Thursday, October 17, 2013

“Banks have become much more resilient.” – A debate about banking reforms and their impacts

At the Institute of International Finance, Axel A. Weber (Chairman of UBS), James C. Cowles (Chief Executive Officer, Europe, Middle East and Africa (EMEA), Citi), Dr. Thomas F. Huertas (Partner, Ernst & Young), Dr. Yves Mersch (Member of the Executive Board, European Central Bank), and Frédéric Oudéa (Chairman and Chief Executive Officer, Société Générale) discussed, on June 26, 2013, the resilience of banks.

The discussion was lead by Axel A. Weber who describes safety, stability, and protection of the overall economy from systemic risks as major objectives of today’s reforms in the financial sector. Obviously, nobody criticizes these objectives. What is blamed, however, are implementation and possible absence of a level playing field for banks.

Basel III

Compliance with Basel III is not only a regulatory, but also a competitive issue for banks. According to James C. Cowles, clients and other stakeholders expect banks to comply. He says: “Our clients want to do business with banks that are safe and sound.” Another competitive aspect is that Basel III compliant banks will face a lower cost of capital.

James C. Cowles

European banking union

The speakers applaud the European banking union as it triggers a higher discipline of banks and their creditors and brings a bank’s cost of capital in line with its risk profile. Another positive aspect of the new regulation is that supervision will become much stricter and proactive.

Agreeably, EU-wide recovery and resolution plans are key to ensure that the financial system remains stable even if a large institution fails. What’s more, they welcome the idea to place the cost of resolution upon investors instead of taxpayers. However, as Dr. Thomas F. Huertas emphasizes, the European recovery and resolution directive is not the whole answer to the question of how to ensure a sustainable financial system. As a matter of fact, banks should use a recovery process to improve their business in the future as opposed to simply returning to the status quo.

Dr. Thomas F. Huertas

On the downside, people are mostly concerned about inconsistent implementation across Europe and the implementation cost this will trigger for banks. As Dr. Yves Mersch points out, exemptions, waivers, derogations, and grandfathering should remain exceptional; no member state should be allowed to opt out from the European banking union.

Role of central banks

Dr. Yves Mersch turns to the role a central bank can play to secure banking resilience: “The main contribution [of a central bank to higher banking resilience] would be to remain predictable and true to its mandate.”

In addition, Yves says that banking resilience does not require ECB’s OMT program (Outright monetary transactions are the purchase by the ECB of bonds issued by an EU member state to provide financial assistance to such state.) to soften its conditions (namely linked to structural reforms in the beneficiating country). ”Those who believe that we will give away conditionality [on OMT] live in Alice's wonderland and, as far as I know, wonderland is not applying to become a member state of the Euro area.”

Dr. Yves Mersch

Universal banking model

Frédéric Oudéa highlights the positive role the universal banking model plays for the resilience of the banking sector. In his view, a universal bank is, because of its diversification, not a negative but a positive element in the debate about banking resilience.

Practical aspects of regulatory reforms

Reforms of the European banking sector should not overstretch financial institutions in their capacity to absorb new regulation. Frédéric Oudéa gives four reasons for this statement:

  • The European economy is still stagnant and needs banks to provide credit.
  • The transformation of the European banking system towards a more capital market based economy is already a huge challenge for the industry.
  • Financial markets usually require banks to anticipate approved regulation, even though it is not yet formally applicable.
  • Banks’ shareholders need a decent return on their investment.

Frédéric Oudéa

Additional Quotes

James C. Cowles

“Major global banks are already in a position where they are adopting the provisions of Basel III, adjusting their balance sheets and business models.”

“When you have finite resources, what you have to do is to say yourself – I can't be everything to everybody everywhere. I need to focus my balance sheet and the resources I have on those businesses and those products in which I have a real competitive advantage.”

“Bail-in is something that is appropriate.”

Dr. Thomas F. Huertas

“Banks have become much more resilient.”

“Many of us have flown on airlines in bankruptcy. The objective of resolution plans is to put banks in the same type of situation so that you can restructure the capital and, at the same time, have the bank continue customer operations.”

Dr. Yves Mersch

“We have seen national bias in supervision.”

“We have seen protection of national champions that has lead both to forbearance but also to blunders in supervision.”

“We have seen excessive flexibility [in European banking supervision].”

Frédéric Oudéa

“The big crisis has come, at the end of the day, from residential mortgages.”

“The structure of banks – for us – is not at the heart of resilience.”

“The quality of supervision is absolutely key.”

“Markets do not tolerate graduate implementation.”

“In the regulatory agenda today, we should be careful not to add too much regulation that sometimes contradicts itself and of that we are sometimes not sure about its impacts.”

“If shareholders of banks don't get a decent profitability, banks will not be resilient.”

“You can imagine a splendid car with very thick doors and huge airbags, but which cannot move forward because it has no gas. Let's make sure that the car moves forward at a decent pace.”


Sunday, October 13, 2013

The Future of Europe – How the European banking union and structural reforms will get us back on track.

On June 26, 2013,

  • Jörg Asmussen (Member of the Executive Board, European Central Bank),
  • Dr. Enrico Tommaso Cucchiani ([Ex] Managing Director and Chief Executive Officer of Intesa Sanpaolo),
  • Jens Henriksson (President, NASDAQ OMX Stockholm),
  • Dr. Gerard Lyons (Chief Economic Advisor to the Mayor of London), and
  • Xavier Musca (Deputy Chief Executive Officer, Crédit Agricole)
discussed the future of Europe at the IIF spring meeting in Paris.

Recovery from the financial crisis

Jens Henriksson
Jens Henriksson traces back the European crisis after the asset bubble burst in the 2008 financial crisis:

  • 1st phase: European authorities had to deal with failing banks through guarantees, equity injections, and nationalizations.
  • 2nd phase: To combat recession following the banking crisis, European member states used fiscal and monetary policies to stimulate demand, weaken the Euro, and lower interest rates.
  • 3rd phase: As phase 2 triggered budget deficits, member states now deal with budget consolidation, as consistent and coherent as possible.

In this situation, the panel wonders how Europe can regain competitiveness. Two key concepts come back again and again – the European banking union and the need for structural reforms.

European banking union

Jörg Asmussen
The European banking union is of vital importance to increase the confidence in the European banking sector, reintegrate financial markets, and improve the transmission of ECB's monetary policy. This is the opinion of Jörg Asmussen who says that “this project [the European Banking Union] is of key importance to us [the ECB]”.


The European banking union project comprises two key elements, i.e. the single supervisory mechanism (SSM) and the single resolution mechanism (SRM). In the future, it might also include a common deposit guarantee insurance scheme.

The SSM provides for a joint supervisory model in Europe. The idea is to introduce a common supervisory scheme which reviews the quality of banks’ assets, assesses their balance sheets, and carries out stress tests. The SSM will rely primarily on the ECB. National regulators, external advisors, and the European Banking Authority will also intervene.

The SRM will create a European resolution authority, backed by a single resolution fund. This is necessary to deal with future crisis situations affecting large cross-border banks, in particular to avoid political imponderables between governments. The primary SRM tool will be the bail-in which will allow a recapitalization of banks in times of crisis.

A common deposit guarantee scheme is currently not discussed in Europe and Jörg Asmussen doesn’t expect this discussion to become relevant in the medium term. As a matter of fact, a common resolution scheme will lessen the need for a common deposit guarantee scheme: Because banks will have to maintain a minimum amount of liabilities eligible for their resolution, there is not need for a common deposit insurance.

Jörg Asmussen

Our objective at the ECB is to start supervision with a clean slate and to restore credibility in the European banking sector.”

It is clear that the results of the asset quality review and stress tests may require capitalization or other means of support for weak banks.”

The credibility of the SSM requires more transparency on the banks' balance sheet. Markets also need to be confident that, in the future, the supervisor can pull the plug on banks that are failing or likely to fail.”

The resources for this fund [the single resolution fund] should not come from the taxpayer. It should be financed by ex ante risk-based levies on the banking sector.”

The financial sector itself should pay for the cost of financial crisis.”

Global investors need certainty about the rules of the game in Europe.”

Only in extreme cases, deposit guarantee schemes will have to pay out.”

We said a number of times in Europe that we need a banking union to break the links between banks and sovereigns.”


Xavier Musca
The whole story of this crisis [in Europe] is about the delicate balance between solidarity and responsibility and the research for a new equilibrium of powers.”

People have realized that structural reforms are key.”

Structural reforms

Dr. Enrico Tommaso Cucchiani reports that Europe is loosing economic ground vs. the rest of the world. He criticizes today’s debate about [economic] integration in Europe and says that the continent should focus on regaining competitive advantage instead. Focusing on external (as opposed to internal) benchmarks, Europe should improve

  • competitiveness,
  • economic freedom,
  • containment of the role of the state,
  • investment in education and R&D,
  • quality of infrastructures, and
  • early and mandatory adoption of English as a second language which is a fundamental prerequisite for labor mobility.

Jens Henriksson underlines the human aspect when putting structural reforms into practice: Any fundamental change process requires the following subsequent steps:

  • Show empathy with people
  • Analyze the problem
  • Make a value judgment (“This is unfair and needs to be changed.”)
  • Plan for the measures to implement change

As people must be convinced of the necessity of structural reforms and be helped to adapt to new circumstances, it is actually not possible to skip the first three steps, as is nevertheless often the case in politics.

Dr. Enrico Tommaso Cucchiani

Until 2010, the Euro has been a very good thing for Euroland.”

Europe's growth differential of 4 % vs. the world average and 3 % vs. the US is not sustainable.”

It is clear that we have to get Europe back – back on the competitive track.”

The notion of integration is losing momentum: The Nordics are afraid to pay the bill for the lazy members of the MED club and the Euro periphery feels suffocated by the rigor imposed by the North. In this environment, centrifugal forces are clearly gaining ground.”

To sum it up: Less emphasis on integration, more emphasis on alignment! Less focus on internal benchmarking, more focus on competing with the rest of the world! Less emphasis on who gains or looses sovereignty, more on how to win back growth and full employment!”

If we don't align to the global reality, the EU can implode. If the EU implodes, individual countries are too small to succeed.”

If we align, we can both get back into the race and turn the dream of true integration into reality.”

Jens Henriksson

[In ten years], we will make funny jokes about how we used to call Europe “the sick man of the world”.”

When everybody complains [about higher taxes and government spending cuts], it is ok. The point is to have full burden sharing.”

The key lesson to be successful with budget consolidation is to be consistent and coherent.”

Politics is not about being loved, it's about being respected. If you are looking for love – well – go into show business.”

Protect people, not jobs!”


Gerard Lyons

When we look globally, I think it's important to stress that the world economy is continuing to grow and Europe is loosing out.”

Europe is very good at talking a good story, very good at talking a regional story. But then, everyone goes off and acts in a national perspective.”

Demand side and supply side problems need demand side and supply side solutions.”

We need basically Germany to align almost fully, I would argue, with what Britain wants, which is to make the single market work.”

I don't think the Euro and the EU debate are the same.”

I still see London remain the financial center of Europe, whether Britain is in the EU or outside the EU.”

Xavier Musca

We need a clear and convincing commitment from the European Union that the same will be ready to intervene in order to fix the situation when the need arises.” [Talking about the importance of the European banking union]

What is my takeaway from this discussion? Europe will be better off if it implements the European banking union and structural reforms. We seem to make progress on the first point but much less so on the second point.


Sunday, October 6, 2013

Sovereign Debt Restructuring – A discussion about collective action clauses, negotiation principles, and timing

In times where the level of indebtedness is high in many countries and future growth expectations oftentimes decline, the topic of how to restructure sovereign debt becomes ever more important. The discussion at the IIF spring meeting on June 26, 2013, was, therefore, very helpful to follow.

Statutory vs. contractual approach

To restructure sovereign debt, you can take two principal approaches: The idea of the statutory top-down approach is to fix binding rules on a supranational level. As there is currently no international consensus on such rules, the contractual approach, namely through collective action clauses (CACs), is the only approach which is left. Besides this pragmatic argument in favor of collective action clauses, Ramon Fernandez, Director General for Treasury and Economic Policy in France and Chairman of the Paris Club, says: “There is a collective agreement that the contractual approach to debt problems is preferable over a more statutory approach and this is where CACs [collective action clauses] kick in.”

Ramon Fernandez

Broadly speaking, collective action clauses allow a super-majority of bondholders to buy in 100 % of all bondholders.

However, as Whitney Debevoise, Partner at Arnold & Porter, points out: “Collective action clauses can be both a shield and a sword.” Ergo, they are not always the panacea for any sovereign restructuring. Whitney says that most important is the degree of support among bondholders for a restructuring – At 97 %, you will always strike a deal whereas a 60 % support will hardly be sufficient to restructure. “If you believe in the market, there will always be a market-clearing price for a deal.”

Whitney Debevoise

Finally, CACs should only be implemented prior to a bond issue. This is, at least the opinion of Jean Lemierre, Advisor to the Chairman, BNP Paribas who says: “I think it's a reasonable tool when it is embedded at the beginning in the bond. You know the rule of the game.” [However,] “retroactive CACs are horrible.”

Jean Lemierre

Aggregation clauses is another important tool to organize sovereign debt restructurings efficiently. An aggregation clause tries to combine interrelated claims into a single litigation. In the case of bonds, this means to combine several bond issues of a sovereign and apply voting majorities (typically 75-85 %) at aggregate level and, at the same time, respect lower majority levels (typically 2/3) on an individual issue basis. Obviously, this type of clause is especially important, if you seek to replace the entire debt stock of a country in one go, as was the case in Argentina’s recent debt restructuring.

Finally, engagement clauses, organizing creditors among themselves as well as recognizing and structuring creditor committees, play an important role. Such clauses should be aim at a transparent debt sustainability analysis and a fair burden sharing among creditors.

Principles of sovereign debt restructurings

Ramon Fernandez, Director General for Treasury and Economic Policy in France and Chairman of the Paris Club, reminds the need for common principles guiding sovereign debt restructurings: “We have to be aware that each case [of sovereign debt restructuring] is different. But we need principles in order to deal with them.”

The general principles which should apply to any sovereign debt restructuring are the following:

  • Transparency and availability of information
  • Dialogue and cooperation between creditors and debtors
  • Good faith negotiations: “Good faith is crucial. There is a tendency to lead bilateral discussions with separate bondholders. But it is childish because people talk to each-other and understand what is happening. This makes the process only more complicated. It's better to sit around the table altogether.” (Jean Lemierre, Advisor to the Chairman, BNP Paribas)
  • Inter-creditor equity

On the merits, solutions must address not only debt sustainability, but also long-term economic growth and international financial stability.

Timing of sovereign debt restructurings

Negotiations must get two sorts of timing right:

  • First, it is hard for the kick-off for sovereign debt restructurings to intervene timely, as the necessity for restructuring is not always obvious and subject to market perception. Ramon Fernandez says – “It is and it will remain difficult to establish in a clear-cut way the necessity of debt restructuring and its optimal timing.” Because market perception of the necessity fluctuates.” Jean Lemierre, Advisor to the Chairman of BNP Paribas seems to agree on this point: “I am extremely surprised by the level of information that is given before the difficulties.”. On the other hand, his talk implies that people tend to ignore the necessity for sovereign debt restructurings: “From time to time, the market doesn't give the exact risk.” and “We should not act with a herd instinct and we should not be led only by the upper end yield on the bond but the real risk.”
  • Second, negotiations are complex and require a lot of time. “Negotiations can take time and need to take time in order to go to a good solution, in good faith, and in a cooperative way.” (Ramon Fernandez, Director General for Treasury and Economic Policy in France and Chairman of the Paris Club) / “It [the Greek debt restructuring] was extremely difficult. It took time – a lot of nights – this is part of the game, but it was well managed.” (Jean Lemierre, Advisor to the Chairman, BNP Paribas)

Sovereign debt restructurings data

Bart Oosterveld

Bart Oosterveld, (Managing Director, Head of Sovereign Risk Group, Moody’s Investors Service) summarizes some Moody’s research about sovereign debt restructurings:

  • A high debt/GDP ratio is neither necessary nor sufficient for a [sovereign debt] default to occur.”
  • Sovereigns that default are likely to do that again.”
  • Final losses to investors [in sovereign debt restructurings] are widely distributed. The range is 5 % to 95 %, the average is 50 %.”
  • Maturity extensions are the preferred tool [in sovereign debt restructurings], followed by a reduction in the coupon. Hardly ever is there a normal haircut on the debt.”
  • Holdout problems are not so relevant as the current public debate suggests. According to Moody's research, the Argentina case is the only really relevant case here.



Tuesday, October 1, 2013

Multilateral Investment Guarantee Agency (MIGA) – Promote foreign direct investment into developing countries

MIGA is one to the very few organizations, where it makes sense to look at what its shortcut means: MIGA is a Multilateral Agency (i.e. an international organization) that Guarantees foreign direct Investments. What you can’t abstract from its name is that MIGA only supports projects in developing countries.

Organization and Mission

MIGA is a member of the World Bank group but legally and financially independent. Thus, it is governed by a proper convention and issues its own financial statements, in accordance with US GAAP and IFRS. The agency has been established in 1988 and currently joins together 177 member countries. The voting rights of the member countries depend on the amount of capital stock subscribed. The most influent countries are shown in the graph below.

MIGA’s funding sources are

  • Subscribed capital: Roughly 20 % are paid-in, either through cash or through non-interest bearing negotiable promissory notes. The additional 80 % are made available by member states to MIGA when needed.
  • Retained Earnings
  • Accumulated and other comprehensive income
  • Net insurance portfolio reserve

MIGA’s has a simple mission:

Promote foreign direct investment into developing countries to support economic growth, reduce poverty, and improve people's lives.”

According to the World Bank president, Robert B. Zoellick, MIGA's four strategic priorities are to

  • invest in the poorest countries (41 % of guarantee volume in FY 2012);
  • invest in countries affected by conflict;
  • carry out complex and transformational projects;
  • do south-south investments (22 % of guarantee volume in FY 2012).


MIGA provides, through guarantees, the comfort necessary for international investors to invest in developing countries. It plays especially a countercyclical role here, as the agency supports banks and other financiers in times of stress. To be eligible, projects must be economically, environmentally, and socially sustainable and promise a strong development impact.

MIGA’s core business is to grant political risk insurance (PRI). It this sector, its guarantees can cover any or all of the below:

  • Transfer restriction / inconvertibility: Local currency is either inconvertible or cannot be transferred outside the host country.
  • Expropriation: The host government reduces or eliminates ownership or control over the insured investment.
  • Breach of contract: The investor cannot obtain or enforce an arbitral or judicial decision recognizing the breach of an obligation by the host country.
  • War and civil disturbance
    Non-honoring of financial obligation: A sovereign fails to honor an unconditional financial payment obligation or guarantee. Contrary to the breach of contract cover, this insurance does not require a final judicial or arbitral decision.

MIGA’s PRI can cover equity investments, shareholder and non-shareholder loans, loan guarantees, and other forms of investment such as technical assistance and management contracts, franchising and licensing agreements.

Besides PRI, MIGA offers dispute resolution services, technical assistance (= help governments design and implement reforms to improve their business environment and attract foreign investment), and research and knowledge services.

A very useful section in MIGA’s annual report is the description of exemplary projects:

  • Guarantee of an investment of a 20 MUSD investment by Deutsche Bank in its Bangkok branch in Thailand.
  • Guarantee of an equity investment of 121 MEUR by EVN to build a 53 MW hydropower plant in in Albania.
  • Guarantee of a 250 MUSD shareholder loan by UniCredit to a subsidiary in Croatia.
  • 132 MUSD guarantee for the benefit of ProCredit Holding of central bank deposits for mandatory bank reserves carried out by its subsidiaries Bolivia, El Salvador, Georgia, Serbia, and Ukraine.
  • Guarantee of an investment in a Coca Cola bottler in Turkmenistan in the amount of 9 MUSD.
  • 120 MUSD guarantee for a non-shareholder loan provided by a banking pool for an upstream gas project in Uzbekistan.
  • 320 MUSD guarantee to cover the financing of the construction of a metro line in Panama City by a banking pool.
  • Guarantee of a 2 MEUR Spanish private equity investment in Morocco and a 4 MEUR Spanish private equity investment in Tunisia.
  • Guarantee of a 12 MUSD investment by ADC Financial Services in banking subsidiaries in Botswana.




MIGA Annual Report 2012