ABA Section of International Law Spring Meeting 2011 The Aftermath of the Financial Crisis – Part 1 Globalization of the crisis and European responses Dorothee Fischer-Appelt April 6, 2011

2 Overview The global nature of the crisis National and EU responses to the crisis The eurozone sovereign debt crisis and further EU measures

3 Global nature of the crisis – Significant exposure of European financial institutions to US mortgage-backed securities and CDOs – Global nature of credit and capital markets UK – Northern Rock: ‘run on the bank’ on September 14, 2007 – Mortgage lender using securitization, heavily reliant on international capital markets Three European bank bailouts on September 28/29, 2008: – Bradford & Bingley (UK) – Fortis (Belgium, The Netherlands and Luxembourg): cross-border nature of crisis and problem of national banking supervision – Hypo Real Estate (Germany) – Irish incorporated subsidiary Depfa short-term loan financing model ratings downgrade trigger for underwriting of U.S. municipal bonds resulted in liquidity crisis

4 EU Member States’ Responses to the Crisis UK – £500 bn multi-part rescue plan for banking sector (April 2008) – Included acquisition of preferred shares in distressed banks (RBS, Lloyds) UK regulatory changes announced June 2010 – break-up of FSA into Prudential Regulation Authority as subsidiary of Bank of England (BoE), Financial Policy Committee (within BoE) and an independent Consumer Protection and Markets Agency Variations in European national governments’ reactions and specific measures taken

5 EU Responses to the Crisis Significant EU level changes as a result of the crisis, mixed with “ordinary course” European regulatory agenda New institutional architecture: European System of Financial Supervision (ESFS), composed of European Systemic Risk Board (ESRB), three new supervisory authorities, a joint committee and the national regulators of each EU Member State New macro-prudential oversight: European Systemic Risk Board (ESRB) to monitor threats to the stability of the financial system – Independent EU body based in Frankfurt – Chaired by the President of the European Central Bank – Includes governors of central banks of all EU Member States and chairpersons of the new supervisory authorities

6 EU Responses to the Crisis – cont’d Transformation of three existing committees into EU level authorities: – European Banking Authority (EBA) – European Securities and Markets Authority (ESMA) – European Insurance and Occupational Pensions Authority Significantly more important role than previous committees: – Authorities develop drafts of binding regulatory and implementing technical standards by qualified majority vote, to be adopted by the EU Commission – Role in supervision of national regulators – can adopt binding decisions vis-à-vis financial institutions in certain cases – Can impose binding mediation in cases of disputes among national regulators – Special powers in emergency situations, following determination of an emergency situation by the European Council

7 Specific EU directives and regulations EU Commission proposal on regulation of OTC derivatives, central counterparties and trade repositories pending – Significant involvement of ESMA in developing standards, including decision on eligible derivatives – Central counterparties (CCPs) must be authorized by national regulators, but ESMA has power to recognize CCPs from third countries as equivalent – Market participants have to report information on OTC derivative transactions to trade repositories; trade repositories have to register with ESMA

8 Specific EU directives and regulations – cont’d New EU regulation of Credit Ratings Agencies (April 2009; amendments pending) – No substantive regulation of CRAs in the EU prior to financial crisis – Significant powers to be carried out by new ESMA – direct supervision of CRAs by July 2011 Directive on Alternative Investment Fund Managers EU deposit protection – revisions pending

9 The Eurozone sovereign debt crisis Eurozone sovereign debt crisis since 2010 – Greek bail-out – misstatements (May 2010 bail-out, €120 bn) – Ireland – subprime and banking crisis (November 2010 bail-out, €85 bn) – Portugal – no bail-out as of yet, but downgrades etc. – Concern over bigger states, such as Spain and Italy? Bail-out of eurozone member states versus defaults and restructuring? The role of rating agencies European Financial Stability Facility (EFSF) and European Financial Stability Mechanism (EFSM) agreed in May 2010 – EFSF – bonds backed by guarantees of eurozone member states up to €440 bn; EFSM – funds raised from the Commission and guaranteed by the EU budget; and IMF loans; combined safety net up to €750 bn

10 The Eurozone sovereign debt crisis – cont’d Permanent mechanism agreed end of March 2011: European Stability Mechanism – Safeguard financial stability of the euro – Lend up to €500 bn – Will replace old mechanism from June 2013 – Relies on guarantees from AAA-rated states and paid-in capital from weaker states – Granting any financial assistance subject to “strict conditionality” – investors may have to share in burden of insolvencies, but discussion delayed until June 2011