IS BANK OF Italy governor Ignazio Visco right in urging the EU to roll back rules aimed at preventing taxpayer-funded state bank bailouts? Frankly, I wouldn’t be a bit surprised if the European policy, regulatory and supervisory technocrats privately agree with him.
ESMA issued an intriguing statement this past week that fairly transparently evidenced anxiety about how credit institutions and investment firms apply MiFID requirements to the distribution of financial instruments subject to the EU bank resolution regime. The specific focus was the impact of bail-in provisions and the risks to investors of understanding the moving parts that can lead to full or partial write-down.
The agency seemed happy enough to absolve investors of any responsibility or accountability, which is ridiculous. But its main area of concern was a patent lack of trust in the banks. Running through the core of the entire statement was a reminder to banks of their general duties of conduct vis-a-vis clients: an obligation to act in their best interest; providing fair, clear and not misleading information; point-of-sale transparency; timely disclosure on an ongoing basis; and dealing with conflicts of interest. And another reminder of existing provisions around selling or advising on the sale of financial instruments.
ESMA acknowledges that taxpayer bailouts during the financial crisis may have been necessary to prevent widespread disruption to financial markets and the real economy. But I’m guessing, unlike Visco, ESMA claims to be comfortable that the BRRD’s extensive toolkit and sweeping powers introduce a clear and comprehensive bank recovery and resolution regime that is “crucial for … minimising the potential public cost of possible future financial crises”. I sense a lot of crossed fingers around that comment.
The risks ESMA highlighted in instruments subject to the BRRD include lack of liquidity in stressed conditions in bank term debt markets no longer protected by implicit government guarantees; as well as concentration risk in investors’ portfolios.
But in highlighting concerns about the ability of investors to understand the resolution regime, where they rank in the creditor hierarchy, and the conditions under which losses can be incurred, the agency unwittingly brings to the fore key issues of concern in the burgeoning market for bail-in instruments. These are their inherent complexity, the latitude that resolution authorities have to alter terms of investments, and the lack of a level playing field. Individual jurisdictions have slightly different resolution flavours, not to mention local tax and accounting vagaries.
LET’S BE CLEAR, there’s zero certainty that the bail-in regime will work at all for a bank of systemic importance or prevent vicious contagion. In fact, some argue that the new regime is just as likely to initiate a negative death-spiral (see Feature, “Bank bail-in faces European pushback”).
ESMA worries that investors just won’t understand what they’re buying. And so they should. “[ … ] investors will generally have limited understanding of how the risk of losses under this set of circumstances [i.e. in resolution] differs from losses resulting from ordinary (non-financial) counterparty default and entry into insolvency,” ESMA said. I’m not sure quoting the “No Creditor Worse Off” safeguard instils much confidence.
The fact that ESMA felt moved to remind us of its 2014 warnings around CoCos, and its view that only knowledgeable institutional investors can really understand them, speaks volumes. In telling firms now that they should have solid procedures around client suitability and categorisation, it’s clearly warning them off selling bail-in instruments to unsuitable investors.
If they’re that concerned, I wonder why they don’t just move to ban sales of capital instruments to retail, as the UK has done. Italy is likely to bring in restrictions, following the political pain of last December’s bail-in of Banca Etruria, Cassa di Risparmio di Ferrara, Banca delle Marche and CariChieti.
Speaking to Visco’s contagion point, that episode led to a run on deposits at other banks deemed to be weak. The governor was unhappy that – by forcing a bail-in over a bailout by the deposit guarantee fund and, more widely, the lack of state bail-out as a policy option in Europe – this creates a situation of vulnerability that will leave national and European authorities powerless to prevent a major shock.
I’ve spoken to very senior investment banking executives who profess total bewilderment about bank capital and funding instruments
THE PROBLEM IN this entire debate is that the resolution regime, the language around it, and the wide range of possible outcomes have become so convoluted that almost no-one beyond a narrow set of specialists on the sell-side, buy-side and issuer communities understands them.
I’ve spoken to very senior investment banking executives who profess total bewilderment about bank capital and funding instruments and their interaction with the resolution and tax/accounting regimes. Want to see a grown man cry? Ask him to explain the bewildering and jargon-ridden silliness the capital and funding story has become. He will fail. Or get an expert to run him through it; watch his eyes glaze over, well up and tears of pain start to run down his face.
ESMA exhorts firms to use simple and comprehensible language; provide clear and straightforward explanations of technical terms; and present information in an objective way, ensuring that the potential risks inherent in financial instruments subject to the resolution regime are brought to the fore. Frankly this should be the least of their concerns. Their major concern should lie in the very fact that the European institutions have created something so absurdly convoluted in the first place.
