Failure to launch

In the days leading up to the meetings in Cannes, there had been some hope that the crisis would finally be tamped down by committed action by the world’s leaders — specifically, to ensure a major expansion of Europe’s bailout fund (the European Financial Stability Facility), either directly or through larger commitments to the International Monetary Fund.

In the week prior to the summit, European leaders had agreed to expand the EFSF to more than one trillion euros, recapitalize the region’s banks and adopt yet another bailout plan for Greece — all of which was seen to be encouraging in principle but short on detail. And the hope had been that some of the critical details would be fleshed out at the summit.

However, it appears that will not to be the case. The Cannes meeting has failed to deliver any substantial new funding commitments to the EFSF or the IMF. Instead, the summit has ended with vague pledges to revive growth, create jobs and develop a more stable international monetary system while punting the IMF funding issue off the table until the next G20 finance ministers’ meeting in February.

The Cannes summit’s one concrete achievement on the European crisis was an announcement that Italy will accept IMF surveillance of its planned fiscal and structural reforms, says a research note from Karen Ward, HSBC Bank PLC’s senior global economist.

This is important because, while Greece was the story overshadowing the summit, some market-watchers expect Italy to be the next focus of concern in the region — and its economy is a much bigger, more critical part of Europe.

“While Greece is in the spotlight, its outcome is not enough to make or break the euro,” suggests a recent BMO Capital Markets report. “On the other hand, events in Italy are likely to be a key determinant of whether the euro remains intact.”

The BMO report points out that Italy, with the world’s third-largest debt market, is “almost certainly too large to be bailed out.” Yet, government bond yields there have risen to unsustainable levels, and the government is under pressure to deliver on austerity reforms.

Although there’s some hope that the newly promised IMF surveillance will keep Italy’s reform plans on track, the reality is that the political situation there is rather precarious, too. And markets can hardly take much comfort from this surveillance measure.

So, regarding the biggest issue for financial markets heading into the Cannes summit, the meetings ended pretty much where they began, with the European sovereign-debt crisis hanging over the global economy.

Indeed, the Bank of Canada’s latest Monetary Policy Report, published in late October, indicates that the European sovereign-debt situation is the biggest risk threatening the outlook for the Canadian — and the global — economy. The BoC report says that if the crisis isn’t effectively contained, the “effects on Canada through financial, confidence and trade channels would be substantial, given the size and importance of the euro area.”

The BoC’s base-case scenario assumes the crisis will be contained and that Europe will take additional action to ensure debt sustainability, bolster banks’ capital positions and create a larger and more effective EFSF. “This assumption is clearly subject to downside risks,” the report cautions — and the Cannes summit did nothing to alter that view.

Yet, notwithstanding the G20 summit’s failure to tackle the biggest risk facing the global economy, participants did manage some progress on the regulatory front, on which policy-makers still are trying to address some of the problems that caused the financial crisis in the first place and to limit the damage to public finances from the next crisis.

Notably, the G20 leaders did endorse a set of policy measures proposed by the Financial Stability Board — the international body that co-ordinates financial regulatory reform — that will impose additional regulatory requirements on banks that are deemed to be systemically important to the global financial system.

None of the big Canadian banks made the list of these global systemically important financial institutions (known as G-SIFIs), which includes 17 large European banks, eight U.S. institutions (including Wall Street firms Goldman Sachs Group Inc. and Morgan Stanley) and just four Asian banks.

The initial list of G-SIFIs has been developed by global banking regulators using data from the end of 2009. The FSB says the list will be updated annually and published in November every year, and the list’s development methodology will be reviewed every three years. Also, although only banks have been included on the initial list, it may be expanded to other sorts of financial firms in future.

By being included on the list, G-SIFI banks will face policy measures designed to shelter the global financial system from the risks posed to systemic stability, including additional capital requirements (of between 1% and 2.5%) above the revised, higher Basel III levels, and more intensive supervision.

However, the only measures the banks on the G-SIFI list will face in the immediate future are requirements to develop recovery and resolution plans in the event they fail. These requirements will need to be met by the end of 2012.

The additional capital charges and higher supervisory requirements will apply starting in 2016 for banks that are identified as G-SIFIs in November 2014.

At the same time, the long-rumoured appointment of BoC governor Mark Carney to chair the FSB also came to pass at the Cannes summit. Carney, who has received a three-year appointment, will also remain as the head of Canada’s central bank.

In announcing his appointment, Carney didn’t give away much about his plans for the FSB, apart from pledging to strengthen its capacity and governance (which was also mandated by the G20 leaders) and to continue to work toward the implementation of the G20’s financial reform plans — and there is still a long list of reform plans outstanding.

At Cannes, the leaders had reiterated their commitment to adopting tougher capital requirements and new liquidity and leverage requirements for banks, which the Basel Committee on Banking Supervision has been developing for a couple of years.

They also have asked the FSB to enhance its monitoring of banks’ compliance with new principles regarding the structure of compensation in the financial services sector. And they have identified enhanced regulation of the “shadow banking” sector as the top regulatory priority for 2012.

G20 leaders are seeking stricter rules governing the relationship between the traditional sector and the shadow banking sector, along with tighter rules for securitization, loans and securities lending for the latter.

Regarding market regulation, the G20 leaders at the Cannes summit also have committed to complete the reform of regulation of the over-the-counter derivatives market and to ensure that these reforms are co-ordinated among countries to prevent regulatory arbitrage. These commitments have been ongoing for several years and are supposed to be completed by the end of 2012, although that looks somewhat unlikely.

For example, the Canadian Securities Administrators had published a consultation paper on OTC derivatives regulation late last year and another paper on trade repositories in the derivatives sector earlier this year. But the CSA still has a slew of forthcoming initiatives on its schedule for this month and next, dealing with surveillance in the derivatives market, central counterparty clearing, registration, exchange and platform trading, and capital and collateral requirements. It’s hard to imagine that much, if any of this will be completed by the end of next year.

In addition, the G20 has endorsed recommendations developed by the global umbrella group for securities regulators, the International Organization of Securities Commissions, for enhancing market oversight in light of technological advances in securities trading (such as the rise of algorithmic trading in general and high-frequency trading in particular).

The G20 is also asking IOSCO to implement a common regulatory and supervisory framework for commodities derivatives markets by the end of next year, as well as examine the operations of credit-default swap markets.

Furthermore, the G20 wants the FSB to develop proposals for the creation of a legal entity “identifier” system (to make it clear which entities are involved in complex transactions) by the next G20 summit, which will be hosted by Mexico in June 2012.  IE