The Euro CrisisHow it could happen and why it would be horrible Computers changing the world of Cancer

Issue number 1 November 2011 Edited by Henry Black08066412

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James Murdoch comes up empty, again

Contemporary Issues in FinanceU52080

With all this talk of regulation, do the proposals signify a convergence of financial systems?
Since the financial crisis of August 2007 there have been a number of proposals to regulate and reform financial systems across the globe. But do these this proposals indicate a convergence of financial systems internationally? One suspects not. Although there is very much a global market in the twenty-first century, the makeup of one financial system still varies from the next. To investigate further this article will look at the latest regulatory proposals of the UK, USA and EU, as these three financial systems embody the western world economy that is currently experiencing one of its worst declines in history. vestment activities such as derivatives and securities trading. bility.

Mid-Crisis Regulation

US The ICB report goes into detail about Since the crisis of 2007 the Dodd what is and isnt allowed inside the Frank Reform has been the only ring-fence whilst also leaving it up to proposal approved by Congress the banks to decide where certain areas sit. For this it has created three principles describing the types of services. The mandated services are services that must be provided by ring-fenced banks and the prohibited services are services that must not be provided.

Berlusconi Steps Down

Italian President Giorgio Napolitano was holding talks Sunday aimed at forming a new government following the resignation of Italy's Prime Minister Silvio Berlusconi. Ex-European commissioner Mario Monti was favourite to replace Berlusconi in a bid to stave off bankruptcy for Eurozone's third-largest economy. Last week Foreign Minister Franco Frattini said he supported an emergency government of national unity led by Monti. "He has an international profile that no one can deny," Frattini said, according to his press office. The departure of Berlusconi seemingly brings to an end to a long career played out on centerstage in the country's volatile political arena. The thrice-elected 75year-old business magnate has said he does not intend to stand again if new elections are called. Berlusconi stepped down just hours after the lower house of parliament approved austerity measures aimed at restoring confidence in Italy's economy. Crowds that had gathered outside the presidential palace erupted in cheers -- waving the Italian flag, dancing and singing the national anthem -- when news of his resignation broke. Since entering politics nearly two decades ago, Berlusconi has been one of his country's great survivors, hanging on... Continued on page 8

The third principle is that of ancillary services. This is designed to encapsulate the activities a ring-fenced bank would need to do in order to deliver those services that they UK would be permitted to proIt makes sense to start at home with vide (Vickers 2011). The report prothe UK. There has been much media, vides a good example of this. A ringand therefore public, furore regard- fenced bank would have to hedge its interest rate risk but it is not aling the operations of the UKs marlowed to provide this hedge as a ket based financial system. The banks have suffered the majority of service to its retail customers. this focus through pressure to imple- (Vickers 2011). ment strategies such as ring fencing Such reform should offer more secuand more vehemently, restrictions of rity to retail and SME aspects of the pay-outs of bonuses (the latter banking, but there are downsides to appearing more of a political rebutsuch an approach. A proposed imtal than an actual proposal). The plementation date is expected from subject of ring-fencing is investigated the treasury by the end of the year. in the ICBs (Independent CommisThe significance of such a proposal sion on Banking) Final Report reindicates a UK inclination towards leased in September this year. It highlights how ring-fencing could be the protection of peoples money. Furthermore, the ICB report proimplemented. The proposal is to poses high equity to RWAs ratios for separate the retail and investment arms of the banks which should en- the ring-fenced banks (7-10% desure that the banks retail customers pendant on their RWA to UK GDP ratio), reinforcing this need for staare protected from the riskier, in-

(Tropeano, 2011). It has been met with a lot of criticism from those in the financial sector, due to the shear size of it (some 2600 pages). The main, and most controversial, elements of it are the newly modified Volcker Rule on proprietary trading and the derivatives reform. The Volcker Rule has been put in place to stop the banks making investments that do not provide benefits to their customers i.e. using their deposits to create profits only enjoyed by the bank. This has largely been translated as a ban on proprietary trading for commercial banks. Before the Volker Rule these activities where often shown on the same balance sheets as their commercial activities (Tropeano, 2011). In such instances, when proprietary trades made profits, they went to the bank, but when they made losses, the banks fell back on the deposit insur-

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2008 when its entire international banking system collapsed, has emerged less affected by the sovereign debt crisis. In the EU, especially in countries where sovereign debts have increased sharply owing to bank bailouts, a crisis of confidence has emerged with the widening of bond yield spreads and risk insurance on credit default swaps Continued page 42

Eurozone Crisis - 4 page special

From late 2009, fears of a sovereign debt crisis developed among investors concerning some European states, intensifying in early 2010.[1][2]This included Eurozone members Greece, Ireland, Italy, Spain and Portugal, and also some non-Eurozone European Union (EU) countries. Iceland, the country which experienced the largest financial crisis in

Mid-Crisis Regulation Continued...

ance provide by the FDIC (Federal Deposit Insurance Corporation). The Volcker rule has placed a ban on such activity, echoing the Glass-Steagall act of 1933. The Volcker rule again illustrates an emphasis on segregating risk. Another major element of the Dodd-Frank act is the derivatives reform. This is the biggest ever shake up of the derivatives markets and as a result the exact rules on it are still being written up a year later. The reform requires derivatives trading to move from over-the-counter trading to exchanges or swap execution facilities. This is intended to add security through an increased clarity of responsibility. During the 2007 crash it proved very difficult tracing back trades. This resulted in large burdens being placed on single organisations who had irresponsible amounts of exposure. On top of being moved to exchanges, derivatives are now subject to mandatory clearing (Huntingdon. D et al, 2010). This enables real time public reporting to be made available and further insures that trades are accurately recorded. Such moves show an emphasis on creating more transparency in the market and also increasing regulation through special repositories that can judge over the dangers of systemic risk (Tropeano, 2011). EU The bank based European Union has illustrated a quite different approach to post crisis regulation. For better for worse, regulation has tended to be directed at market based practices. Proposals such as a financial transaction tax, as well as limits on short selling have been considered. The financial transactions tax proposal is still yet to gain traction. At the G20 summit, the tax was once again postponed due to countries such as the UK who are not in agreement. The tax proposes that trades in bonds and shares would be taxed at 0.1 per cent, while more complex derivatives would face a 0.01 per cent levy (Chaffin, J. 2011). The money raised by the Tobin Tax (Tobin being the US economist who created the idea in the 1970s) is intended to raise capital for governments in the European Union. signed to curb the enthusiasm of lending at the top of the economic cycle (Persaud, A. 2011). These higher capital requirements have been met with resistance from the banks due to the current pressure they are Much of Europes regulatory focus has been under to increase lending. As a result of this aimed at limits on short selling. Certain EU the Basel III accord is not expect to be fully nations first applied temporary limits to implemented until January 2019 (FT Alshort selling but as of October have agreed phaville 2010) to making these restrictions permanent (Barker, A. 2011). Such legislation, when it Convergence or Divergence comes in to play, will mean that the short It appears that the UK, US and EU have selling of bonds, shares and credit insurance quite contrasting proposals for the regulawill be put under close scrutiny. It is argued tion of their Financial Systems. The EUs that holding a short position creates a negafocus has tended to be on reforming the tive outlook and can amplify market tumarkets, likely due to its roots as an institumult (Froymovich, R .2011). A particular tion based system. Proposed measures such emphasis has been on banning naked CDS as the Financial Transaction tax have been (Credit Default Swaps). A CDS is usually used firmly opposed by the UK and US. Critics of as a means of reducing ones risk exposure the tax say that it would reduce the comon their held position. This is done through petitiveness of the market unless it was purchasing credit insurance to protect rolled out on a global scale. Traders may against default. But when a CDS become decide to move their trading elsewhere to naked, the actual investor does not hold the avoid such a tax. The fact that this proposal position they are insuring against. They are has been met with this level of resistance therefore only going to make a profit should indicates that these systems vary not only that borrower fail. Again this is not conduthrough their regulatory bodies but through cive to moral trading and as a result the EU the member participating in them. has considered a ban necessary. The agreeThe US and UK are more closely aligned, ment still needs to be processed by the with proposals that have shown a focus on European council and the full European Parliament and is therefore not expected to the segregation of risk. Both the ringfencing from the Vickers report and the be in place until November 2012 Proprietary trading ban from the Dodd (Froymovich, R .2011) Frank act are attempts of keeping riskier Basel III investment away from lower risk ones. This indicates a realisation that risk needs to be The third of the Basel accords has been released as a direct result of the 2007 crisis contained. But even between the UK and the US there are differences. The Dodd and signifies one of the few multinational Frank reform has shown a huge emphasis regulatory initiatives. It builds upon the on the reform of the derivatives markets failing of Basel II through increasing the capital requirements of banks substantially. which has not been replicated elsewhere. The new capital ratio has been set at 4.5 per One thing that the 2007 crisis has taught all cent which illustrates a significant increase financial systems is that capital requirefrom the previous 2 per cent level ments need to be increased. Basel III re(Wearden, G . 2011). On top of this banks flects this with substantial increases to the would be required to hold a counter cyclicapital ratio and the UK US and EU have cal capital buffer of 2.5 per cent. Should collectively adopted these. This adoption of they fall short on this amount they are likely higher capital requirements shows an agreeto find themselves facing bans on paying ment by all parties that inadequate requireout dividends to shareholders (Wearden, G . ments had a fundamental part to play in the 2011). Coupled with this are limits on lever- crisis. But does this truly show a common age, which Avinash Persaud believes is deapproach going forward? These requireDue to the resistance that the tax has met in the European Union, Belgiums finance minister has suggested that it could be rolled out to just the Euro zone countries.

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Mid-Crisis Regulation Continued...

ments are from the perspectives of the after party (Persaud, A. 2011) and would suggest, rather than being a collaborative approach, they are the corrections of collective imprudence in the run up to the crisis. From the regulation investigated in this article is does not appear that the systems are likely to converge any time soon. Although the financial markets operate on a global scale, the intricacies of each system belong to those regulating and operating in it. Until these preferences become aligned it will not be feasible. To finish, there is one striking similarity between the regulation of these financial systems and that is the shear lack of attention shown to the shadow banking system. Regulation has been directed a previously regulated areas when the liquidity crisis in the shadow banking system was a major source of financial and economic stability (Pomerleano, M. 2011). By Henry Black (08066412) Disclaimer: The articles Berlusconi steps down and Eurozone Crisis are by no means my own written work. They are purely there as a means of displaying the Economist look and feel. The same applies for the cartoon on page one. Please do not consider these when marking, they are PURELY for display purposes

References and Bibliography

Barker, A. (2011). EU ban on naked CDS to become permanent. Available: http://www.ft.com/cms/s/0/cc9c5050-f96f-11e0-bf8f00144feab49a.html#axzz1dUSTXcLK. Last accessed 13th Nov 2011. Chaffin, J. (2011). Business attacks transaction tax plan. Available: http://www.ft.com/cms/s/0/f9d2188a-e9ec-11e0-a14900144feab49a.html#axzz1dUSTXcLK. Last accessed 13th Nov 2011. Froymovich, R. (2011). EU Approves Short-Selling Curbs . Available: http://online.wsj.com/article/ SB10001424052970204346104576639260797836664.html. Last accessed 13th Nov 2011. FT Alphaville. (2010). Basel III has landed full details. Available: http://ftalphaville.ft.com/blog/2010/09/12/340356/basel-iii-has-landedfull-details/. Last accessed 13th Nov 2011. Hasselbach, C. (2011). EU remains divided over financial transaction tax . Available: http://www.dw-world.de/dw/ article/0,,15518641,00.html. Last accessed 13th Nov 2011. Huntingdon, D et al. (2010). Summary of Dodd-Frank Financial Regulation Legislation. Available: http://blogs.law.harvard.edu/ corpgov/2010/07/07/summary-of-dodd-frank-financial-regulation-legislation/. Last accessed 13th Nov 2011. MacBeth, S. (2011). Dodd-Frank may add to opacity in derivatives market. Available: http://www.ft.com/cms/s/0/79a9fef6-06e9-11e1-b9cc -00144feabdc0.html#axzz1dUSTXcLK. Last accessed 13th Nov 2011. McDermott, J. (2010). Happy Birthday, Dodd-Frank. Available: http://ftalphaville.ft.com/blog/2011/07/20/629161/happy-birthday-doddfrank/. Last accessed 13th Nov 2011. Persaud, A. (2011). Do not be detoured by bankers and their friends; our future financial salvation lies in the direction of Basel . Available: http://www.voxeu.org/index.php?q=node/7018. Last accessed 13th Nov 2011. Pomerleano, M. (2011). The Fallacy of Financial Regulation: neglect of the shadow banking system. Available: http://blogs.ft.com/ economistsforum/2011/06/the-fallacy-of-financial-regulation-neglect-of-the-shadow-banking-system/#axzz1daXWiwOM. Last accessed 15 Nov 2011. Tropeano, D. (2011). Financial Regulation after the Crisis. International Journal of Political Economy. 40 (2), 45-60. Vickers (2011). Final Report. London: Independent Commission of Banking Wearden, G. (2011). Basel III rules will force banks to hold more capital. Available: http://www.guardian.co.uk/business/2010/sep/12/ banking-basel-capital-requirements-raised. Last accessed 13th Nov 2011