Watered down

When the financial crisis broke in 2008, politicians in Europe and the United States issued strong statements on the need for fundamental reform of financial markets. Regulation had been too lax in the past, and oversight too limited. In the European Union, key players from the European Commission (EC) and member-state governments urged a radical overhaul of existing rules for financial markets. It was time for action, they said.

When EU finance ministers met in Brussels Sept. 7 to discuss regulation of financial markets in the wake of the crisis, they could celebrate a rather belated first step. For the first time, a major deal was struck, clearing the way to set up four new EU bodies to supervise financial markets.

The new institutions are to be "watchtowers" or "radars," a warning system for financial markets. But it's one thing to detect problems, such as speculative bubbles, and another to have the tools to prevent or cure a crisis. To do that, effective regulation has to be in place. At the moment, the prospects are pretty unlikely. For the past two years, the EC has consistently given the financial industry a key role in defining the terms of the debate on reform. While the private financial sector isn't making the decisions, it has been allowed to set the terms of the debate.

There's nothing new about this. It's an old pattern. Ever since the EU started working on an integrated financial market in 1999, the financial industry has established itself in key positions as advisers in the EC's various "expert groups." In fact, when the crisis broke in 2008, all the legislation that was up for revision - on banking, investment funds, accounting standards, credit rating agencies, derivatives, etc. - had been forged in close collaboration with banks, investment funds and other financial players. (For more on this, see "A Captive Commission," a report by the transparency coalition ALTER-EU released in November 2009.) In each case, financial corporations managed to persuade the commission that only legislation that would give them the widest possible margin of operation should be considered. And note that only the EC - not the Parliament - can propose legislation in the European Union.

Following the crisis, you would have thought the lesson would have been learned.

"I've learned that all consultation bodies should be able to stand back also [and] say, 'It's wonderful what the industry has said, but we need to be a bit more objective ourselves,' " the then Single Market Commissioner Charlie McCreevy said in February 2009. "The fact that consensus [among stakeholders] has been reached does not mean it should all be implemented."

Those statements were, even then, in sharp contrast to the reality. Months before, the commission had already taken the first decisive steps to return to the old pattern.

In October 2008, the EC summoned a group of experts to form a "High Level Group" to advise on the overall strategy of financial reform in the wake of the crisis. The group headed by an adviser to French bank BNP Paribas, Jacques de Larosiere, included five individuals linked to financial corporations, and two others known for their strong preference for market deregulation. Four months later, the group delivered a document that would be extremely influential in the ensuing debate on financial reform. The new supervisory system was a brainchild of the "de Larosiere Group," and the debate on reform has generally followed the rather timid and light-handed approach proposed by the group.

On banking, for instance, the group never came close to questioning the fundamentals of the existing rules at either the European or the international level. From the beginning, legislators have mostly awaited negotiations at the international level on a new set of proposed rules called Basel III, which were released Sept. 12. De Larosiere in fact went on from advising the commission and the council to become a lobbyist for the association of big banks, the International Institute of Finance (IIF). From that position, he has helped caution regulators that applying tougher rules to banks' liquidity will harm nascent growth. While the challenge from the outset of these negotiations was to ensure that banks are solid enough to withstand the pressure of a future crisis, ambitions have been lowered considerably over the summer primarily due to pressure from the IIF. The extent to which proposed reforms have been weakened have led many experts, even at the OECD, to start pushing for a Basel IV in the future.

How will Basel III feed into regulation in the European Union? Before lawmakers answer that question, the EC will discuss it with their advisers. And the advisers are mainly those in the newly formed Group of Experts on Banking Issues (GEBI). Maybe it should come as no surprise that the group is heavily dominated by "experts" from banks that are affiliated to de Larosiere's IIF lobbying group, which has worked hard to water down any international regulations. Of the 42 members, 34 come from banks and investment firms; of the 25 that come from banks, 23 are members of the IIF. In other words, the banks that have managed to water down international rules are now to advise the commission on the best approach for the EU. As a consequence, it's unlikely that we will see much change in banking regulation.

The same goes for some of the most controversial financial instruments: derivatives. Often used in speculative attacks on bonds and commodities, and almost universally seen as a major contributor to both the financial crisis and the Greek economic crisis, they are often called "financial weapons of mass destruction" - a term coined by U.S. financier Warren Buffett. The derivatives market is likely the most unregulated and opaque market around. And it's likely to remain that way.

In the wake of the 2008 crisis, McCreevy announced that he had set up the "Working Party on Derivatives" group to take "a systematic look at derivatives markets." This group was made up solely of representatives of the major financial lobby organizations with a stake in derivatives: the Alternative Investment Management Association (AIMA), European Banking Federation (EBF) and the International Swaps and Derivatives Association (ISDA). This in turn led to a more permanent advisory group on derivatives, dominated completely by the key lobby organization on derivatives, the ISDA. Of 34 representatives from financial corporations on the group, 25 are linked to the ISDA. Five of the remaining nine are from similar associations, four of which share a large number of their membership with the ISDA.

Deeply entrenched in the advisory structure, the ISDA has managed to set the terms of the debate. While belittling the role of derivatives in the crisis, they promote responses that will not affect the daily business of derivatives dealers, and fight vigorously to stave off attempts to ban particularly "toxic" and speculative instruments, such as one called "naked CDS" used in speculative attacks on Greece earlier this year.

Banking and derivatives are but two of many areas on a broad reform agenda. But the approach of the commission is applied uniformly across the board. It's standard procedure to ensure the deep and often almost exclusive involvement of the financial sector whenever new regulation is on the table. When presented with the report from lobbying transparency coalition ALTER-EU on the link between the crisis and the extensive use of advice from financial corporations, an official dryly commented, "If you want financial advice, you don't ask a baker."

When confronted with a major crisis created by the irresponsible behavior of major financial corporations, should their advice really form the basis of the response?

Paradoxically, commissioners occasionally appear to recognize the problem of the one-sided advice they are receiving, as is the case with the current Single Market Commissioner Michel Barnier. He claims to want to tackle the problem of financial firm lobbyists framing the debate, yet nothing seems to happen.

There is a strong chance that, in terms of EU regulation, the financial crisis that took off in 2008 will be remembered only for the huge and expensive bailout operations and support schemes for banks, but not for introducing major reforms of financial markets. This will be thanks in part to the ample space given to financial corporations to promote their interests in the framework of the commission's advisory structure.

As a consequence, new waves of financial instability and crisis are likely to follow.

- The author is a researcher at Corporate Europe Observatory (CEO), a Brussels-based organization focused on monitoring the influence of corporate lobbyists on European Union policy.

Kenneth Haar can be reached at
features@praguepost.com