Cicero Policy Briefer

Issue 17, October 2007

EU Finds Common Ground in Wake of Credit Crunch

By Michael Cooper

The financial turmoil this year that has followed the crisis in the US sub-prime mortgage market has given rise to a number of run-ins in the EU, with numerous officials wanting to set out their stall on what is to blame for current instability, what extent the damage is and how it can be addressed.

It has further entrenched the battle between French Prime Minister François Fillon and Jean-Claude Trichet, head of the European Central Bank. The ECB’s decision to pump around €300 million into financial markets had brought more unwelcome criticism from the French premier who is openly battling for more control over Eurozone interest rates. Trichet, on the other hand, has been so understated as to call the current situation a “market correction” at last—month’s meeting of EU finance ministers. A correction for a central banker, however, can be a government’s nightmare—as Alistair Darling has found out. Consumer confidence can be harmed, and economic growth stunted. The battle is not likely to leave headlines any time soon as the rising strength of the euro against the dollar can only increase pressure on the Bank to cut its rates in response.

Meanwhile, the Commission has seen varying takes on the situation: remaining cautiously reassuring about the turmoil, Commissioner for Economic and Monetary Affairs Joaquín Almunia has indicated that he does not anticipate the current malaise having an adverse effect on EU growth this year, although there has been careful dodging of specific forecasts from economic policymakers in Brussels. At the same time Charlie McCreevy, not always the most popular figure within the Commission, has broken ranks publicly, saying that a strengthening euro would pressurise EU exports and that an economic slowdown was likely given the current financial situation and faltering US growth.

Amidst the squabbling, contradictions and fighting for soapboxes, it is encouraging to see that EU finance ministers have reached agreement this week to create a blueprint for reviewing financial rules in the Union and a system to improve the way in which it can handle cross-border financial upheaval in the future. The ‘roadmap’ has been agreed upon for 15 months and will examine whether or not existing financial rules need to be changed in order best protect markets.

The usual calls for greater transparency and reinforcing supervisory mechanisms were joined with more a specific focus on credit ratings agencies. Although they have not been labelled as a scapegoat to explain the financial crisis, concern has long been raised in Brussels about a potential conflict of interest in these agencies which are paid as consultants by the banks whose debt they rate. Even in London, Hector Sants, the Chief Executive of the FSA, told a UK Parliamentary committee that the FSA had "lessons to be learnt" about supervisory issues such as extreme stress testing and investigating the role of credit agencies and claimed practical obstacles rather than EU law were the main barrier to a covert lender of last resort facility. Charlie McCreevy, renowned for his light-touch regulatory preferences, has raised concerns about the quality of the agencies’ judgement and their effectiveness to change in response to markets and has set up a Commission inquiry into their conduct, much to agreement of European Parliament big-hitter Pervenche Berès who has long mooted stricter controls in the face of the risks of ‘structured debt’ in credit ratings agencies.

In parallel to the inquiry, CESR will publish a report on credit ratings agency code of conduct in April 2008. Action at EU level comes in advance of the autumn meeting of the G7 later this month, with even the US now in agreement with the rest of the group that reforms are necessary, having previously been averse to joint action. France and Germany are reportedly looking to push the idea of distinguishing between an agency’s consultancy activities and its business rating in an attempt to avoid conflicts of interest. A clearer idea of what shape these reforms will take will follow from the group’s meeting, but one thing is for sure. All are beginning to sing from the same hymn sheet: it cannot remain business as usual for credit ratings agencies.

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