City of London warns against EU crackdown. A symbolic nutcracker will not solve the crunch

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EU's plans to kill a golden goose
The second piece here is the important one commenting on the first.
The proposals coming from Brussels are those typical for
bureaucrats. They believe they can stop the world going round with a
bit of paper. Canute proved them wrong there.

Britain benefitted great from the Americans making such a mistake
which is why London is the world’s leading financial centre today.
At a stroke all those American companies located in London could up-
sticks and go home again.

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FINANCIAL TIMES 1.8.08
1. City of London warns against EU crackdown
By Nikki Tait in Brussels

European Commission efforts to strengthen the regulation of financial
services in the wake of the credit crunch risk exacerbating the
sector's downturn and adding to the tens of thousands of job losses
already forecast, the City of London will warn today.

"Proposed changes could greatly increase the cost of capital across
Europe with detrimental effects far beyond the financial services
industry," said Stuart Fraser, chairman of policy and resources at
the City of London, which will today publish its gloomy forecasts.

His comments are targeted, in particular, at amendments to the
European Union's capital requirements directive. These are due to be
formally presented by the Commission in the autumn as part of its
broader response to the crisis in the financial markets.

Draft proposals have already been circulated in Brussels, and one
possible measure could involve tightening the "originate-
todistribute" model used by banks to devise the off-load securitised
products that have been at the heart of the recent crisis. Brussels
has suggested that originators should retain capital for at least 10
per cent of the exposures they securitise. This idea has, however,
already been attacked by banking organisations.

Mr Fraser cited the proposal as the type of regulation that the City
believed could seriously hamper the financial sector's prospects.
"The message we're trying to get across is that it's a very difficult
environment for financial services. What we don't need is regulation
that will exacerbate the downturn. The 10 per cent holding rule is
exactly what we don't need," he said.

Intervention by the City - home to the UK's largest financial
services sector - brought an equally forceful response from Brussels.
"If the industry wants to avoid a materially tighter regulatory
environment, they must come forward with more robust and meaningful
proposals to clean up their act," said a Commission official.

"When the financial sector is in such a state that losses risk being
socialised while profits from risk-taking are privatised, nobody
should be surprised if, in the absence of meaningful and
comprehensive industry response, there is a regulatory response to
address the misaligned incentives that are at the heart of the
problems that have arisen."

Investor confidence would not be restored by a race to the bottom,
said the official.

The City is preparing to publish its annual report on wholesale
financial services and their role in the EU economy. It is expected
to predict the sector's contribution to the EU economy by 2009 will
have fallen by 8.3 per cent from the €225bn ($350bn, £177bn) of last
year.

About 75,000 jobs could also be lost in the sector, which last year
employed a record 1.4m people in the 27 EU member states.
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2. A symbolic nutcracker will not solve the crunch
By Stuart Fraser

The first of August should herald the sleepiest month of the year in
Brussels. Not this time: on the anniversary of the credit crunch, the
European Commission is trying to act against collateralised debt
obligations, the complex repackaged debt products that are blamed for
the US subprime mortgage crisis. Unfortunately, internal market
commissioner Charlie McCreevy’s approach is to use the proverbial
sledgehammer to crack a walnut.

To start with the walnut: it is true that excessively complex debt
products were not properly understood or valued and that this
contributed to the US subprime mortgage crisis. But this nut is
pretty much cracked already – the companies that bought CDOs have
been thoroughly punished by the market and no sane investor will buy
a CDO for years to come. Investors now are interested only in
transparent products. The Commission can regulate CDOs if it pleases,
but the discipline of the market will kill them off anyway.

Now to the sledgehammer: the proposed amendment to the European Union
capital requirements directive will allow EU-regulated firms to hold
securitised assets only if the originators of debt hold at least 10
per cent of it on their books. This applies to all originators, not
just EU ones, and does not apply only to the problematic CDOs, it
covers all credit risk transfer products, no matter how transparently
packaged.

The logic driving this proposal – that it is possible to regulate
against irresponsible lending – is flawed. Bad loans are nothing new:
even before CDOs, banks made loans that were irresponsible. If the
CDOs had not led to big losses, they would not even be on the
Commission’s radar. By the time investors’ mistakes become a
financial crisis, their fingers are thoroughly burned. By the time
the regulators draft a complex ruling in response, they are banning
yesterday’s problem. So crisis-driven regulation is destined to chase
the tail of the market forever.

I am not advocating a free-for-all. We need regulation to protect
depositors and taxpayers. Compare, for example, the mis-selling of
mortgages to poor American families to the mis-selling of complex
debt between global banks. The first is morally reprehensible and
should be prohibited. The second may be naive and short-sighted, but
the big losers are the banks that should have known better. They need
the discipline of the market to make sure they learn the lessons next
time. We need consistent, principles-based regulation, not knee-jerk
responses to the latest drama.

Mr McCreevy’s move would deal a severe blow to the competitiveness of
the EU’s debt markets, driving large parts of Europe’s securitisation
industry back to the US overnight. Finance companies are footloose
and global. They will relocate to avoid burdensome regulation.

Europe cannot afford a stagnant financial services industry.
Wholesale financial services companies alone employ about 1.4m people
in the EU and account for two-thirds of labour productivity growth
since 2000. Financial services are also an important motor for the
European economy. This proposal will make credit in the EU more
expensive and less available. As the EU economy takes a downturn,
higher interest rates are surely the last thing on anyone’s wish list.

The potential threat of this legislation is real and substantial. New
research for the City of London Corporation, published on Friday,
shows that introducing the proposed capital holding requirement would
reduce EU-wide financial services growth by 3.5 percentage points
during 2007-2009 and by 7.3 percentage points in 2009-2012.

Given the serious implications of this legislation, I am particularly
disappointed by the way it is being introduced. The 10 per cent
capital holding requirement has been brought in as a “technical
amendment” to the EU capital requirements directive. But there is
nothing technical about this move: it is a political response to the
credit crunch. In its rush to be seen to “do something”, the
Commission has thrown its own rule book out of the window. Ignoring
the principles of Better Regulation, there has been no impact
assessment and no reasonable consultation period.

The Commission may feel compelled to legislate against complex
products. Fair enough: it needs a symbolic nutcracker. But the
current proposal goes far beyond a rational response to the credit
crunch. The result will not be “safer” financial markets in Europe,
but smaller markets instead.

The writer is chairman of the policy and resources committee, City of
London Corporation