Europe Split over Financial Regulation

Peer Steinbrück's face always darkens when he is asked how much more taxpayers' money he will need to bail out the banks. "I don't know," says the German finance minister. "I won't know until after the fact." And when he is asked how he feels, late in the evening after a cabinet meeting in Berlin or a meeting of European Union finance ministers in Brussels, Steinbrück sometimes grumbles in response: "Lousy!"

Europe's finance ministers are not in an enviable position these days. Washington is constantly putting pressure on them to inject additional billions into the economy. Meanwhile Brussels threatens to take them to court for incurring too much government debt.

And in times of so much uncertainty, they are also expected to provide answers to the big questions on everyone's mind: How can we jump-start the economy without completely destroying government budgets? Can banks be relieved of their toxic assets without unloading all the risk onto the shoulders of taxpayers?

In addition, the 27 EU finance ministers have been given a special task to complete for their respective leaders. At their last meeting in March, the heads of state and government of the EU countries charged the European Commission in Brussels and their finance ministers with investigating new regulatory options.

At their next summit in June, "the European Council will take first decisions (sic) to strengthen EU financial sector regulation and supervision," as it is phrased in Brussels bureaucratese. The G-20 summit of the world's leading heads of state and government also vowed to proceed in the same direction. But what happens to the summit visions when attempts are made to put the lofty ideas into practice?

There has admittedly been some progress. The European Commission has made some preliminary proposals and the parliament has passed a law under which the amount that one bank can lend to another will be limited in future to 25 percent of the bank's own capital. And banks will be required to retain at least 5 percent of any high-risk securities that they sell.

But that was the extent of it, at least for the time being. Moreover, it is highly unlikely that further concrete measures will follow the politicians' bold announcements.

There is a crack running straight through the EU, says Werner Langen, a member of the European Parliament for Germany's conservative Christian Democratic Union. Sources close to the EU's finance ministers have expressed similar sentiments, saying that the traditional, continental core of Europe is once more facing off against the British, the Irish and some of the organization's new Eastern European members.

London and Dublin, in particular, are blocking anything that could create problems in their respective financial industries. This is understandable, given the fact that Great Britain and Ireland have very few other future-proof industrial sectors. But this path is immensely dangerous for Europe.

"We have absolutely no risk management today," says David Wright, deputy director general of the European Commission. According to Wright, there were no warning signals before the financial meltdown because "the necessary mechanisms simply do not exist." Wright believes that it is high time for change.

Almost everyone agrees, at least in theory. Even Britain's Prime Minister Gordon Brown had come out clearly in favor of "a strong step in the direction of regulation" at the meeting of EU leaders, a satisfied Chancellor Angela Merkel said after the March summit. "Complex products like banking derivatives which were supposed to disperse risk around the world have instead spread contagion," Brown said in a speech at the European Parliament in Strasbourg in March, where he called for the creation of "global standards" to respond to "global problems."

But in expressing these sentiments, Brown apparently neglected to inform his own ministers, undersecretaries and officials of his change of course. They continue to block the creation of substantial regulations for financial institutions at the negotiations in Brussels.

All the same, the majority of EU members seem determined to re-establish, as far as possible, political control over markets that have become widely deregulated. Specifically, they want:

stricter equity capital regulations for banks, the goal being to prevent excessively risky transactions;

a registration requirement for large hedge funds which would also cover their debt-financed leveraged transactions;

guidelines for salaries and bonus payments in the financial industry, which would be tied to long-term corporate results;

a licensing requirement for rating agencies, which would no longer be allowed to provide consulting services to the same customers they rate;

Europe-wide control of financial market players and common regulatory requirements.

For some, these proposals are much too far-reaching, while for others they do not go far enough. Poul Nyrup Rasmussen, president of the Party of European Socialists, is critical of the Commission's draft law and describes it as having "more holes than a Swiss cheese." Martin Schulz, chairman of the Socialist group in the European Parliament, wants to see a "greater unbundling" of executive compensation and bank profits.

A simple "recommendation" on the regulation of executive compensation is worthless, says Christian Democratic European Parliament member Klaus-Heiner Lehne. What is needed, according to Lehne, is a real law or—in EU jargon—guideline. A similar recommendation, says Lehne, has been in place since 2004, but "only one member state has observed it."

Christine Lagarde, France's conservative finance minister, also believes that the proposals are "not enough," and she even sees dangerous gaps. For instance, she says, Brussels wants to allow investment funds which are certified in other regions of the world to be sold in the EU without further examination. Lagarde fears that such funds could prove to be a "Trojan horse" for intruders from tax havens and would "open the door to funds from the Cayman Islands."

The British, in particular, take a completely different view of things. On Feb. 22, during a preparatory meeting in Berlin ahead of the G-20 summit, the British negotiator warned his counterparts against excessively extensive regulatory plans. "We should be careful that we do not create problems for the future," he said.

The defenders of Britain's investment funds are indeed making sure that the gentlemen in London's City will not be asked to endure too much regulation. They threaten that if regulation becomes too strict, they will move to other markets in Asia or the United States. Meanwhile the British press has been drumming up support for the industry.

Even Stuart Fraser, the head of the Policy and Resources Committee of the City of London, warns that tighter EU regulation "would drive the whole industry overseas." Antonio Borges, chairman of the Hedge Fund Standards Board, told the Daily Telegraph that the proposed regulations are "a blatant attack on the UK and US financial systems by Continental countries that neither have a tradition of alternative investments nor a proper understanding of them."

Such views are applauded in Europe's new east, where many politicians identify ideologically with the British-Irish position, even though they have no banking centers of their own to protect. Some believe that unregulated growth is more useful in economic terms than the German-style security-focused model. Many of them came of age in communist planned economies and later studied the free market approach at US universities.

The resistance coming from both the west and the east has already produced results. For one, a powerful European regulatory authority is unlikely to emerge in the future; regulation will remain in the hands of national authorities. The only remaining bone of contention will probably be the extent to which national regulators should cooperate with each other, and under which rules they should assess risk and, if necessary, intervene in the market. Germany's central bank, the Bundesbank, also supported London's rejection of the idea of an EU-wide authority—partly in an effort to protect its own turf.

"Only the leaders themselves" can now ensure that the June summit will yield more than just "insubstantial chapter headings," says one of the summit's Brussels organizers, noting that French President Nicolas Sarkozy would secretly like to present himself as a "great regulator." German Chancellor Angela Merkel, in the midst of an election campaign, will hardly be willing to stand on the sidelines, says the Brussels official, and Gordon Brown has gone too far in his rhetoric to be able to block everything.

Many experts doubt whether all of this will be enough to make sure the right lessons for the future are drawn from the crisis. "We have no understanding at all of the macroeconomic effect of microeconomic processes in these markets," says Carsten Pillath, the general director of the General Secretariat of the Council of the European Union. "A market regulator needs tried-and-tested models in order to evaluate what is happening there. But such models don't exist."

Before coming to the EU, Pillath worked in the Finance Ministry and Chancellery in Berlin. The lessons learned from past debacles "did not make us immune to the current crisis," he says. And the next crisis, which will presumably take a completely different course again? "We will enter that," he says, "with the same lack of knowledge."

Translated from the German by Christopher Sultan

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