Friday, July 18, 2008

Banks Fight EU Plan for Credit Derivatives Reserves

(Bloomberg) -- The financial industry is fighting a European Commission plan to boost capital requirements on credit- default swaps and other instruments used to transfer risk in response to the market turmoil of the last year.

Banking groups object to a draft from the European Union that broadens new capital rules beyond asset-backed securities to cover syndicated corporate debt as well as the $62 trillion market for credit-default swaps. The plan would force banks to maintain a 10 percent stake in any such instruments they sell.

The initiative, which isn't yet a formal proposal, seeks to give banks more incentive to make safe loans. Policy makers argue that standards loosened as banks sold off their loans, leading to U.S. mortgage defaults that touched off a credit crunch and more than $423 billion of losses and writedowns at banks.

``Fundamental flaws'' in the plan will crimp financing and weaken risk management, banking groups including the European Banking Federation and the Securities Industry and Financial Markets Association said in a letter to Financial Services Commissioner Charlie McCreevy. ``It will damage the competitiveness of Europe.''

After a call for action by EU leaders in March, the commission plans to make a formal proposal as soon as September. The contents may change from the current draft, which is open for public consultation until tomorrow. The initiative's main elements would need backing of national governments and the European Parliament to become law.

Policy Versus Profit

McCreevy said he will listen to what the trade groups have to say and conduct an impact assessment on the proposal.

``People should never get confused as to the roles of, say, the commission, which is the policy maker, and the industry, which is the profit maker,'' McCreevy said before a conference in Brussels yesterday. ``This notion that either governments or the commission will always come up with proposals that the people that are regulated are going to like, that's nonsense.''

The commission plan, revised two weeks ago, would bar EU banks from buying asset-backed securities or other risk-transfer instruments unless the seller, regardless of where it is located, keeps an interest in the assets. The mandate would apply to syndicated loans and credit-default swaps.

Market Grind

``Any credit market would be impacted,'' Bob Penn, a lawyer at Allen & Overy's regulatory funds and financial products group, said in a telephone interview. ``If implemented it would cause European capital markets first to grind to a complete halt, and then to move offshore.''

The commission in April had proposed forcing EU banks to keep a 15 percent stake in any asset-backed securities that they sell. After industry officials complained they would be at a disadvantage, the agency shifted focus to investments, giving U.S. and Asian lenders an incentive to keep an interest in their loans if they want to attract European buyers.

``The proposal potentially weakens the incentives for investors to perform appropriate additional due diligence and credit assessments,'' said the letter from the trade groups, also including the British Bankers' Association, the European Securitisation Forum, the International Swaps and Derivatives Association, the Commercial Mortgage Securities Association and the International Association of Credit Portfolio Managers.

Other critics include the European Savings Banks Group and the Association of German Banks.

The restriction on holdings ``would seriously limit the investment possibility of banks,'' Nicolas Jeanmart, head of supervision and economic affairs at the savings banks' organization in Brussels, said in a telephone interview.

`Adverse Incentives'

``Perceived adverse incentives can only be eliminated by applying appropriate lending criteria and improving risk management,'' Hans-Joachim Massenberg, deputy general manager of the German group, said by e-mail. ``Regulatory interference in the banks' business activities and higher capital charges are not suitable instruments. These could lead to regulatory arbitrage.''

Industry officials also called on the EU not to impose rules ahead of a review by regulators and central bankers at the Basel Committee on Banking Supervision, which sets international guidelines on capital.

Forcing banks to hold more capital on funding instruments will make it more expensive to finance credit to consumers and businesses, said Mark Nicolaides, a Latham & Watkins LLP law partner specializing in structured finance.

``Banks are starting to cut back on their mortgage lending'' due to financing in the market, Nicolaides said in a telephone interview from London. Further constraining the business by raising capital requirements may push activity ``outside the banking system'' to unregulated lenders.

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