Examination of Witnesses (Questions 20-39)
DR KERN
ALEXANDER, DR
JON DANIELSSON
AND PROFESSOR
RICHARD PORTES
CBE
3 NOVEMBER 2009
Q20 John Thurso: Some organisations
have told our staff that they fear the new structure will not
respect the better regulation principles, and measures will be
imposed without proper consideration of their effect on competitiveness.
Do you agree with that and, if you do, how would you want to see
them change?
Dr Alexander: First of all, the
European system of financial supervisors is decentralised; it
relies on Member State supervisors to discharge most responsibilities
and financial supervision. One of the key roles it is playing
is, each ESA publishes a rule book or a code to help provide more
harmonised and uniform practice of prudential supervision across
the European Union. I agree with the earlier comments: this is
very detailed; a lot of specifics regarding who does what in these
proposals; but that is precisely to promote accountability and
to show that the decision-making structure is accountable and
that it is transparent, regarding ESAs and their relationship
with the Member State Supervisors. I do not really think that
it deviates from any type of good practice principle.
Q21 John Thurso: Any dissent? No.
Members of the Board of Supervisors are meant to act independently,
yet decisions on technical standards and guidelines and recommendations
are being taken by qualified majority vote. Is there a contradiction
in that? Professor Portes?
Professor Portes: No, this is
absolutely standard in European Union practice. We have lived
with it for many years, and to see it extended in this way at
least there is a possibility that you might get some outcomes.
As it stands, if you go to a meeting of CESR or CEBS you say,
"What am I here for? What are they here for?"
That is one of the few new promising possibilities here, that
you might actually get these fiercely independent—jealous
of their authority—regulatory agencies to come to some common
principles that would actually be imposed on the recalcitrant
ones.
Q22 John Thurso: Given London's position
as the clear major financial centre in Europe and one of the world
leaders, is there any threat in the possibility of regulatory
decisions being taken by QMV, particularly for London and its
competitiveness?
Professor Portes: Of course, there
is always that possibility but we live with that possibility in
many areas. Again, take the Alternative Investment Funds Management
draft Directive, the original proposals are completely unacceptable
and you can see I think that we are going down the right road
that is not in the end going to be unacceptable to the City of
London, and it could not be; that is just a practical matter.
Qualified majority voting could not, in practice and in political
practice, override a really strong objection, backed up by substance,
from the most important financial centre in the European Union.
Dr Danielsson: I do worry about
that because I am looking, as I say, at the one specific area
mentioned, which is the compensation area. Clearly one gets a
sense of where they are heading, that they are looking to set
European-wide rules on systemic risk; and those rules might be
correct for European countries with small financial systems but
they might not be appropriate for London; because what constitutes
systemic risk in London may be different than in other European
countries. I could see a possible conflict between the objects
of London on the one hand and the objects of Europe on the other.
Given the fact that these proposals are so light on any detail
as to what is systemic risk or what the mandate of the report
is, it is something that does give me a worry.
Q23 John Thurso: The devil is obviously
always in the detail. Is there anything in the process? I get
the sense people agree with the principle; at what point should
we be concerned with the detail?
Dr Danielsson: I do worry about
the fact that they do already say, as I said earlier, that the
Authority may be able to take actions that require national supervisors
to apply requirements effectively. They are already assuming some
power even at this early stage. This is contradictory to some
of the statements in the document. At least those things I would
like to see clarified.
Professor Portes: How can you
clarify that further? It is a straightforward statement. Finally
somebody might be able to tell a national regulator what to do.
Again, it is very hard to see, even by a qualified majority vote,
telling our national regulator what to do—especially if
you take the matter, which seems to concern you, Jon, compensation.
We are out front in this for good or for ill. We are actually
being tougher than other jurisdictions—or going to be tougher
as things seem to be going.
Dr Alexander: The UK plays a very
important role presently in the three level three committees;
and they will continue to play a very important role in influencing
the decision-making of the European Supervisory Agencies. I cannot
imagine that they would make decisions that are directly contrary
to the views of the FSA, unless what the FSA want to do is in
direct breach of EU law of an EU Directive. Let me briefly mention
also, regarding the Systemic Risk Board it does not have legal
personality; it has got no binding power. It meets simply in a
pre-crisis situation to be involved in surveillance information
and assessment; and if there is a crisis they cannot make decisions
in a crisis because they have no legal power; but they are meant
to try to raise red flags to issue warnings and recommendations
and that is key; because in Europe the focus has always been on
Member States, by Member State Central Banks, so we have not had
enough focus on the broader European system. The ECBs played a
role recently in that; but this is an incremental step regarding
the Systemic Risk Board; and what we see on the supervisory agencies
is simply a continuation of what we had with the Lamfalussy process,
where we have got the supervisors already negotiating setting
standards, overseeing each other's implementation through peer
review, and this will be continued one step further in this framework.
Q24 Mr Plaskitt: Can I come back
to this question of emergency powers and looking at Article 10,
which is in the draft. It says that what can trigger an emergency
situation and the powers that go with it are "adverse developments".
Is it enough to rely on that?
Professor Portes: We rely on the
judgments of central bankers in these matters all the time. It
is very hard to specify in advance what the nature of any given
crisis is going to be. All crises are somewhat different. They
may have common roots in many cases but their manifestations are
always different: if it is an individual distressed financial
institution that can differ quite considerably. I think it would
be very difficult, if not impossible, to draw up any specific
guidelines for intervention. As I say, central bankers for good
or for ill have functioned in that way now since time immemorial.
Q25 Mr Plaskitt: The envisaged consequence
of triggering this is that the Commission, according to the draft
wording, can "upon its own initiative" immediately intervene.
That is a huge power. In your view, does there not need to be
some more definition about what constitutes an adverse development?
Lots of things can be an adverse development, but if that is enough
to trigger the Commission on its own initiative to make an intervention,
is that alright, in your view?
Professor Portes: What exactly
do you mean by "intervention"? You mean declaring that
there is a crisis?
Q26 Mr Plaskitt: No. What Article
10 says is the Commission can on its own initiative adopt a decision,
and the next section says that will give it the power to require
the competent authority to take a necessary action. It becomes
quite direct and quite specific as I read it; and yet it all rests
on the development of an "adverse development". Is it
not a sweeping opportunity to exercise that power?
Professor Portes: As I say, I
cannot see how you can draw more specific requirements because
of the immense diversity. If we look even at the nature of the
financial institutions that have gotten into trouble and the things
that have gotten them into trouble over the past couple of years
the range of possibilities is enormous. I could sit here as an
academic—and we academics are known for going into all sorts
of "I couldn't possibly speculate"!
Q27 Mr Plaskitt: How about there
being some indication of the potential extent of risk?
Dr Danielsson: Could I add a little
bit to this. I would agree very much with Richard. One problem
with financial regulations in general is that they tend to guard
against the previous crisis and not against the next one. There
is always a danger, if you specify a regulatory structure for
monitoring, that a reaction to whatever happened in the past creates
inflexibility in dealing with the future. Therefore I think we
do need to rely on the judgment of the central bankers to define
the sequence and therefore writing them down is not the right
way to do it.
Dr Alexander: I would say that
discretion is very important. We do not know what the source of
the next financial crisis will be. I think also there is protection
in Article 10 because the European Supervisory Authority may take
measures to require a competent authority to do something but
they have to do that on a qualified majority vote; and then the
competent authority, say it is the UK FSA, they can appeal to
a board of appeal, so there is a procedure in place. For an emergency
there is an expedited procedure for appeal. I do not think it
will get to that point. This would be unusually exceptional circumstances.
The UK FSA, in their role in influencing the European Supervisory
Authority, they are going to be right at the table and I doubt
there would be a compulsory determination made against the UK
FSA or the regulator.
Q28 Mr Plaskitt: Do you think there
is enough in the draft as it is currently constituted to put in
place early warning intervention, so there is intervention before
you start hitting emergencies?
Dr Danielsson: I worry about all
these early warning mechanisms. We have been talking about early
warning mechanisms in the global financial system for the past
30-40 years and these proposals have been made and none of them
seem to work properly. With so many of the systemic events they
seem to come out of the blue. After the facts we know what happened,
but before the event we cannot identify any specific things that
might lead to a future crisis. There is also a danger in having
an early warning system like that might lead us to make a decision
which is wrong.
Q29 Mr Plaskitt: Have we been looking
for them? One of the arguments is that they were not spotted because
no-one was bothering to ask penetrating questions; everyone was
just gliding along. Have we not learnt from what has just happened
that there ought to be some questions that are periodically being
asked? Some stress testing that should be being done on a regular
basis, could that not be part of a trigger mechanism for an early
warning system?
Professor Portes: It is not that
warnings were not issued by competent international bodies—and
that is why I smile when I read paragraph 6.2 in the Impact Statement
about the tasks and powers of the SRB; it sounds exactly like
the tasks and powers of the IMF or the BIS. We have the Global
Financial Stability Report of the IMF every six months, and the
BIS Annual Report every year for quite some time was warning of
the dangers that were being created in the system, the search
for a yield, the excessive risk-taking and so on and so on; but
as Dr Danielsson said quite rightly in the event you did not know
how that was going to manifest itself. Some of us, myself included,
were wrong about the way in which those imbalances would manifest
themselves. I wrote that there were serious difficulties but I
got it wrong like most of my colleagues in how they would come
out. I think that is where with specific early warning—
Q30 Mr Plaskitt: You are saying there
is nothing in here to strengthen early warning systems in the
future?
Professor Portes: As I say, you
could write this paragraph 6.2 here and it would apply absolutely
to the IMF and the Bank for International Settlements, and they
are a reputational body with a high level composition that will
point out potential imbalances in the financial system which are
likely to increase systemic risk and so on and so forth. That
is exactly what the major international organisations did.
Q31 Mr Plaskitt: Do the other two
of you share the same view?
Dr Alexander: I would say that
there is an incremental improvement here. The European Systemic
Risk Board will be entitled to obtain information that would have
been considered confidential before from national supervisors
and that will enable it to conduct, I think, more effective surveillance.
Many Member State national supervisors would not disclose information
either for proprietary reasons or for other reasons, including
embarrassment, to the ECB, and so now we have a framework set
up where any national legal restriction on the disclosure of information
is going to be amended and Member State supervisors shall share
information with the Systemic Risk Board and also the European
Supervisory Authorities. I am not going to say that is foolproof
prevention for a future crisis but I think that is an important
step, to link up macro-prudential oversight with micro-prudential
supervision.
Q32 Mr Love: Dr Alexander, earlier
on in an answer to Mr Fallon you indicated that in your view the
regulations ensured that the decisions made do not impinge on
the fiscal responsibility of Member States. Would you accept that
that is not a confidence that others share?
Dr Alexander: Right now there
is no legal requirement that a state bail out a bank because of
a decision made by the European Systemic Risk Board. There is
no legal obligation to do that in the current proposal, if we
are in a crisis, for instance. That would have to be a decision
made at ECOFIN and the Council of Ministers as a finance ministry
decision, so I just do not share that concern. I think there are
other concerns that we might talk about regarding these proposals.
Out in the future there could be burden sharing arrangements introduced
and agreed to by all Member States regarding how we might respond
in a crisis, and that is something that needs to be addressed
in the future. Also, how do we bail out cross-border banks that
are viewed to be too big to fail? The Commission has now got a
consultation paper; last month they proposed on that, so I think
these are discussions that we need to keep having in the future
but presently there is no legal obligation for a state to use
taxpayer money for that.
Q33 Mr Love: What has been said to
us is that there is a safeguard clause related to Articles 10
and 11 but not in relation to Article 21 and therefore it is open
that a decision made by the Systemic Risk Board could trigger
the need for fiscal intervention in a Member State. Do you not
accept that?
Dr Alexander: The Systemic Risk
Board cannot make that decision. They can make a recommendation
to ECOFIN and the Council of Ministers, so it goes up the political
chain.
Q34 Mr Love: Let me pose it to you
another way. They may make a judgment. That judgment is then leaked.
There is then a run on a financial institution that triggers a
fiscal intervention. Is that not a possibility, what could happen
in any of the circumstances that we are talking about?
Dr Alexander: The European Systemic
Risk Board can issue warnings, recommendations, and these all
have to be acted on. They are not legally binding decisions, and
that is their role, to point out problems, red flags, certain
developments in the financial system. It has no power to compel
a Member State to use taxpayer money to bail a bank out or subsidise
it directly. It might say that the European supervisory agencies
can make decisions that are legally binding by qualified majority
voting which may have indirectly a fiscal impact. It might require
that supervisors perform more active supervision at the local
level which is going to involve taxpayer money probably, certainly
indirectly, but regarding a bank bail-out during a crisis, there
is nothing legally binding in that area.
Professor Portes: If you go down
that road you might as well try to muzzle Robert Peston, that
is to say, yes, anybody saying an institution is in trouble, better
do something about it, can provoke a run; that is absolutely standard.
There is not much you can do about that. There is no authority
here, however. Dr Alexander is perfectly right—there is
no authority here and I do not know who is maintaining that there
might be some hidden authority. If so, it is hidden awfully well.
I just do not believe this. It is quite explicit that there shall
be no such powers.
Q35 Mr Love: Is it appropriate for
the Council of Ministers to rule on this issue by qualified majority
voting, considering the sensitivities of this as an issue?
Professor Portes: To rule on what?
To rule on imposing fiscal obligations? Again, if we did not like
what was being proposed we would invoke the standard safeguard,
which is that no external instance by qualified majority voting
or any other way can impose a fiscal obligation on the UK Treasury,
full stop.
Q36 Mr Fallon: I just want to come
back on this, Professor Portes. Article 23 does not say that.
It says that the Council considers an appeal from a Member State
and can uphold the Authority's original decision, so the safeguard
you are referring to is not in the draft.
Professor Portes: Not on fiscal
obligations. I am sorry, I do not agree; I certainly do not read
it that way, and there are enough explicit provisions in there
that say that none of these new instances can impose fiscal obligations
on Member States.
Q37 Mr Fallon: But Article 23(2)
says, "Where the Council by majority voting decides to maintain
the Authority's decision ... the suspension of that decision shall
be immediately terminated".
Professor Portes: Decision on
what?
Q38 Mr Fallon: A decision that a
Member State appeals as in terms of its fiscal responsibilities.
Professor Portes: No, I am sorry.
I do not have that passage in front of me.
Q39 Mr Fallon: Have you read Article
23?
Professor Portes: Closely, and
I cannot see any room for that interpretation.
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