratings became evident. As a result, market participants’ confidence in the performance of credit rating agencies and in the reliability of ratings has suffered. Self-regulation based on voluntary compliance with the International Organization of Securities Commissions (IOSCO) code does not appear to offer an adequate, reliable solution to the structural deficiencies of the business.
In the US, where most of the credit rating agencies with significant EU activities have their parent companies, credit rating agencies have been subject to regulation and supervision since the summer of 2007. Given the global nature of the ratings business, it is important to level the playing field between the EU and the US by setting up a regulatory framework in the EU comparable to that applied in the US and based on the same principles. In the light of these considerations, this proposal for a regulation has four overall objectives aimed at improving the process of issuing credit ratings:
to ensure that credit rating agencies avoid conflicts of interest in the rating process or at least manage them adequately
to improve the quality of the methodologies used by credit rating agencies and the quality of ratings
to increase transparency by setting disclosure obligations for credit rating agencies; and
to ensure an efficient registration and surveillance framework, avoiding ‘forum shopping’ and regulatory arbitrage between EU jurisdictions.
Capital requirements directive
This is aimed at improving the management of large exposures: banks will be restricted from lending beyond a certain limit to any one party. As a result, in the inter-banking market, banks will not be able to lend or place money with other banks beyond a certain amount, while borrowing banks will effectively be restricted in how much and from whom they can borrow. The Commission proposes to limit all inter-bank exposures to 25% of a bank's own funds or an alternative threshold of €150 million, whichever is higher.
We require:
the establishment of colleges of supervisors to facilitate the tasks of the consolidating supervisor and host supervisors
a joint decision on two key supervisory aspects for group supervision (Pillar 2 and reporting requirements) with a final say for the consolidating supervisors, coupled with a mediation mechanism in case of disagreement
the competent authorities involved in the supervision of a group to consistently apply within a banking group the prudential requirements under the directive.
The consolidating supervisors will be required to inform the Committee of European Banking Supervisors (CEBS) on the activities of colleges in order to develop consistent approaches across colleges. Colleges will also be required for supervisors overseeing cross-border entities that do not have subsidiaries in other Member States but that do have systemically important branches.
In addition, the rights and responsibilities of the respective national supervisory authorities will be made clearer and their cooperation will become more effective. Furthermore, the quality of bank capital should be improved: there will be clear EU-wide criteria for assessing whether ‘hybrid’ capital, that is, including both equity and debt, is eligible to be counted as part of a bank's overall capital–-the amount of which determines how much the bank can lend.
Also, liquidity risk management should be improved. For banking groups that operate in several EU countries, their liquidity risk management–-how they fund their operations on a day-to-day basis–-will also be discussed and coordinated within ‘colleges of supervisors’. These provisions reflect the ongoing work of the Basel Committee on Banking Supervision and the CEBS.
Risk management for securitised products should be improved: rules on securitised debt–-the repayment of which depends on the performance of a dedicated pool of loans–-will be tightened. Originators and sponsors of the more opaque credit risk transfer instruments retain a proportion of the risk that is being transferred to investors. For this reason, originators and sponsors must retain a material share (not less than 5%) of the risks so that effectively both originators and sponsors that are regulated by this Directive and those that are not will have to retain a share of the risks for their own account. This requirement is complemented by ensuring that investors have a thorough understanding of the underlying risks and the complex structural features of what they are buying. To enable informed decisions, detailed information has to be available to investors.
Solvency 2
The main aim of the EU solvency law is to ensure that insurance undertakings are financially sound and capable of withstanding adverse events in order to protect policyholders and to guarantee a stable financial system.
This proposal contains a number of amendments of a non-substantive nature in order to improve the drafting of the proposed Directive. Articles or parts of articles that have become obsolete have been deleted. At the same time, however, a number of important new provisions have been inserted in order to modernise and update the EU solvency law. In principle, the new solvency provisions are based on, and follow, the four-level structure of the Lamfalussy financial services architecture. This will allow the new solvency regime to keep pace with future market and technological developments, as well as with international development in the accounting and (re)insurance regulation.
In essence, the new system will make possible more sophisticated solvency requirements for insurers, allowing them to guarantee that they have sufficient capital to withstand adverse events such as floods, storms or major car accidents. Under existing requirements, only insurance risks are covered. Under the new requirements, however, future insurers will be required to hold capital against market risk, credit risk and operational risks.
Insurers will also be required to focus on the active identification, measurement and management of risks and to consider any future developments such as new business plans or the possibility of catastrophic events that might affect their financial standing. Furthermore, the proposed reform will oblige insurers to assess their capital needs in light of all risks by means of the ‘Own Risk and Solvency Assessment’, while the ‘Supervisory Review Process’ or SRP will shift the focus of supervisors from compliance monitoring and capital to evaluating the risk profiles of insurers and the quality of their risk management and governance systems.
Moreover, the reform of the solvency provisions will enable insurance groups to be supervised more efficiently through a ‘group supervisor’ in the home country who would have specific responsibilities to be exercised in close cooperation with the relevant national supervisors. This would entail a more streamlined approach to supervision that recognises the economic realities of such groups. The introduction of group supervisors will ensure that group-wide risks are not overlooked as well as enabling groups to operate more efficiently, while at the same time providing policyholders with a high level of protection. Groups that are sufficiently diversified may also be allowed to lower their capital requirements under certain conditions.
The European Union has an important legislative responsibility to make sure that an economic crisis such as the one we are now experiencing never happens again.
Footnotes