EU Commission Proposes Stronger Financial Supervision in Europe

The European Commission yesterday put forward its framework proposal on Financial Supervision in Europe. The proposal covers a set of far-reaching reforms to the current architecture of supervisory committees, with the creation of a new European Systemic Risk Council (ESRC) and European System of Financial Supervisors (ESFS), composed of new European Supervisory Authorities. Legislation to embody these proposals will follow in the autumn and will thus be finalized under the leadership of new Commissioners who will be appointed during the summer.

With this initiative, the Commission is responding to the weaknesses identified during the financial crisis as well as to the G20 call to take action to build a stronger, more globally consistent, regulatory and supervisory system for financial services. The proposed financial supervision package involves two key elements.

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California on the Cutting Edge

Occasionally, the FRW team ventures out to take the pulse of the country on key issues coming up. Based on several days talking to journalists, business leaders, and government officials in California, we bring to our readers words of caution: the fiscal meltdown in California holds no small dangers for the recovery.

When California voters on May 19th rejected the key elements of the budget deal which averted disaster earlier in the year, top officials in Sacramento were sent back to the drawing board for an approach that will stave off a budget gap of more than 15 percent. With observers of the legislature saying that tax cuts, program cuts, and layoffs are all non-starters, where lies the answer?

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TALF -- Expanded to Include Legacy CMBS

Yesterday afternoon, the Federal Reserve announced the expansion of TALF to include "certain high-quality commercial mortgage backed securities issued before January 1, 2009 (legacy CMBS)" as eligible collateral for TALF loans. When the Fed originally announced the expansion of the program to include CMBS, it limited eligible CMBS to those issued after January 1, 2009.  Noting the CMBS market "came to a standstill in mid-2008," the Fed's move to include legacy CMBS is aimed at promoting price discovery and liquidity in the CMBS market in the hopes of reviving the market and stimulating the issuance of new CMBS. That would then enable borrowers to purchase new commercial properties or refinance existing mortgages. The TALF Terms and Conditions list the criteria for legacy CMBS to be eligible TALF collateral.  A few noteworthy ones are that legacy CMBS must be senior in payment priority to all other interests in the underlying pool of commercial mortgages; they must have at least two triple-A ratings from DBRS, Fitch Ratings, Moody's Investors Service, Realpoint, or Standard and Poor's; and they must not have a rating below triple-A from any of those rating agencies.

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A Story of a Hundred Days

In which we look back at an action-packed hundred days of change in an allegorical-ish kind of way. Please click here to read how a cast of characters who may seem very familiar has dealt with some very large-ish problems.
A Story of a Hundred Days



The news last week that six insurance companies had been preliminarily approved for TARP money was viewed as the culmination of a process that began under the Bush Administration through which insurers sought assistance from the Federal government. In the six months since they initially applied for TARP funds, the companies' ardor for this sort of federal investment seems to have cooled somewhat.

The insurance companies approved for TARP money are being consistently cautious about accepting it. One, Ameriprise Financial, announced it would decline the funds. The others -- Prudential, Hartford, Lincoln National, Principal, and Allstate -- released statements to the effect that they are still evaluating their options.

The companies’ reactions could be viewed as a positive sign that, unlike in November when they submitted their applications, there are now alternatives to the TARP for raising capital. It may also be that companies are wary of getting too entangled with the government in light of issues surrounding executive compensation and business structure that have been faced by banks and auto companies who have taken federal assistance. In any case, it may be that they will view it as sign of strength to turn down assistance from Washington. While Treasury Department officials might see that as a "bait and switch" strategy, the companies have a legitimate case to make that things have changed between November and now.

We will be following the insurance industry's relationship with Treasury and the TARP and will keep our readers posted on developments.

EU Agrees to Disagree on Banks Stress Tests

The International Monetary Fund’s (IMF) call earlier this week for Europe to conduct stress tests on individual banks has again put the solvency of European banks and the EU’s efforts to clean up bank balance sheets into the spotlight. The solvency ratios of European banks are often lower than those of their US counterparts, making them more vulnerable to write-downs and requirements to raise further capital. The IMF likened the stress tests to a good “spring cleaning.”

Most estimates show that European banks still have significant write downs ahead of them, which in turn will make further government interventions necessary. For instance, the Belgian government on Thursday had to step in to help its troubled banking sector by offering guarantees to KBC Bank. The measure became necessary through the possible default of MBIA Inc, the New York-based bond insurer.

However, European banks argue that US-style stress tests are less applicable to their institutions, because the economic fundamentals and accounting rules are different. The EU officials are also satisfied that individual national regulators have long been conducting stress testing and that there is no need to make them public.

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Regulating OTC Derivatives

In a letter to House and Senate leaders yesterday, Treasury Secretary Timothy Geithner proposed amending the “Commodity Exchange Act , the securities laws, and other relevant laws” to enable the government “to regulate the OTC [over-the-counter] derivatives markets effectively for the first time.” A related Treasury press release explains, “As the AIG situation has made clear, massive risks in derivatives markets have gone undetected by both regulators and market participants. But even if those risks had been better known, regulators lacked the proper authorities to mount an effective policy response.”

The Obama Administration therefore proposes changing laws, rules, and practices in order to put in place the following requirements aimed at minimizing risk to the financial system; promoting efficiency and transparency; preventing fraud and market abuses; and protecting against the inappropriate marketing of OTC derivatives to “unsophisticated parties”

  • Clear all standardized OTC derivatives through regulated central counterparties (CCP), which are to impose robust margin requirements and necessary risk controls.
  • Subject OTC derivatives dealers and firms that create large exposures to counterparties to a “robust regime of prudential regulation” to include—conservative capital requirements; business conduct standards; reporting requirements; and initial margin requirements with respect to bilateral credit exposures
  • Authorize the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) to impose—recordkeeping and reporting requirements; requirements for trades not cleared by CCPs to be reported to a regulated trade repository; obligations on the CCPs and trade repositories to make aggregate data on open positions and trading volumes publicly available and individual counterparty’s trades and positions available to federal regulators; moving standardized trades onto regulated exchanges and regulated transparent electronic trade execution systems; the development of a system for timely reporting of trades, prices, and other trade information.
  • Give the CFTC and the SEC the authority—to police fraud, market manipulation, and other market abuses; to set position limits on OTC derivatives that perform or affect a significant price discovery function with respect to futures markets; and to gather the complete picture of market information from CCPs, trade repositories, and market participants for market regulators.
  • Strengthen the laws and participation limits to ensure that OTC derivatives are not marketed inappropriately to “unsophisticated parties.” The CFTC and SEC are reviewing current participation limits to recommend tighter limits or increased disclosure requirements related to marketing derivatives to counterparties “such as small municipalities.”

House Financial Services Committee Chairman Barney Frank (D-MA) and Agriculture Committee Chairman Colin Peterson (D-MN), whose committee has jurisdiction over the CFTC, released a joint statement welcoming the Treasury proposals and committing to working together to achieve “strong, comprehensive, and consistent regulation of OTC derivatives.”

Treasury: Letter to Harry Reid Re: Regulatory Framework for OTC Derivatives (PDF) 

Treasury: Press Release Re: Regulatory Reform for OTC Derivatives

CPP: Re-Open for (Small Bank) Business

Treasury Secretary Timothy Geithner announced this morning that, in anticipation of some large institutions paying back their TARP money, the department plans to re-open the Capital Purchase Program (CPP) for small banks with total assets under $500 million. Since the launch of the program in November, 579 institutions have received money through the CPP, 300 of which are small banks. Treasury will soon open a six month window during which new banks can apply, current CPP participants can reapply, and small banks can “form a holding company for the purposes of CPP.” Participants already in the CPP will have an “expedited approval process.” Treasury is raising the amount for which qualifying institutions can apply from 3 percent to 5 percent of risk-weighted assets. Presumably more details about the re-opened program will be forthcoming.

EU Takes Further Steps Towards a New Financial Supervisory Architecture


The EU this week took an important step on the path of re-organizing both its institutional set-up as well as the substantive rules related to financial reform. On Thursday, the EC Commission organized a full-day conference with representatives from the EU Institutions, national supervisors, the financial industry, consumers, and trade unions. The EC Commissioner in charge of the reform, Charlie McCreevy, confirmed that “We are on the eve of a quantum leap forward for effective supervision in the EU.”


A particular problem facing the European financial industry is how to share the burden of supervising cross-border financial groups. Some 40 to 45 large cross-border groups now account for almost 70 percent of all banking assets in Europe. The flaws of the current system are particularly acute for the new EU Member States, where banking markets are mostly dominated by foreign banks. Although the concentration of foreign banks has provided significant benefits to these Member States, it has also made it increasingly difficult for these countries to genuinely safeguard the stability of their financial systems.

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Who Passed the Stress Test?

At 5 p.m. Eastern Daylight Time today, the Federal Reserve and Treasury unveiled the official results of the Supervisory Capital Assessment Program (SCAP), revealing that ten of the 19 participating banks need to increase their capital buffers for a combined total of $74.6 billion. The SCAP conducted stress tests on the nation’s largest bank holding companies to predict “potential losses, the resources available to absorb losses, and the resulting capital buffer needed” based on various economic scenarios.

The banks needing to increase their capital buffers will have to work with their primary regulators, in consultation with the FDIC, to develop a capital plan sometime in the next 30 days (by June 8, 2009), and they will have six months to implement the plans (by November 9, 2009).

Each capital plan must contain the following three elements:

  • A detailed description of specific actions the bank will take to increase capital in order to satisfy the capital buffer requirement. Treasury and the Fed encourage banks to raise new capital from private sources.
  • A list of steps to address weaknesses in the bank’s internal processes for assessing capital needs and engaging in capital planning.
  • An outline of steps the bank will take over time to repay government-provided capital.

As part of their 30 day review process, banks are also directed to evaluate their existing management and board of directors to make certain their leadership has the capability to “manage the risks presented by the current economic environment and maintain balance sheet capacity sufficient to continue prudent lending to meet the credit needs of the economy.”

The banks needing to increase their capital buffer (amounts in billions) are Bank of America ($33.9); Citi ($5.5); FifthThird ($1.1); GMAC ($11.5); KeyCorp ($1.8); Morgan Stanley ($1.8); PNC ($0.6); Regions ($2.5); SunTrust ($2.2); and Wells Fargo ($13.7). See the Fed report for more details.

Federal Reserve: Supervisory Capital Assessment Program - Overview of Results (PDF)

Stress Tests, Economic Indicators, and the Light at the End of the Tunnel

Call it green shoots or mustard seeds or hope, but according to some of the nation's leading economic experts, the outlook for the American economy is improving. These experts are venturing the opinion that the economy has hit bottom and the recession is ending. Some of the evidence cited is the fall in unemployment claims from March to April; the first quarter increases in consumer spending and consumer prices; and the stabilization in sales of existing and new homes over the past couple of months. Even Federal Reserve Chairman Ben Bernanke sounded optimistic (for a Fed Chairman) about the recovery. During testimony before the Joint Economic Committee this morning, Bernanke said, “We continue to expect economic activity to bottom out, then to turn up later this year.” Although he qualified his statement as dependent on a restored and healthy financial system, that too could be interpreted as a positive sign since the Fed is supposed to go over stress test results with the affected banks today.

Bernanke did not comment on the test results, but media leaks suggest that ten of the 19 banks will need to find more capital. The results are not supposed to be publicly available until later this week, but markets rallied somewhat yesterday based on White House spokesman Robert Gibbs’ comments that the administration does not anticipate needing more financial bailout money from Congress and suggesting the banks will be able to raise private capital.

Since unemployment is a lagging indicator, most experts predict it will be a few months before people feel the effects of an economic upturn. If the economy is pronounced in recovery by the fall, it will be far enough into his presidency that President Obama will likely receive appreciable credit . The potential return to better times could add momentum to a major administration priority: health care reform. Despite the White House Chief of Staff’s strategy of capitalizing on a crisis, we suspect the White House will find it is much easier to score congressional victories when there is hope on the horizon rather than fear.

Fed Expands TALF to Commercial Mortgage Backed Securities

The Federal Reserve announced this afternoon that starting in June, commercial mortgage backed securities (CMBS) would be eligible assets for the Term Asset Backed Securities Loan Facility (TALF). The Fed is also expanding the term on some CMBS TALF loans to five years, up from three year terms for other assets. The Federal Reserve Bank of New York plans to set up a separate TALF subscription cycle for CMBS, which will occur later each month than the regular TALF cycle. The longer-term CMBS loans will also have larger haircuts.

Term Asset-Backed Securities Loan Facility (CMBS): Terms and Conditions