New World Order Merkel's Financial Summit Wish List
When she heads off to the world financial summit in Washington D.C. on Friday, German Chancellor Angela Merkel can take comfort in the fact that she has plenty of firepower. In her briefcase, she will have with her proposals and aims prepared for her by a group of six experts, headed up by Otmar Issing, the former chief economist at the European Central Bank (ECB). The group churned out the documents in just two weeks.
German Chancellor Angela Merkel has a long list of changes she would like to see made to the global financial markets.
Foto: REUTERSThe German package, which SPIEGEL ONLINE has obtained, includes proposals for radically strengthening the oversight of numerous world financial markets. Still, Merkel's panel of experts is not interested in a radical restructuring of oversight mechanisms. Rather, they would like to gradually strengthen the institutions and rules that already exist.
In addition to Issing, former EU Director General for Economic and Financial Affairs Klaus Regling, University of Frankfurt Professor Jan Pieter Krahnen, government finance expert Jörg Asmussen and Chancellory economics expert Jens Weidmann were all involved in producing the paper. And it is indeed an ambitious document. All of the shortcomings of the current financial oversight system are to be systematically eliminated. Of particular note, the position paper calls for all financial institutions that have systemic importance to be subject to a supervisory and regulatory scheme.
Increased Oversight of Offshore Havens
The document is intended as a challenge to the hedge fund industry, which has thus far been largely free from oversight, but also on tax and regulation havens like the Cayman Islands or the Channel Islands. Increased oversight of such offshore havens is paramount, the paper argues.
The Issing paper clearly enumerates the blind spots that it now seeks to eliminate. In addition to hedge funds, the document also mentions departments within companies, such as insurance firms, that operate similarly to hedge funds. But the document also calls for increased oversight of off-balance sheet activities.
Derivatives trading is another area where the German advisors would like to see greater control. The paper calls for an improvement in transparency when it comes to ratings agencies as well, proposing the idea of an central oversight body which would produce an annual report on ratings practices.
Making the markets more transparent is a consistent theme in the German paper, and one tool to improve the sharing of information is that of a so-called credit register. The idea would be to document the major loans made worldwide so that institutions know of the primary exposure of other institutions with whom they do business.
So far, such a mechanism only exists on a national level -- in Germany, the Deutschen Bundesbank has a division which monitors loans that exceed a certain size. But a cross-border system doesn't yet exist. The Issing group argues that it would be simple to compile such information gathered by specific countries into a central database.
World Map of Risk
Indeed, it is this step which leads to a real innovation proposed by Merkel's group of experts. The paper proposes the establishment of a world map of risk. All major financial institutions, banks, insurance firms, hedge funds and financial products would be shown. At a glance, one would be able to tell where risk was concentrating.
Issing's experts have also adopted a pragmatic stance when it comes to the issue of how executive salaries should be limited in the future. They advocate a system in which the salaries of bank executives will be geared toward long-term goals. In their view, the system of compensation to date has been oriented toward the short term, which has led many managers to take big risks in the hope that they can increase their share of the profits.
The experts are not advocating imposing any ceilings on salaries or prohibiting the payment of bonuses. Instead, they propose imposing a merit-based arrangement -- meaning a reduction of executive incomes when their companies perform poorly. The paper takes pains to point out that the state should not be responsible for dictating salaries. Rather, if feels that regulatory officials have a role to play in finding principles for sound compensation.
(Be)Rating the Raters
Several recommended improvements concern the work performed by the rating agencies. A significant degree of the blame for the current misery has been attributed to rating agencies because they provided good ratings to many of the financial products that, in hindsight, turned out to be unsound. One potential cause of this was a classic conflict of interest: Banks, which sold the complicated financial products, paid the agencies for the ratings leading many ratings experts to shy away from issuing bad reports on the products of their customers.
In particular, the proposals envision that regulatory officials will also keep a close eye on the rating agencies. They also imagine a new central regulatory agency that assesses the work and practices of the agencies in annual reports. In the end, the experts hope that such measures will improve the quality and integrity of the risk estimates. In addition, they foresee a system in which the fees collected by the rating agencies are dependent upon the degree to which their risk estimates were correct.
Issing and his experts also propose stringent restrictions on institutions offering complicated structured financial products. The goal should be to make risk more apparent. In the future, the paper recommends, companies offering structured financial products should be required to keep particularly risky tranches on their own books. To date, they have been allowed to distance themselves from all risk.
The expert group opposes transforming the International Monetary Fund into the policeman of the global financial markets, as was suggested by French President Nicolas Sarkozy. The IMF lacks the expertise to function as a standard-setter for the financial market, according to the paper. This has long been the task of the Bank for International Settlements (BIS). Still, the two institutions should strengthen their collaboration, the experts recommend. The same applies for the Financial Stability Forum (FSF), a working group of finance ministries, central banks, and regulatory bodies from selected countries.
National banking regulators are also encouraged to collaborate with one another more than they've done up to now. Agencies from different countries should join forces to monitor transnational financial institutions.
Safeguarding the Euro
Central Banks, too, need to strengthen their cooperation both with international financial institutions like the IMF and with national regulatory authorities. Up to now, the former have analyzed primarily national economic data while the latter have concerned themselves with commercial data from financial institutions. If both types of information were consolidated, there could be a world-wide early-warning system.
The experts are aware that there are countries that stand against their recommendations. For this reason they recommend that the countries of the European Union lead the way in the implementation of a new financial architecture.
Above all the EU needs a uniform regulatory authority for the biggest transnational banks. A reform of the European oversight structure is necessary to create an integrated market in the EU and to safeguard the euro.
With their suggestions, the group is on a collision course with the French, and, in equal measure, with the Americans. They're not set on a totally new financial world order, as has been floated by French President Nicolas Sarkozy. But neither do they want to leave everything as before, which, at any rate, is what the representatives of the current American administration would most like to do.