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The perils of multiple regulators

19 November 2014
Richard Kemmish

The Single Supervisory Mechanism is something of a misnomer. There will not be one central regulator for all systemically important banks, there will be two. It is just that the one in Frankfurt will be the important one and will delegate the ‘non-crucial’ regulatory tasks to the existing national regulator.

The hierarchy of the supervisors is conformed in the rule book of the SSM which makes it clear that the ECB has the power to direct the local regulators whenever it feels that they might have got it wrong, or whenever the ‘non-crucial’ regulation is subordinate to a higher goal. And that’s the bit that worries me.

Why am I concerned? It is clear that the ECB will take precedence in the regulation when it comes to a potential bank failure. Decisions about which of the resolution tools to use and how and when to use them will be made with bankers with a very clear objective: systemic stability. These central bankers also have a vast amount of discretion, they think themselves omnipotent. After all, what is more important than financial stability as defined by the ECB?

Do you see where I’m going with this? If non-crucial tasks – like the amount of over-collateralisation needed in a cover pool – are decided at a local level but are at odds with more systemic decisions – like how much to bail-in senior creditors, there is a very clear potential for a conflict of interests. Paris says put more asset in the pool to protect covered bond holders, Frankfurt says take assets out to protect the bank’s liquidity.

The recent changes to the pfanbrief law allowing the regulator to set issuer-specific over-collateralisation can be seen in this light. Can the ECB set aside ‘voluntary overcollateralisation’? does it become less voluntary if it was an order of Bafin? Can the ECB contradict such an order at all? A conflict of interest could become a conflict of laws.
Am I worrying unduly? Quite possibly. The ECB is so long covered bonds and the various arms of the European Union are so supportive of the product that it would take a significant seismic change in attitudes for the ECB to create a default by reducing over-collateralisation.

But, maybe a lower score on the richter scale would allow an acceleration of the bonds? Take this scenario: resolution was inadequate and a major European bank is to be wound down. There are covered bonds outstanding for perhaps thirty years, but healthy amounts of over-collateralisation in the cover pool protecting the bond holders from the current crisis and crises yet to come. Presumably, one day some of this excess over-collateralisation will be spare and be due to the senior creditors.  But companies can not be wound up when there is still the potential for a recovery, no matter how small or distant.

Do you think that the resolution of a major financial institution will be kept open for thirty years on the off chance that some collateral might eventually flow back from a cover pool? Probably not. Would the bonds be forced into acceleration? Possibly.

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