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Analysis

Financial Markets: Something Significant or Status Quo?

Lida Preyma,
Director, Capital Markets Research, G20 Research Group, and author, The Preyma Report
June 26, 2012

The meeting of G20 leaders in Los Cabos, Mexico, on June 18-19, 2012, saw temperatures that were hot and temperaments that were even hotter. Once again, Greece and the troubled European Union were centre stage. To the collective sigh of relief by the global capital markets, pro-austerity Antonis Samaras, leader of the New Democracy party, won the Greek election. This calmed the speculation that Greece had one foot out the door of the EU.

The tone for the Los Cabos Summit was set at a press conference before it began, where European Commission president José Manuel Barroso responded to a question by a Canadian reporter asking him to sell why North Americans should provide funding to Europe when it had enough money to solve its own problem. Barroso replied that the debt crisis had not, in fact, started in Europe. The crisis had spread from "unorthodox practices" in North America and that the Europeans were not there to learn any lessons from the North Americans. They were going to solve their own problem, said Barroso, but democracies take time to sort things out due to their very nature.

The definitive commitments made by the G20 leaders to solve the crisis came with the euro area members committing to take all necessary measures to safeguard the integrity of the area, improve the functioning of financial markets and break the feedback loop between sovereigns and banks. This would set the stage for the EU summit scheduled for June 28-29 as the euro area leaders (supported by the rest of the G20) pledged to adopt the Fiscal Compact — a treaty signed by all but two EU members, to enter into force on January 1, 2013 — and its ongoing implementation, together with growth-enhancing fiscal and economic integration that will lead to sustained borrowing costs. This is most crucial for Spain and Italy, where bond yields have increased to unsustainable levels in recent weeks.

In an attempt to stem the current banking crisis, the G20 leaders supported the euro area’s intention to consider a more integrated financial architecture encompassing banking supervision, resolution and recapitalization, and deposit insurance. To move away from austerity and spur growth, they supported a more meaningful economic and monetary union in the EU and the growth measures being considered, which include making better use of the European Investment Bank (EIB), pilot project bonds, and structural and cohesion funds. These measures would allow for more targeted investment, employment, growth and competitiveness while maintaining the firm commitment to implement fiscal consolidation to be assessed on a structural basis. In this way Europe can finally stabilize, come out of recession and begin its recovery. A country cannot be choked by austerity and be expected to grow without any measures to make up for the loss in revenue from the cutbacks. The leaders’ confirmation of these commitments in front of their peers would ensure a successful EU summit in less than two weeks after the Los Cabos Summit — time that markets need to restore some calm and order.

To strengthen the global firewall, at Los Cabos the leaders committed more money to the International Monetary Fund (IMF) than had been anticipated. They agreed that the current surveillance framework should be significantly enhanced through better integration of bilateral and multilateral surveillance with a focus on global, domestic and financial stability, including spillovers from domestic policies. These two components are most important to stabilize the global economic issues facing countries. The IMF received $456 billion from member countries that contributed relative to their weight within the IMF. The emerging markets of Brazil, Russia and India all contributed $10 billion, with the condition that changes to the quota system be implemented. China, which originally pledged $60 billion, instead gave $43 billion. Although the total contribution increased from the amount pledged in April 2012, it was a long way from the $500 billion originally requested by the IMF to secure its crisis intervention funding needed for the spillover effects of the European sovereign debt crisis in emerging markets. Notably missing were contributions from Canada and the United States, which have long stated that Europe has the means within its borders to contain the crisis (even though the contributions to the IMF are not earmarked for any region in particular).

With respect to financial regulatory reform, not much new came out of the Los Cabos Summit. The leaders reaffirmed their commitment to reforming over-the-counter derivatives. All contracts should be reported to trade repositories and non-centrally cleared contracts should be subject to higher capital requirements by the end of 2012. To avoid regulatory arbitrage, the next step is to have international margin standards also by the end of 2012 to match the implementation deadline of reforms.

The leaders received progress reports on Basel III and executive compensation standards. Basel III begins on January 1, 2013. Its increased capital requirements on banks have encouraged great deleveraging and a decrease in available credit. According to the Bank of International Settlements (BIS), which released a progress report in the spring 2012, Argentina, Indonesia, Mexico, Russia, the United States and Turkey have yet even to implement Basel II. The next six months will see these six countries going to market to increase bank capital in order to comply with Basel III’s requirements. This will create an even greater credit squeeze and banking crisis — the beginnings of which can be seen in Spain, which had to ask for bank bailouts in order to meet the 9% capital requirement set by the European Banking Authority (EBA) by the end of June. The deleveraging also feeds directly into the shadow banking sector as buyers must be found for the assets that the banks are selling. The Financial Stability Board (FSB) is compiling recommendations in this sector, which will not be reviewed until November 2012 at the meeting of G20 finance ministers and central bank governors.

To further the work already done on global systemically important financial institutions (G-SIFIs), the G20 leaders tasked the FSB, together with the International Association of Insurance Supervisors (IAIS), to complete their work on identification and policy measures for global systemically important insurers by April 2013. Likewise, the FSB and the International Organization of Securities Commissions (IOSCO) will look at methodologies for identifying non-bank entities as well as important market infrastructures by the end of 2012. Any area in the financial industry that is globally important and interconnected will fall under the heading of systemically important and will have greater regulatory impositions placed upon it in order to manage contagion in a future crisis. Recognizing that some banks are not global in nature but their failure would have dire domestic consequences, the leaders have asked their finance ministers and central bank governors to recommend principles for a common framework for identifying domestic systemically important banks (D-SIBs) and any relevant policy measures, which they will review at their November meeting.

IOSCO presented the G20 leaders with a report on the functioning of the credit default swap market and, in turn, they asked IOSCO to report the next steps at the November meeting of the finance ministers and central bank governors.

Clearly, the agenda for the ministerial meeting in November is already packed with regulatory items. It is evident that the eight months between the Cannes Summit in November 2011 and the Los Cabos Summit in June 2012 was not long enough to complete the work needed. It is no coincidence that the G20 finance ministers and central bank governors have a meeting planned exactly one year after Cannes. Changing the global regulatory landscape takes time. As different countries are at different stages of either recovery or crisis, there is no single unifying crisis point that predicates meeting more frequently than annually. For now, it seems to be the status quo. Those guidelines, recommendations and clarity that will come in November will prove to be something significant.

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