SAFE policy letter
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86
This Policy Letter outlines a pandemic insurance solution through a pandemic-related “Insurance Linked Bond”. It would be originated by governments, with a principal amount to cover significant costs resulting from a pandemic. These bonds, which would be traded on a secondary market, generate a risk-adequate return for private and institutional investors that is financed through the insurance premiums paid by the public domain. In case of a pre-defined pandemic trigger event, the principal of the bond becomes available for the originating governments to cover pandemic-related costs. Through this approach, governments can insure themselves against future pandemic-related risks, while funding comes primarily from private and institutional investors.
85
The European Commission is trying to reboot the CMU project: The High-Level Forum on Capital Markets Union – a group of 28 selected experts from industry, academia and civil society – is expected to submit policy recommendations by the end of May 2020 which will feed into the Commission’s new CMU agenda. This contribution is largely based on a letter to the High-Level Forum that gives feedback on the Interim Report published in February. There, we introduce a comprehensive approach to distinguish, from a functional finance perspective, between the ‘game changers’ and what is nice to have. We highlight the importance of common and consistent supervisory practices across Member States and recommend building up a European Securities and Exchange Commission (E-SEC) according to the American model.
84
This Policy Letter presents a proposal for designing a program of government assistance for firms hurt by the Coronavirus crisis in the European Union (EU). In our recent Policy Letter 81, we introduced a new, equity-type instrument, a cash-against-tax surcharge scheme, bundled across firms and countries in a European Pandemic Equity Fund (EPEF). The present Policy Letter 84 focuses on the principles and conditions relevant for the operationalization of a EPEF. Our proposal has several desirable features. It: a) offers better risk sharing opportunities, augmenting the resilience of businesses and EU economies; b) is need-based, thereby contributing to an effective use of resources; c) builds on conditions and credible controls, addressing adverse selection and moral hazard; d) is accessible to smaller and medium-sized firms, the backbone of Europe’s economy; e) applies Europe-wide uniform eligibility criteria, strengthening support among member states; f) is a scheme of limited duration, reducing (perceived) government interference in businesses; g) creates a template for a growth-oriented public policy, aligning public and private sector interests; and h) builds on the existing institutional infrastructure and requires minimal legislative adjustments.
82
The case for corona bonds
(2020)
Corona bonds are feasible and important to preserve the European project. We set out a number of principles that might serve as a blueprint for the European institutions. Importantly, Corona bonds could be issued through a new public law entity and include all the safeguards required for the protection of the fundamental values of the EU. This proposal is pragmatic in the sense that it facilitates the choice European leaders have to make now; necessary to secure the resilience of the European Union. The political risks are significantly higher now than in 2010. The gargantuan challenge of tackling the combined impact of climate change, migration, digitalization, geopolitical shifts, and the spread of autocracy, requires leadership and joint action by the Council and the Eurogroup.
81
This policy letter adds to the current discussion on how to design a program of government assistance for firms hurt by the Coronavirus crisis. While not pretending to provide a cure-all proposal, the advocated scheme could help to bring funding to firms, even small firms, quickly, without increasing their leverage and default risk. The plan combines outright cash transfers to firms with a temporary, elevated corporate profit tax at the firm level as a form of conditional payback. The implied equity-like payment structure has positive risk-sharing features for firms, without impinging on ownership structures. The proposal has to be implemented at the pan-European level to strengthen Euro area resilience.
78
The spreading of the Covid-19 virus causes a reduction in economic activity worldwide and may lead to new risks to financial stability. The authors draw attention to the urgency of the targeted mitigation strategies on the European level and suggest taking coordinated action on the fiscal side to provide liquidity to affected firms in the corporate sector. Otherwise, virus-related cashflow interruptions could lead to a new full-blown banking crisis. Monetary policy measures are unlikely to mitigate cash liquidity shortages at the level of individual firms. Coordinated action at European level is decisive to prevent markets from losing confidence in the resilience of banks, particularly in countries with limited fiscal capacity. In contrast to the euro crisis of 2011, the cause of the current crisis does not lie in the financial markets; therefore, the risk of moral hazard for banks or states is low.
77
Discussions about the banking union have restarted. Its success so far is limited: national banking sectors are still overwhelmingly exposed to their own countries’ economies, cross border banking has not increased and capital and liquidity remain locked within national boundaries. The policy letter highlights that the current debate, centered on sovereign exposures and deposit insurance, misses critical underlying problems in the supervision and resolution frameworks. The ECB supervisors’ efforts to facilitate cross-border banking have been hampered by national ringfencing. The resolution framework is not up to its task: limited powers of the SRB, prohibitive access conditions and limited size of the Single Resolution Fund limit its effectiveness. A lack of a coherent European framework for insolvency unlevels the regulatory field and creates incentives to bypass European rules. The new Commission and European Parliament, with the new ECB leadership, provide a unique opportunity to address these shortcomings and make the banking union work.
76
Facebook’s proposal to create a global digital currency, Libra, has generated a wide discussion about its potential benefits and drawbacks. This note contributes to this discussion and, first, characterizes similarities and dissimilarities of Libra’s building blocks with existing institutions. Second, the note discusses open questions about Libra which arise from this characterization and, third, potential future developments and their policy implications. A central issue is that Libra raises considerable questions about its role in and impact on the international monetary and financial system that should be addressed before policymakers and regulators give Libra the green light.
75
In early July 2019, Christian Sewing, the CEO of Deutsche Bank, proclaimed a fundamental shift of the bank’s strategy after finally obtaining the approval of the Supervisory Board, which the management seems to have requested for quite some time. The essential point of the reorientation is a deep cut into the bank’s investment banking activities. At the same time, those parts of the bank’s activity portfolio that had been the mainstay of Deutsche Bank’s business 20 to 25 years ago, in particular lending to large and mid-sized German and European corporate clients, shall be strengthened in spite of a simultaneous reduction of the bank’s staff by 18,000 FTEs over the next three years.
The bank’s CEO, who has only been in office since about one year, was reported to have called this shift of strategy a “return to the roots of Deutsche Bank” at the press conference at which it was announced, without, however, making it clear to which roots he was referring: those of some 40 years ago, when Deutsche Bank was essentially a Germany-focused commercial bank, or even those from the late 19th century, when the bank had been founded with the mission to become an international bank with a strong capital market-orientation. In any event, the press was impressed and keeps repeating these words, that deserve to be taken seriously and irrespective of their vagueness may be justified. If it were successfully implemented, this change of strategy would indeed be fundamental and imply undoing what Deutsche Bank’s former management teams had aspired to do in the last 20 or 25 years.
The newly announced strategy shift raises two questions. Can it be successful, and what does it mean for the bank itself and its shareholders, for its staff and for its clients? And what does it imply for the German financial system? This note focuses on the latter question. What makes it interesting is the fact that the last fundamental change of Deutsche Bank’s strategy of two decades ago, which aimed at transforming Deutsche Bank from a Germany-centered commercial bank into a leading international investment bank, had a profound – and in my view clearly negative - effect on the entire German financial system.
73
In this exploratory article, we consider the future of Deutsche Bank and Commerzbank and develop a new approach to the topic: instead of a merger of DB and CB we propose to consider a partial merger of the IT and related back office functions in order to create the basis for an Open Banking platform in Germany. Such a platform would act as a cross-institutional infrastructure company in which the participating banks develop a common data and IT platform (while respecting the data protection regulations). Significant parts of the transaction processes would be pooled by the institutions and executed by the Open Banking platform. Moreover, the institutions remain legally independent and compete with each other at the level of products and services that are developed and produced using just this common data and IT platform – “national champions” would not be created.
But such an “Open Banking Platform” could become even the nucleus of a European Banking platform that could be competitive with existing global data platforms from the USA and China which are already offering financial services and are likely to expand their offerings in the foreseeable future. The proposed model of an open data platform for banks prevents the emergence of national champions and supports the main goal of the banking union: creation of a financial system, in which single banks can be resolved without provoking a systemic crisis and forcing taxpayers to finance bailouts.
71
Recently, Fuest and Sinn (2018) have demanded a change of rules for the Eurozone’s Target 2 payment system, claiming it would violate the Statutes of the European System of Central Banks and of the European Central Bank. The authors present a stylized model based on a set of macro-economic assumptions, and show that Target 2 may lead to loss sharing among national central banks (NCBs), thus violating the no risk-sharing requirement laid out by the Eurosystem Statutes.
In this note, I present an augmented model that incorporates essential features of the micro- and macroprudential regulatory and supervisory regime that today is hard-wired into Europe’s banking system. The model shows that the original no-risk-sharing principle is not necessarily violated during a financial crisis of a member state. Moreover, it shows that under a banking union regime, financial crisis asset value losses at or below the 99.9th percentile are borne by private investors, not by taxpayers, and particularly not by central banks.
Therefore, policy conclusions from the micro-founded model differ significantly from those suggested by Fuest and Sinn (2018).
70
In the context of Brexit, changes to the regulatory architecture of CCPs that empower the European securities markets regulator are under way to prevent the threat of a regulatory race to the bottom. However, this empowerment currently leaves the national supervision of common European rules within the EU intact. This policy letter argues that supervisory arbitrage is as much a threat within the EU as outside of it, wherefore a common supervision of CCP rules in the EU is called for. The paper traces the origins of the current set-up and criticizes the current regulatory proposal by the EU Commission as too cumbersome while discussing possible ways forward to achieve European supervision. In contrast to the current proposal of the Commission, we call for a unified supervision within ESMA, combined with a European fiscal backstop.
69
This policy letter provides evidence for the crucial importance of the initial regulatory treatment for the further development of financial innovations by exploring the emergence and initial legal framing of off-balance-sheet leasing in Germany. Due to a missing legal framework, lease contracts occurred as an innovative social practice of off-balance-sheet financing. However, this lacking legal framing impeded the development of this financial innovation as it also created legal uncertainties. This was about to change after the initial legal framing of leasing in the 1970’s which eliminated those legal uncertainties and off-balance-sheet leasing entered into a stunning period of growth while laying the foundation of a regulatory resiliency against efforts that seek to abandon the off-balance-sheet treatment of leases. As the initial legal framing is crucial for the further development of a financial innovation, we propose the French approach for the initial vindication of new financial products in which the principles-based rules are aligned with the capabilities of regulators to intervene, even when a financial innovation complies with the letter of the law. In this way, regulators could regulate the frontier of financial innovations and weed out those which are entirely or mainly driven by regulatory arbitrage considerations while maintaining the beneficial elements of those products.
68
While the debate about the needs and merits of cryptocurrency regulation is ongoing, the unprecedented price hikes of cryptocurrencies towards the end of 2017 triggered a somewhat unexpected sort of regulation in the form of public statements by governments and financial supervisors. It kicked in rather quickly and turned out to be much more effective than imagined. These interventions can be identified as one of the main factors that drove asset prices down, thereby preventing destabilizing bubbles. The experience of the supervisory response to the cryptocurrency bubble of the past months keeps important insights for any prospective regulation of cryptocurrencies. First, public statements are a highly effective regulatory tool in the short term as they manage market expectations, a fact which is well-known as forward guidance in monetary policy. So far, the legal framework in the EU takes insufficient account of the regulatory role of public statements. Second, regulation needs to keep up with the incredible speed of fintech innovations. Some regulators addressed the challenge by adopting a ‘sandbox’ approach. However, the ‘sandbox’ approach clearly calls for international cooperation. To achieve a balance between safety and innovation, international cooperation should emulate the experimental character of sandboxes. One could conceive of a ‘sandbox for regulators’, an arrangement which would facilitate the exchange of information on regulatory initiatives among authorities but also the coordination of communication and forward guidance.
67
Even if the importance of micro data transparency is a well-established fact, European institutions are still lacking behind the US when it comes to the provision of financial market data to academics. In this Policy Letter we discuss five different types of micro data that are crucial for monitoring (systemic) risk in the financial system, identifying and understanding inter-linkages in financial markets and thus have important implications for policymakers and regulatory authorities. We come to the conclusion that for all five areas of micro data, outlined in this Policy Letter (bank balance sheet data, asset portfolio data, market transaction data, market high frequency data and central bank data), the benefits of increased transparency greatly offset potential downsides. Hence, European policymakers would do well to follow the US example and close the sizeable gap in micro data transparency. For most cases, relevant data is already collected (at least on national level), but just not made available to academics for partly incomprehensible reasons. Overcoming these obstacles could foster financial stability in Europe and assure level playing fields with US regulators and policymakers.
64
Digitalization expands the possibility for corporations to reduce taxes, mainly, but not exclusively, by allowing improved planning where profits can be shifted. Against this background, the European Commission and several countries emphatically demand and design new tax instruments. However, a selective turning away from internationally accepted principles of international taxation will bring up more questions than solutions. While there are good reasons to think about a fundamental regime switch in international corporate taxation, there are also good arguments for not turning to ad hoc measures that selectively target the relatively small market of Google and Facebook and raise only negligible tax revenues.
63
Monetary policy and prudential supervision – from functional separation to a holistic approach?
(2018)
When prudential supervision was put in the hands of the European Central Bank (ECB), it was the political understanding that the ECB should follow a policy of meticulous separation between monetary policy and financial supervision. However, the financial crisis showed that monetary policy and prudential supervision deeply affect each other and that an overly strict separation might generate systemic risk. As a consequence, the prevalent model of “functional separation” – central banking and financial supervision in separate entities – has been questioned and calls for a more holistic approach increased.
This policy letter states that from a legal perspective, such a holistic approach would be in conformity with the current legal framework of the Economic and Monetary Union. Although the realization of a holistic approach might intensify the doubts of democratic legitimation under the framework of the ESCB, the independence of the ECB should not be given up. As viable alternatives to protect monetary policy against the time inconsistency problem that would render central bank independence moot do not seem to be available and given the great importance of the independence of the European institutions for the European integration, the democratic control over the ECB should be strengthened instead of stripping the ECB of its independence.
62
During the last IAIS Global Seminar in June 2017, IAIS disclosed the agenda for a gradual shift in the systemic risk assessment methodology from the current Entity Based Approach (EBA) to a new Activity Based Approach(ABA). The EBA, which was developed in the aftermath of the 2008/2009 financial crisis, defines a list of Global Systemically Important Insurers (G-SIIs) based on a pre-defined set of criteria related to the size of the institution. These G-SIIs are subject to additional regulatory requirements since their distress or disorderly failure would potentially cause significant disruption to the global financial system and economic activity. Even if size is still a needed element of a systemic risk assessment, the strong emphasis put on the too-big-to-fail approach in insurance, i.e. EBA, might be partially missing the underlying nature of systemic risk in insurance. Not only certain activities, including insurance activities such as life or non-life lines of business, but also common exposures or certain managerial practices such as leverage or funding structures, tend to contribute to systemic risk of insurers but are not covered by the current EBA (Berdin and Sottocornola, 2015). Therefore, we very much welcome the general development of the systemic risk assessment methodology, even if several important questions still need to be answered.