As governments step in to help, bureaucrats in Europe are imposing rules that can make even the safest debt harder to sell
As a lawyer who prepares prospectuses for bond offerings from major banks, Anna Pinedo never thought she'd have to assemble hundreds of pages of facts on the creditworthiness of Federal Deposit Insurance Corp. and the U.S. government. But a frustrated Pinedo is doing just that, in a telling example of the new sand that's grinding the gears of the global financial system.
This grit was thrown in by regulators in London who won't authorize Pinedo's bank clients to sell newly guaranteed debt to European investors without detailed disclosures about the FDIC, which is promising to make sure the bonds are repaid. So Pinedo and her firm, Morrison & Foerster, are rounding up all manner of facts about the FDIC's solvency, about dates U.S. government debt matures, about trends in the U.S. trade balance, and so on. It doesn't seem to matter that U.S. currency and creditworthiness are still among the strongest in the world.
"We've been held up for months trying to get the U.K. Listing Authority to sign off on our disclosures about the U.S. economy and the FDIC," says Pinedo.
Absurd? Get used to it, experts predict. Bureaucrats and politicians are assuming new power now that many financial firms and capital markets are on their knees and desperate for government help. "It is going to be a pain in the ass and it will cost more as well," says Willem Buiter, professor of European Political Economy at the London School of Economics.
In some cases, the new barriers will amount to simple overregulation by nervous bureaucrats. In others, Buiter says, they will be weapons in international trade battles. The only difference is that these protectionist measures will involve securities and lending instead of goods and services. "Financial protectionism is spreading on a much wider scale," says Buiter. It is a shift that's also reflected in increasing complaints from politicians that their own international banks are using that nation's bailout money to fund loans to foreigners.
Some of the new hurdles will emerge from stern applications of existing rules to new situations. A prime example is the burden on bonds guaranteed by the FDIC. The U.S. offered the guarantees to banks in October to quickly try to stop the tightening credit crunch. The guarantees were intended to encourage investors from anywhere in the world to lend to the banks so that the banks would have money to lend to customers. But the U.S. goal isn't such a priority for regulators in Britain, whose approval of bond sales would open the door to investors throughout Europe. They won't let the bonds through without the reams of information about the FDIC and the U.S.
A spokesman in London for the Financial Services Authority, Joseph Eyre, says that is because the FSA is following a Dec. 17 memo from the Committee of European Securities Regulators, of which Britain is a member. The memo says regulators should require disclosures about guarantees as they have in the past—unless the guarantors are from European governments, which are members of the committee. Then, of course, exceptions can be made. The result is that European regulators are quickly approving sales of bonds guaranteed by their governments, a big advantage in raising scarce capital. It doesn't seem to matter that in the past the regulators allowed the U.S. banks to sell bonds without the new safety provided by the U.S. government.
Other battlefronts are opening, too. Bankers are worried about brewing fights between governments over new regulations on credit-rating agencies and credit-default swaps, a type of derivative. The European Commission is proposing to require that ratings used there be issued by rating agencies operating in Europe with approval of European authorities. The new requirement would mean, as a practical matter, that banks and corporations wanting to sell bonds in Europe and in the U.S. would have to get ratings from both sides of the Atlantic. (Rating agency Standard & Poor's is owned by BusinessWeek's parent, The McGraw-Hill Cos. (MHP).)
Not Enough U.S. Oversight?
The Securities Industry and Financial Markets Assn., a trade group, complained last year that the European proposal "does not sit well with the global trend towards facilitating cross-border business…and elimination of bureaucratic obstacles." The extra burden will likely discourage companies from raising money where it is cheapest. European officials say they must exercise more oversight of rating agencies because U.S. authorities aren't doing enough.
Meanwhile, U.S. and European regulators have been taking separate steps to have credit-default-swap clearing houses set up in their own jurisdictions. Different clearing systems would work against the goal of centralizing markets in derivative contracts to reduce risk from defaults, according to a recent study by Darrell Duffie and Haoxiang Zhu of Stanford University.
Public officials, of course, say they intend to cooperate internationally. In a Feb. 14 communiqué, finance ministers and central bankers from the so-called Group of Seven large economies said they intend to develop "common principles and standards" for finance. It is a pledge likely to be repeated in the runup to the Apr. 2 meeting of heads of state from the G-20, which includes the G-7 plus other economic powers. Ahead of that meeting, the G-20 finance ministers and bankers were searching this past weekend in London for consensus on ways to coordinate economic stimulus programs and new financial regulations.
Christine Lagarde, finance minister of France, said recently at a conference at Columbia University in New York that to make regulation effective, nations must work together to write rules that are consistent with one another. Otherwise, she warned, financial institutions will play one set of rules off another to profit through what's known as "regulatory arbitrage." "Coordinated supervision is particularly needed for big, international players," Lagarde said.
The cooperation pledges sound good, says Malcolm Knight, vice-chairman of Deutsche Bank (DB) and former general manager of the Bank for International Settlements, who was at the conference with Lagarde. Knight says he's encouraged that officials have been quietly discussing possible international agreements on credit-rating agencies and credit default swaps. Still, he worries that the costs to taxpayers of bank failures will overwhelm the best intentions.
"Deep government involvement means that politicians must satisfy their own domestic constituents," Knight says.
The boundaries between nations were shrinking. Now they seem poised to rise at what may well be the worst possible time.