Europe may have largely overcome its sovereign debt crisis, but the region, and its financial industry, still faces both market and regulatory challenges, says Investment Industry Association of Canada (IIAC) president and CEO, Ian Russell, in his latest letter to the industry.
The European markets have been through a succession of crises since the initial global financial crisis in 2008. Yet, Russell reports that at a recent conference hosted by the International Capital Markets Association (ICMA), the consensus was that the recent succession of sovereign debt problems has now been put to rest.
“This is not to say that problems will not reappear, rattling investors and markets,” he says, but markets have generally been calmed by the European Central Bank’s (ECB) pledge to prevent sovereign debt defaults.
“The prospect of another euro crisis fades as market participants conclude the ECB will succeed in its stated objective. Fears of another crisis, however, are displaced by fears of an emerging asset bubble, particularly in property markets and financial assets,” he says. “But that outcome is in the future, and for the time being at least the spectre of inflationary bubbles lies dormant, despite a massive injection of reserves into the banking system through quantitative easing programs.”
Indeed, he notes, that the expectation is that Europe will likely suffer slow growth for the next three to five years, amid an ongoing lack of consumer, business and investor confidence; fiscal austerity; high oil prices; public and private sector deleveraging; and, new financial regulations. “Longer-term growth prospects are further impaired by the structural imbalances in financial balance sheets, reflecting the holdings of legacy illiquid assets and insufficient capital,” he says, adding that this constrains bank lending.
On the regulatory front, Europe is facing a “barrage” of reforms, he notes, from the Basel III reforms to bank capital and liquidity to the rule initiatives, known as the European Market Infrastructure Directive (EMID) and the Market in Financial Instruments Directive (MIFID2). Moreover, European policymakers are focused on further structural reforms to the banking system, and harmonized regulatory oversight, “to strengthen the banking system from future shocks, promote more bank lending, and bolster confidence,” he notes.
In addition to higher capital requirements, policymakers are seeking reforms to ensure the safety and resilience of the banks, including new ‘bail-in’ provisions that aim to reduce implicit government guarantees, and measures to create a single supervisory scheme and resolution framework for banks.
Notwithstanding these efforts, and some improvement in market conditions, Russell notes that the financial industry is still struggling to come to terms with the widespread changes. He notes that market liquidity remains below pre-crisis levels, which has led to increased fragmentation in bond market trading. Dealers are also worried about the impact of enhanced bond market transparency requirements, he notes.
Additionally, “asset managers have been adversely impacted by recent conditions in the government and corporate bond markets,” he reports. And, they are facing their own slew of new regulations, making it tougher to deal with the tough market conditions.
“While the growing confidence that the sovereign debt crisis has been put to rest is welcome, in many areas Europe seems stuck between the rock of difficult market conditions and the hard place of new regulatory standards,” Russell concludes. “The challenge is to address the former without making the kind of adjustments in regulatory standards that will create more problems than they solve.”