WP2 Financial markets and international regulation

1. WP2 Financial markets and international regulation The Future of Financial Markets and Regulation: What Strategy for Europe? Challenges for Europe in the world in 2030 Brussels stakeholder’s, 17-18 November 2011 Jean-Baptiste GOSSÉ* Dominique PLIHON ** *CFAP, University of Cambridge ** CEPN, Université Paris-Nord

2. Outline of the paper • Aims of the study • Future developments in financial markets • Challenges of financial regulation • 5 scenarios • Conclusions

3. The aims of this study • To provide a base for strategic thinking • To define the best strategy for Europe

4. Future developments in financial markets

5. Future developments in financial markets • Strategies of financial operators • Increase the size of financial institutions to face the growing international competition • Concerns about new regulatory constraints which can jeopardize their competitiveness. They would prefer self-regulation rather than close state control. • Extend the use of automation • Promising markets • 2 minor tendencies: ethical and green finance • 2 major tendencies: derivatives and Over-The-Counter markets

6. Future developments in financial markets (Cont’d) • Future locations of financial markets • Region specific financial products • Strategic role of commodities • Increasing opening of financial markets in emerging economies • Financial innovation vs. regulation

7. 3 dimensions of financial regulation

9. 3 dimensions of financial regulation • Microprudential regulation: stability of individual entities and protection of clients • Macroprudential regulation: stability of the financial system as a whole • International coordination: stability of the international financial system

10. Microprudential tools • Increase the amount and the quality of own funds • Liquidity coverage ratio (LCR) • Net stable funding ratio (NSFR) • Central counterparties for OTC markets (counterparty risk) • Leverage ratio • Etc • Main limitations: evaluation of risks by CRA, consideration of the systemic risk

11. Macroprudential tools • Countercyclal buffer (avoid procyclicality) • Additional loss absorbency requirements for SIFI: reinforce certain actors because of the risk they pose to financial system as a whole. • 2 criteria: • Size on financial markets • Degree of interconnection • Main limitations: • Identification of SIFI • Measure of the systemic liquidity risk • Definition of macroprudential tools to mitigate systemic liquidity risk • Need for better adaptation to financial innovations

12. International coordination problem At the international level, the regulator has three main objectives which are not necessarily compatible: 1) Financial stability 2) Independence of regulatory policy 3) Financial integration

13. Incompatibility triangle of financial objectives

14. 5 scenarios

15. Bipolar • Decision makers: USA – China (Chimerica) • Regulation and supervision: Basel III, regulation reform in the US and in Europe (new architecture and some macroprudential regulation measures) • IMS: IMS mostly based on dollar, growing role of yuan; euro remains a second class currency • Implications for the eurozone: unstability of the euro, slow growth, tensions within the eurozone

16. Reduced government • Decision makers: large financial players & transnational corporations • Regulation and supervision: market friendly reform (race to the bottom), extensive financial deregulation (internal and external) • Regulation is circumvented by financial innovations • Basel III standards: partially applied at national level • IMS: Persistent financial & monetary instability; persistent imbalances; debt crises; domination of large banks & investors; accommodation by central banks • Implications for the eurozone: debt crisis in Europe, default or break up of the eurozone

17. Fragmentation • Decision makers: Nation – States (economic nationalism) • Regulation and supervision: country specific regulation; no coordination; strong heterogeneity • IMS: Currency competition; financial & monetary unstability; dominant role of dollar & emerging country currencies; growing speculation; reduction of international trade & finance => deglobalization • Implications for the eurozone: reduction of intra-EZ trade, vulnerability of smaller countries to speculative attacks, strong appreciation of DM, rise in the borrowing costs of Southern European countries

18. Regionalisation • Decision makers: States & regional authorities • Regulation and supervision: regulation is coordinated at a regional level, capital openness in blocs but capital control between blocs • IMS: regional monetary zone (Mercosur, euro area, ASEAN, CIS, Arab league…). Regional financial integration with differentiation of financial systems (e.g. Islamic finance). Adjustment of global imbalances through exchange rates in order to respect FEER levels. • Implications for the eurozone: extension of the EZ (Eastern Europe, maybe North Africa), definition of a common economic policy with stronger institutions, advantages of financial integration at the continental level, financial regulation compatible with European systemic risk aversion.

19. Multipolar • Decision makers: Growing role of supranational authorities (IMF, Basle Committee) and of civil society (large NGOs) • Regulation and supervision: agreement on financial regulation (e.g. G20 level), strong macro-prudential regulation (global systemic risk management), close supervision of CRA • IMS: Creation of a global currency (SDR or Bancor), euro becomes a regional currency • Implications for the eurozone: growing integration of EZ with the world economy, reinforcement of the power of global institutions instead of European institutions

20. Conclusions • Only 3 stable scenarios

21. Conclusions (Cont’d) • What could be the financial strategy of Europe • Current situation • Europe • World (USA, UK, Australia, Japan)

22. Thank you