DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 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, November 2011 Jean-Baptiste GOSSÉ* Dominique PLIHON ** * CFAP, University of Cambridge ** CEPN, Université Paris-Nord

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 Outline of the paper Aims of the study Future developments in financial markets Challenges of financial regulation 5 scenarios Conclusions

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 The aims of this study 1)To provide a base for strategic thinking 2)To define the best strategy for Europe

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 Future developments in financial markets

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 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

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 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

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November dimensions of financial regulation

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 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

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 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

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 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

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 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

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 Incompatibility triangle of financial objectives

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November scenarios

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 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

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 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

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 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

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 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.

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 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

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 Conclusions Only 3 stable scenarios Decision makers Financial stabilityFinancial integration Heterogeneity of national regulations Inside the euro area Outside the euro area Inside the euro area Outside the euro area Inside the euro area Outside the euro area BipolarUSA-China (Europe?) + − ++ − + Consolidation Big companies (minimum state) −− ++++ Fragmentation Nation-states (Economic nationalism) ++ −− ++ RegionalisationRegional unions +++ −− + Multipolar Supranational institutions ++++ −−

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 Conclusions (Cont’d) What could be the financial strategy of Europe Current situation - Europe - World (USA, UK, Australia, Japan)

DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels AUGUR AUGUR stakeholder’s workshop, November 2011 Thank you