They spent years arguing that over-regulation will kill the goose that lays the golden egg. Now financiers and rating agencies have discovered that not only is there no golden egg, but the goose has already been cooked. Without more of the much-vilified regulation, the rest of the farmyard could end up in the pot too.
The timing of the annual IMF/World Bank meetings could not have been better, coming as they did just after the summer’s disorders and significant investment bank losses on sub-prime, leveraged loans and CDOs. A sombre mood prevailed in Washington, despite the firmer tone of financial markets – and it’s easy to see why. For once the most meaningful discussions were on the traditional engine room of the global economy: US sub-prime fall out and its effects on both American and European finance will undoubtedly lead to greater regulatory oversight, possibly at a global level.
Joaquin Almunia, EU commissioner for economic and monetary affairs told the second annual EU government bond summit at the end of October that all of the authorities charged with ensuring global financial stability are of the same mind on the key areas that need looking at.
The review will likely be completed by the end of next year at the very latest. It will be comprehensive, global and include institutions such as the Financial Stability Forum.
The first topic likely to come up for scrutiny is transparency. While financial innovation has contributed to the efficiency by redistribution, risk market participants are now struggling to assess risk exposures. There is a lack of comprehensive information on exposure to complex financial products. That is unlikely to be allowed to continue. Nor is the circus that masquerades for valuations and accounting treatments of assets.
Ecofin might also do some navel gazing: it has accepted that there might be holes in cross-border prudential supervision and limits on its ability to react in times of crisis. In a statement that will send further chills down the collective backs of the rating agencies, Almunia also made it clear the regulators will scrutinize closely their role, and their incentives, in world of structured finance.
There is every possibility that the market will be presented with a global solution to the perceived weaknesses in the current system of regulatory oversight.
The accusation from the agencies that their ratings should not be a short cut to full due diligence has much validity. But surely including rating agencies as part of regulatory frameworks – as in the Basle I and II – encourages market participants to take short cuts?
It could have been so different had short-term and selfish motives not been given full rein. Market practitioners have consistently resisted industry-led efforts to raise transparency in structured products and credit derivatives. Many of the leading bankers wanted to keep pricing, distribution and structuring as opaque as possible; they may regret that now.
