Are MEPs about to take on the English legal profession?

English knights seeking to protect their estates were a driver behind 
the creation of English Trust law.

MEPs are set to vote this Thursday on the 4th Anti-Money Laundering Directive - which aims to shed light into who owns private companies. This sounds positive and innocuous and the sort of thing politicians, including David Cameron, often - and rightly - call for. But the devil is in the detail. Some MEPs are reportedly now proposing to extend this 'transparency' into Trusts as well as companies, which could have major impact on UK business.

Making a register of the beneficial owners of all private companies, based on millions of underlying arrangements, changing on a day to day basis, was already looking to be complex. But when it comes to Trusts, transparency runs into a serious intellectual and practical problems. Who is the beneficial owner of a discretionary trust? How do you report that a spouse has an interest in a property/company - something that may only become apparent in a divorce court?  Trusts encompass all manner of arrangements; trusts to protect children, trusts holding money pending a transaction, insurance policies, pensions, collective investment schemes etc. Without Trusts the UK's financial services industry would not be able to operate. Will MEPs really seek to have all this reported on a potentially public register? If it is indeed possible, reporting millions of ever changing arrangements could add a massive regulatory cost to everyone's financial affairs. Logic would dictate they would steer clear but lobbyists are already in full swing, pushing amendments that would radically increase the scope of the report.

This is also an important test for how the EU balances the interests of different member states. Trusts are a major innovation of the UK's, (particularly the English) legal system. Whereas continental legal systems traditionally tended not to look beyond the legal ownership of a property, the English legal system has taken a different approach, for better or worse dating back to the Crusades. Essentially, if you hand over the legal ownership of property to a relative in the expectation that you retain an interest (i.e when you come back alive from a Crusade) and it is not respected you could go to the King to receive justice - in the jargon you retained an 'equitable interest'. Other EU states have different set ups such as Stiftungs and Anstalts but these are not as widespread as UK Trusts.

What will happen? Well there are signs that some MEPs are aware of the problem, the EPP for one seems to be against, but David Cameron's ECR group (perhaps to save him embarrassment?) seems, for now at least, curiously undecided about coming out against these ideas.

This is not to say the English legal system should be exempt from transparency, but rather than EU politicians of all colours need to be acutelyy aware of the unintended consequences of regulating 28 different legal systems - with practices sometimes dating back centuries - with one broad brush.

EU caps on bankers' bonuses: the perfect regulatory storm?

The discussion over bank bonuses has been heating up inrecent days. Discussions between EU ministers, the European Parliament and the Commission (so-called trialogues) are restarting today as the three try to reach an agreement on the rules for bank bonuses to be included in CRD IV (the EU’s legislation implementing the Basel III rules and more).

The parliament is pushing for a stringent cap on bank bonuses of 1:1 ratio with fixed salaries, which could be increased to 2:1 with approval from a majority of shareholders.

There is a lot going on here, beyond the actual proposal, including:

• The UK is in a clear minority in categorically rejecting a cap, but unable to block a rule with disproportionate impact on the UK - courtesy of QMV and co-decision.
• Germany being the swing state - no surprises there - having first supported the UK's position, it has shifted as part of a wider political push to get tough on bankers, which strikes a chord with German voters. The revelation in December that Deutsche Bank hid $12bn worth of losses during the crisis and the growing Libor and Euribor rates scandals, haven't exactly helped...
• The European Parliament flexing its muscles, successfully managing to tap into the public mood, breaking the Council common position, which is unusual. (Don't worry, any favour EP thinks it wins with the electorate, would be ruined if it voted down Ministers' proposal for a reduced long-term EU budget).
• "Anglo-Saxon capitalism" in the docks - perception is one of a continental attack on British bankers (ironic since a large part of the talks have focused on making CRD4 more flexible to allow the UK and others pursuing tougher capital rules for banks). This will not make the City any more EU-enthusiastic.
• No one wants to be publicly seen to back bankers - even the UK government itself is keeping a low profile.
• Changing incentives as part of the eurozone banking union, with the club within a club dynamic again coming to the fore (see our December 2011 report to see what we mean). Looking forward, the question is, if a country decides to remain outside the banking union - therefore signalling that it will stand behind its own banks, come what may - should it not also have more discretion in getting the incentive structure in the banking sector right?

So what does the UK want?

On Friday the UK submitted a paper to its EU partners to put forward it’s case. We've seen the paper, and here are some thoughts / points - which also have been largely reported in the media:

• The UK argues against a firm cap. Any extended remuneration should be determined by shareholders (although the UK proposal does water down the size of the majority needed to approve remuneration slightly).
• The UK is pushing for a focus on non-cash deferred bonuses. This is included in the current proposal to some extent but the UK fears (with some grounding) that the current proposal will encourage an increase in fixed salaries and a focus on upfront cash bonuses - and reduce firms' ability to cut costs during a downturn, potentially leading to more lay-offs and less lending (on a bit less solid ground here, we think).
• It also argues that deferred non-cash bonuses (over three years) should not fall under any cap, while also rejecting the proposal that all employee benefits, above those mandated by law, should be categorised as a ‘bonus’.
• The government is also keen to see that subsidiaries of EU banks located in the rest of the world should not have to adhere to the rules. Furthermore, EU subsidiaries of banks headquartered outside the EU should not have to implement the rules (although their bonus plans will still need to be judged ‘prudential’ by the relevant financial supervisor).

So is this special pleading? Well, to some people in the City, the world will end if this comes into force - which is not quite the case. In fact, there's no surprise that politicians seize the opportunity to strike down on bankers' pay, given that many banks have been forced to seek taxpayer-backed bailouts and the rest of it. So the first message to the financial sector is: if you don't want to be subject to tougher regulations, stop screwing up.

But it could still be damaging and there are questions over how much difference a cap would really make on incentives and the distorting effects this could have across the board. Ultimately, the risk taken on and the decisions made by banks are dictated by much more than just bonuses - it is just a small part of a wider culture which needs to be reassessed. Targeting and correcting perverse behaviour still seems to be better done through more effective supervision and tighter regulation - the irony should not be lost that many of those pushing for a cap are also the ones advocating a maximum limit to capital levels and supporting watering down the Basel III liquidity requirements (see here for details). And there should be no doubt that this could make talent less likely to choose the EU over other part of the world, which clearly isn't in anyone's interest.

In the end, bank bonuses are also only a small part of the much larger CRD IV legislation. There is unlikely to be a formal vote on bank bonuses itself - and Ministers rarely vote in the Council - but the UK seems to be heading for a defeat on a pretty symbolic issue at a sensitive time.

On the other hand, if the UK government can pull this one off, it should be given a lot of credit. Ultimately, the final outcome of CRD IV as a whole will be the more important bellwether by which to judge UK success or failure.

The UK and banking union: could the Coalition go for a 'single market lock'?

We also have an op-ed in today's Times, in which we look at forthcoming proposals for a 'banking union' in the eurozone. We urge the UK government to explore creative solutions, including what we call a 'single market lock':

In the desperate search for the euro’s saviour, all eyes have turned to the concept of a “banking union”. Regardless of whether it is a good idea or a bad idea, banking union will undoubtedly cut not only to the heart of a key UK industry — financial services — but also the wider issue of Britain’s future in the EU in the face of further eurozone integration.

However, the typical response of City people, or those in Whitehall for that matter, is confused. On the one hand they love the idea, seeing it as a backstop for shaky eurozone banks that threaten City firms and the British economy alike. On the other, they fear it on the basis that the UK could be left without “a seat at the table” in Europe, meaning that the City would be forced to accept rules written for and by the eurozone. This hardly makes for consistent policy.

A banking union effectively involves three steps: a single rulebook, a single supervisor and a joint backstop (including a deposit guarantee scheme and resolution scheme with a wind-down mechanism). Given the Continent’s vastly differing banking systems and interests, achieving these three steps will be hugely challenging — and probably take years.

Still, the European Commission will kick-start the process this autumn by tabling a proposal to make the ECB the single financial supervisor for eurozone banks, for which there is broad support. While David Cameron has ruled out the UK taking part, with zero chance of it being accepted domestically, he has actively encouraged the creation of a banking union on the condition that “British interests are secured and the single market is protected”. The problem for the UK is that a banking union, if developed to its logical end point, will almost certainly cut across the single market in financial services.

For Britain and the City there are two main risks, the extent of which are unknown at present. First, companies doing business in the euro area could be required to be supervised by eurozone authorities. The ECB has already demanded that City-based clearing houses establish themselves inside the eurozone to be allowed to clear transactions in euros, something the UK has challenged at the European Court of Justice. If such practices become part of a banking union, the City would face a series of hurdles to doing business in the eurozone. The second risk is that the eurozone 17 start to write banking and financial rules for all 27 EU states, using their in-built majority in the Union’s voting system to implement them via the EU institutions.

Here, it is vital to understand the political incentives created by a banking union. To avoid banks free-riding on German taxpayers, Angela Merkel, the Chancellor, is likely to insist on any financial backstop being backed by perfectly harmonised regulations — for example, on capital requirements or bonuses — with little or no national discretion. This could well spill over to Britain, as the eurozone is unlikely to accept an uneven playing field within EU financial services, with the UK having few ways of blocking eurozone-tailored regulation being applied to the single market, even if detrimental or discriminatory.

So what should be done? First, Britain needs a consistent diplomatic position: it cannot both actively call for a banking union and implicitly threaten to veto it, as is the case at present. Second, to avoid the new structure — including the ECB — stepping into single-market territory, the UK needs to work with EU allies to make sure that it is fully accountable. The division of labour between the ECB and the London-based European Banking Authority needs to be made perfectly clear, for example.

However, given the stakes, Britain also needs to think creatively about new institutional arrangements with Europe, not only to guarantee the City’s position as a global entry point to the single market — offered by continuing EU membership — but also to create a space in Europe for those countries not intent on joining the single currency, and also for those that may choose to leave. There are several potential solutions. For example, non-euro members could be given the right to appeal against any proposal at the European Council, where all countries have a veto, if it is deemed to undercut the single market or be discriminatory — a “single-market lock”, if you will.

Such a move may require treaty change, but so will the steps towards banking union beyond the single eurozone regulator. Furthermore, if pitched right, such proposals could draw support from countries on both sides of the eurozone divide, including Sweden, Germany and Poland, given that the motivation would be to protect the single market.

A eurozone banking union is still shrouded in unknowns. But the City, even if it wants things to stay the same, may have to accept that things will have to change.

Europe and the City

A write up from our event from earlier today is now online, featuring a highly interesting panel of speakers including Jonathan Faull, Director General for Internal Market and Services at the European Commission and Hannes Swoboda MEP, President of the European Socialists in the EP. The panellists were seeking to answer the question what impact the euro crisis will have on the UK financial services industry. Read the summary here.

We'll also upload a recording of the event shortly.

And while we're at it, a reminder of the report that we published in December, Continental Shift: Safeguarding the UK's financial trade in a changing Europe, which can be found here. The report certainly hasn't become any less relevant with the conclusion of today's EU summit...

Different perceptions

This is from UK Chancellor George Osborne in today's FT:

The goal of a stronger banking system is so important that we must not allow unnecessary distractions in other areas to get in the way of agreement...Nor should we allow badly thought through regulation needlessly to undermine European competitiveness in financial services. Talk of competition between London, Paris and Frankfurt misses the point. It is the relative competitiveness of Europe, with London as its major financial hub, against other centres in Asia and America that is the real issue. No one should doubt that Britain is determined to remain a global financial centre serving Europe and the world.

And this is from a feature in FAZ (not online), looking at London as Europe's key financial centre:

the City of London has lost support from the British Government. Banks must fear overregulation from Brussels, particularly political decisions and a lack of skilled regulators in the EU’s new financial supervisors. That more than 1000 hedge fund managers have left the UK for Switzerland, is bearable, but that big institutions such as HSBC, Standard Chartered and Barclays are threatening to leave the City if future regulations harm them, is a big hit.

Not quite the same take on the issue...

Gamble

Open Europe published a new briefing earlier this week, looking at the creation of three new EU supervisors to oversee the insurance, banking and securities sectors. The proposal also paves way for the creation of a so-called European Systemic Risk Board - which would be charged with scanning the markets for threats to overall financial stability. On Tuesday, EU finance ministers, including the UK's George Osborne, endorsed the proposal.

The three new EU supervisors would be given binding powers over national regulators in seven different areas, and have the right to interpret, apply and even enforce provisions in over 20 separate directives. So this involves a clear shift in supervisory powers from the national level to the EU.

But putting the power shift aside, from a crude, national interest point of view, will this benefit the UK and the City of London? The short answer is, it could - but that assumes that the UK will stamp its mark on the new supervisory structure (for the long answer - read the full report).

Problem is that relative to its share of the EU's financial markets, the voting system within the supervisors is heavily biased against Britain - most decisions will be taken by a simple majority in the board of the supervisors (consisting of one representative from each member state), which will leave the UK in an unusually weak position to block proposals it disagrees with.

This graph is pretty illustrative:


Irrespective of the merits of the proposal, somehow we doubt that France would sign up to a supervisor with the power to, say, decide the level of farm subsidies by a simple majority vote or that Spain would agree to be part of an EU body which determined fishing quotas by simple majority (both the Multiannual Financial Framework which decides the distribution of farm subsidies, and the Common Fisheries Policy are protected by a veto).

There is a clear need to establish forums for regulators, central bankers and governments to exchange information. The supervisors can also play a useful role in mediating between national supervisors in cases where large cross-border retail banks expose depositors and taxpayers in several different countries to risks.

But the new supervisors will do much more than that - and could well extend their powers incrementally. Interestingly, following the agreement on Tuesday, objections to the new structure did not come from the UK, but from the Czech Republic.

According to the Prague Daily Monitor, Czech Finance Minister Miroslav Kalousek was not entirely happy about being left hanging by his British colleague at the EU meeting. "Great Britain shared our view until yesterday [Monday] and thus has offered an extraordinary show of pragmatism", he said, warning that the new EU supervisors could cause problems in future. He said,

"I have reason to fear that problems may occur sometime in five-six years. One of these [pan-European] agencies will make a wrong decision and will cause harm. This can lead to very complicated discussions about who will pay for it."

We hope he's wrong.

Off topic

This is almost entirely off topic.

Remember the old joke where various poliical systems were described in terms of "you have two cows?" Someone in the City sent us a new version for various financial markets which has gone round on Bloomberg this morning... interesting to us for the City's suitibly jaded view of the EU carbon emissions market...

If Hedge Funds Kept Cows, Your Milk Would Go Sour: Mark Gilbert
2007-02-08 19:04 (New York)

Leveraged Buyouts
You have two cows. You come home from the fields one day to find Henry Kravis chatting to your spouse at the dining-room table. Two days later, you have no spouse, no farm, and no table. Two guys the size of sumo wrestlers have saddled up the cows and
are riding them around the farmyard.

Currency Market
You have two cows. China has 1 trillion cows. Guess who sets the price of milk?

Bond Market
You have two cows. One is Brazilian, one is Australian. They yield 25 quarts of milk per day. That's half as much as three years ago, when you traded your less-lactiferous German and U.S. cows for them. You are thinking of swapping for a pair of Namibian cows. They only have three legs but, hey, they produce 26 quarts per day.

Derivatives
You have two cows. You repackage five of them into a Collateralized Lactating Obligation, pay for a AAA credit rating, slice the CLO into 10 pieces and sell it to investors, skimming the cream from the milk for yourself. Three of the cows fall ill, and the credit rating plummets. You get to keep the cream.

Hedge Funds
You have two cows. A guy in an open-necked shirt drives up in his Bentley and offers to take care of them for you in return for a year's supply of steak and 50 percent of their milk. They won't be allowed to leave his compound for two years. Six months later, you have half a cow, producing sour milk. ``You have to be willing to lose rump today to get rib-eye tomorrow,'' the hedge-fund guy mumbles through a mouthful of sirloin and champagne.

Economics
Assume two cows.

Carbon-Emissions Trading
You have two cows. They produce 1.2 tons of methane gas per day. After a hefty donation to the re-election campaign of your local representative, the government gives you enough emission permits for six cows. You sell three permits, buy another cow, and apply for a European Commission grant to build a methane-gas power station.

Apple Inc.
Nobody wants your cows. You design the cutest little milk bottle. Now, everybody wants your cows.

Goldman Sachs Group Inc.
You have 26,467 cows. They are strapped into the milking machines 24/7. Some of them have more hay than they could ever hope to eat. Others aspire to one day having more hay than they could ever hope to eat. The cows with the most hay end up with
big government jobs.

Pension-Fund Management
You have two cows. How boring is that? You pay a month's supply of milk to a consultant, who advises you to sell one cow and buy two aardvarks instead. The aardvarks die. The consultant charges you four months of your (now reduced) milk supply and advises you to sell half of your remaining cow and buy a wombat. The wombat dies. The consultant charges eight months of milk for a copy of his new report, ``Two-Cow Strategies for Alleviating
the Impending Pensions Crisis.''

Russian Energy
You have two cows. Comrade, those cows are an environmental hazard. We suggest you hand one of them over to us.

Interest-Rate Swaps
You have two cows. You pledge one of them to me as collateral in a swap for some of my pigs. I pledge the cow to my neighbor as collateral in a swap for some of his sheep. He pledges the cow to his cousin as collateral in a swap for some of his cousin's goats. Better pray the livestock market doesn't crash and we have to try and round up that cow.

Commodities
You have lots of stocks and bonds, but no cows. Are you crazy? Cows are the hot new market. Here, buy this exchange-traded cow futures contract. It can't lose. It gained 40 percent in the past six months.

Gold
You have two cows. You wear a cap you made out of tin foil so that the tiny black helicopters can't read your thoughts. You spend your days blogging about how the government's decision to abandon the cattle standard in 1933 was part of a global conspiracy by the world's central banks to destroy the value of your herd.

I wonder if anyone can add to that?