European banks are being forced to sell more long-term bonds as regulators seek to prevent another financial crisis. European insurers say their own regulator will stop them from buying such debt.

Basel III’s liquidity rules mean European banks may need to raise as much as 2.3 trillion euros ($3.2 trillion) in long-term funding, according to New York-based McKinsey & Co. Insurers, the biggest buyers of such debt, are being dissuaded from buying long-term bonds under the European Union’s Solvency II rules, which makes them more expensive to hold.

“The two bits of regulation are at tension with each other,” said Simon Hills, an executive director at the British Bankers’ Association, which represents more than 200 lenders from 60 countries. “One bit is saying you should have more funding with a longer duration and the other is saying watch out when buying this stuff if you are an insurance company. It’s a big problem for banks.”

European Commission President Jose Barroso called for a new system of financial regulation built on “common ground” among countries, regulators and international organizations following the worst financial crisis in 70 years. His efforts, which were supported by leaders such as Germany’s Chancellor Angela Merkel and President Barack Obama, are being undermined by mismatching rules for banks and insurers, say industry executives and lobbyists, who are pushing to relax the new regulations.

Bank Shortfalls Basel III, due to be implemented in 2019, proposes requiring banks to hold enough cash or liquid assets to meet liabilities for a year. The aim is to wean banks off the short- term funding from other lenders that dried up during the crisis and sent Lehman Brothers Holdings Inc. into bankruptcy.

European banks will have a long-term liquidity shortfall of 2.3 trillion euros in eight years based on current business models, according to McKinsey. That’s about half the banks’ total capital and liquidity deficit under Basel III. U.S. banks’ deficit is about 2.2 trillion euros, McKinsey said.

To make up these shortfalls, banks will have to issue more bonds with durations of more than one year or increase retail deposits, the management consultant said. In the past 12 months, European lenders sold $893 billion of debt with durations of five years or more, according to data compiled by Bloomberg.

Insurers hold about 60 percent of banks’ subordinated debt, making them the largest purchasers of bank bonds, according to Paul Achleitner, finance head of Munich-based Allianz SE (ALV), Europe’s biggest insurer.

On 16 December 2010 the Basel Committee on Banking Supervision published the final form of a set of reforms to strengthen liquidity risk management by internationally active banks (the “2010 Liquidity Paper”). The Liquidity Paper brings together and, in parts, revises proposals set out in the initial framework for improving liquidity risk management and controlling liquidity risk exposures set out in the Committee paper adopted in September 2008 “Principles for Sound Liquidity Risk Management” (the “2008 Liquidity Principles”), the December 2009 Consultation Document, “International framework for liquidity risk measurement, standards and monitoring” (the “December 2009 Consultation”) and the proposals set out in the Annex to the 26 July Committee Press Release (the “July 2010 Annex”). The 2010 Liquidity Paper is intended to address concerns highlighted by the economic crisis, where a lack of liquidity and inadequate liquidity risk management operated together to amplify difficulties caused by credit losses and, due to the interconnectedness of markets, quickly infected all markets, with dire consequences.

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Financial institutions face a number of issues when it comes to compliance with the Basel III accord on liquidity and solvency, with data quality one of the challenges they must address.

According to an article on finextra, there are three key areas of concern which banks will have to face with regards to the data legislation - the technological impact, ramifications for capital frameworks and global liquidity standards.

With the latter, the issue of data quality will be one of the biggest challenges, with IT systems required to deliver consistent and accurate data based on several models.

"The IT infrastructure will have to be robust enough to deal with data integrity, usability and be compliant," the source went on to add.

In a recent review of the Irish government's progress, the International Monetary Fund highlighted the efforts made to improve data quality despite the political uncertainty and economic climate in the nation.

Original Article 

Risk-averse super fund members who put their money in capital stable portfolios have had a disappointing few years, with their funds failing to perform at times when their supposed defensive qualities should have provided protection from market turmoil.

This was most apparent in 2008, when fixed interest was the outstanding asset class but many capital stable portfolios were poor performers.

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Things were different last year. Defensive assets were, once again, the strong performers but this time capital stable portfolios passed those gains through to their members.

The Australian bond market (using the UBS composite bond index as a benchmark) was up 5.6 per cent in the year to December 31. Cash (UBS bank bill index) was up 4.5 per cent over the same period.

These defensive assets make up the core of capital stable portfolios. Bonds and cash outperformed the local and international sharemarkets (for Australian investors with unhedged exposures) in 2010.

A SuperRatings review of super fund performance in 2010 shows that capital stable portfolio managers did a good job of capturing these defensive asset returns. The median return for the capital stable portfolios the group surveys was 5.3 per cent for the 12 months to December 31.

Compared with this, the median return for balanced portfolios was 4.6 per cent over the same period and, for growth portfolios, the median return was 4.2 per cent.

SHIFT TO TRADITIONAL ASSETS

The head of global wealth management Australia at Pimco, Peter Dorrian, says the fixed interest managers did a better job in 2010 because they returned to more traditional asset management principles.

"In 2008 some managers went too far out on the risk curve," he says. "Another problem was that they bought illiquid assets. The global financial crisis reminded them of the importance of transparency, liquidity and diversification."

Russell Investments' conservative fund portfolio manager, Andrew Sneddon, says that in the years leading up to 2008 fixed interest managers had adopted a strategy of looking for the sub-sector that would provide relative value when compared with government bonds.

In other words, they sought extra performance by going overweight in high yield corporate credit, mortgage securities or structured credit.

"In 2008 every part of the credit complex underperformed," Sneddon says. "There was nowhere to hide. The problem was compounded by serious liquidity issues."

Dorrian says Pimco had record inflows into its fixed interest funds last year, reflecting a general shift to more defensive assets in super and non-super investment portfolios. "The exposure to fixed interest in our retirement savings portfolios is still low by world standards but we have seen some shift towards holding more defensive assets," he says.

Dorrian says that for 2011, investors can expect returns in line with current yields, which range from about 5 per cent on government bonds to 9 per cent on corporate credit.

Sneddon agrees. "This year is not going to be about capturing any big capital gains from rallying markets," he says. "It will be about capturing yield. At the moment we are re-weighting our conservative portfolio away from longer dated bonds and adding more cash. Enhanced cash yields are about the same as bonds and will get the benefit of any interest rate increases."

WHICH DEFENSIVE ASSETS?

A big decision for investors looking to add more defensive assets to their super or non-super portfolios is whether to invest via a bond fund or capital stable portfolio, or use term deposits.

With yields on six- and 12-month term deposits about 6 per cent and yields on three- to five-year government bonds about 5.2 per cent, term deposits are the better return.

An FIIG Securities analyst, Brad Newcombe, wrote in the group's newsletter, The Wire, in December that investors have to weigh the liquidity of bonds against the superior returns of term deposits. Newcombe's view is that the superior returns outweigh the risk of having to pay an exit fee to get out of a term deposit early.

"Term deposits have a role to play but some investors think they are the only defensive asset," Dorrian says. "Bond funds have done well through active management over the past year."

Morningstar figures back this up.

Its fund manager performance table for the year to December 31 shows that the top-performing fixed interest managers exceeded term deposit rates.

AMP Capital's Australian Corporate Bond Fund was up 10.2 per cent for the year; the Pimco EQT Australian Bond Fund was up 9.3 per cent; the Macquarie Global Opportunities Fund was up 8.8 per cent and the Zurich Investments Australian Fixed Income Pool was up 8.1 per cent.

The median return for Australian fixed income managers in the Morningstar survey was 6.9 per cent. The bond fund managers came out ahead of the term deposit rates by a nose.

Back to being stable

    * Capital stable funds performed poorly during the GFC.

    * Managers had invested in risky, illiquid assets.

    * This included high-yield corporate credit, mortgage securities and structured credit.

    * For super-fund members, this was a bitter pill to swallow.

    * Post GFC, managers have switched back to traditional assets.

    * These include safe investments such as government bonds and term deposits.

    * Morningstar's median return for fixed-income funds was 6.9 per cent.

LONDON, Feb 7 (Reuters) - European shares rose on Monday to their highest close since September 2008, with miners gaining as copper hit a fresh record high on supply concerns and after Randgold Resources profit jumped. The pan‐European FTSEurofirst 300 index of top shares closed up 1 percent at 1,176.81 points. It also rose on Friday after a mixed U.S. nonfarm payroll report. 'Moving on from where it left off last week, I think the equity markets are focusing on the growth that is out there and are being supported by strong earnings,' Mike Lenhoff, chief strategist at Brewin Dolphin, said. 'The markets are reluctant to give up any ground and the underlying trend is up.' Miners extended gains from the previous session as copper and tin hit record highs on supply concerns.

The STOXX Europe 600 Basic Resources rose 2.4 percent, while Randgold Resources gained 2.6 percent after the gold producer said it would raise its dividend 18 percent on the back of 43 percent higher full‐year profit. Xstrata, due to report on Tuesday, rose 3.6 percent, helped by bullish broker comment by Citigroup and Nomura. Top global miners were expected to report a doubling in profit for the December half, thanks to booming iron ore and copper sales.

TECHS GAIN

Technology stocks featured among the best performers, with the STOXX Europe 600 Technology rising 1.7 percent. Nokia gained 2.8 percent as a delayed top of the range model finally started deliveries and hopes grew for a strategy revamp due later this week. Chip designer ARM Holdings was 3.9 percent higher after Numis Securities raises its target price by 10 percent. Looking at individual stocks, French bank Credit Agricole was up 4.4 percent after a report on the Les Echos website quoted a head of one of its parent regional banks saying the lender won't need to raise capital to meet Basel III rules. 'If this happens to be true, we see the share price skyrocketing to 14 euros,' a Paris trader said in a note. Across Europe, the FTSE 100 index gained 0.9 percent, Germany's DAX was up 0.9 percent and France's CAC 40 was 1.1 percent higher.

Original Article

The stress tests that European banks will undergo this year will have to be more credible, like the ones in the United States, and may be completed in the first half of the year, France's Economy Minister Christine Lagarde told CNBC Monday. Gerard Julien | AFP | Getty ImagesFrench Economy Minister Christine Lagarde said bank stress tests should be more credible.
Last year in July, 91 banks in the European Union went through stress tests but only seven of them failed, prompting many critics to say the tests were not tough enough.

"The next European stress tests have to be more credible. They have to be better communicated and that is also part of the picture because if we have to restore confidence and build our stability, we need to safe and secure with our banking system and with our banks," Lagarde said in an interview.

"So we have to go through testing just like in the United States for instance, as will happen in the course of 2011," she added.

Last year, five Spanish savings banks – or cajas –failed the stress test. Spain has taken measures to prop up the cajas but some analysts say that they are likely to need up to 50 billion euros ($67.5 billion) to boost their capital.

"The Spanish banks, like the French banks, like the German banks, like the Swedish banks will be…put to test," Lagarde said.

"And will be stress tested in due course. And just like for any other bank in the European Union. If capitalization or recapitalization is required, then we will have to see to that," she added.

Still No to Single Eurobond

France, along with Germany, has opposed the creation of a single Eurobond – issued in the name of all 17 members of the euro zone - and Lagarde said her country's position has not changed.

"If you do that, you put once again, the cart before the horses," she said.

"You know, when the euro was organized 10 years ago, it was a fantastic move but it should have been consolidated earlier on with common foundations, better fiscal consolidation on a euro zone basis, better integration of our economic policies," Lagarde explained.

Issuing a single Eurobond now would "dilute the strength, the solidity of some of the members, without having integrated and consolidated fiscally, economically," she said.

The bond would be an option in the long term "if we have consolidated the foundations," Lagarde added.

EU leaders are considering various other possibilities, including raising Europe's emergency fund or allowing it to buy bonds, to weather the crisis.

More Austerity for France?

Francehas succeeded in revamping its pension system and extending the working age despite street pressure, which shows the country's determination, but also ability, to implement structural reforms, Lagarde said.

The country will most likely record a lower budget deficit than forecast for 2010, at 7.7 percent of gross domestic product versus an initial ceiling of 8.2 percent, she added

The target for 2011 is to reduce it further to 6 percent, by taking more austerity steps if needed, Lagarde said.

"I will, for myself, regard that as an absolute unconditional performance objective. We have to deliver. There is no option to that … which means that not only are we going to have to renew that measures that we have taken in 2010, but if need be, we will take additional measures," she said.

Original article

Rapidly growing BRIC emerging economies are vulnerable to external shocks as they lack adequate risk management and must synchronize fiscal and monetary policies, a survey of finance ministry officials showed.

The survey, released on Monday by consultancy Booz & Company, said the role of finance ministries have expanded far beyond their traditional fiscal mandate and they must reform so that they are not overly driven by interventions, near-term fiscal targets and benchmarking against local peers.

Booz polled more than 60 policymakers in finance ministries in the Group of 20 and other key economies, along with officials from the IMF, World Bank, European Union and OECD, academic institutions and think tanks.

Brazil, China, India and Russia -- the powerful BRIC group of emerging nations -- rebounded fast from the financial crisis, but the survey warned of shortcomings which could pose risks in the future.

"Russia is vulnerable to swings in the price of oil, Brazil to commodity prices, and India and China to global demand. China faces the additional risk of potential changes in currency policy, which could have ramifications for its trade position," Booz said in the survey.

It said these economies will face volatile swings within the economic cycle, often requiring corrective measures with high costs, unless the economic management functions within these countries are coordinated via a larger framework.

"This being the case, an overall framework for coordinated action is a priority for these economies," the survey said.

It also said BRIC and other growth economies should quantify on- and off- balance sheet risks, including commodity prices, currency fluctuations, private demand, or financial exposure -- and build them into policy decisions.

The survey said generally there was no one-size-fits-all solution for reforming today's finance ministries with overstretched objectives.

But it urged them to move away from ineffective notions such as more government interventions, focus on near-term fiscal targets, and benchmarking against regional peers.

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The European Banking Authority (EBA) has agreed on a strategic plan for a second European Union (EU)-wide stress test to assess the resilience of Europe's banking sector.

The tests, which aim to analyze the ability of banks to react to hypothetical stressed situations, are expected to be conducted in the first quarter of 2011. The results will be published in June or July.

The tests will be carried out in cooperation with the national supervisory authorities, the European Systemic Risk Board, the European Central Bank and the European Commission.

They will run parallel to stress tests undertaken by the European Insurance and Occupational Pensions Authority as part of the framework designed by the European System of Financial Supervision.

According to EBA, the methodology and approach taken in this year's test will build on that used in the 2010 stress test.

Last year's EU stress tests were criticized for not being stringent enough because lenders in the 27-nation region were shown by regulators to need only $4.6bn of new capital, about a 10th of the lowest analyst estimate.

The European Commission sought to include tests on bank liquidity in the wake of Ireland's financial turmoil.

Mervyn King, governor of the Bank of England, warned in October that Basel III on its own would not prevent another financial crisis and industry experts FTAdviser spoke to, agreed.

But Basel IIIscores points on the impact of failure if this does occur again, said Patrick Fell, director in regulatory capital practice at PriceWaterhouseCoopers.

The G20 Leaders at the Seoul Summit on the 11 and 12 November 2010 endorsed the Basel III framework, stating that the new standards will markedly reduce banks' incentive to take excessive risks, lower the likelihood of future crises and enable banks to withstand - without extraordinary government support - stresses of a magnitude association with the recent financial crisis.

The new framework will be translated into UK laws and regulations, and will be implemented starting on 1 January 2013 and fully phased in by 1 January 2019.

Mr Fell warned that financial crises have been around for centuries and a new set of regulations will not eliminate the problem.

He said: "History though does not prove that Basel III is doomed to failure.

"The most important new thing is that Basel III is not a one shot approach. It addresses both the risk of banks failing and the impact if they do fail.

Paul Edmondson said: "In developing a strategy to inhibit the risk or effect of future financial crises, Basel III is an important part of a wider picture.

"The new Basel rules update the international consensus on bank capital requirements and are meant to guard against bank failures."

Ray Boulger, senior technical manager at John Charcol, warned that it is about getting the balance right.

He said: "In evoking better regulation, the FSA and the EU recognise the possibility that banks will fail and by implementing Basel III this will minimise the impact on what will happen to the economy if the banks fail.

"Basel II was in place before the credit crunch happened and it didn’t stop the devastating impact.

"If regulation rules were sufficient enough to prevent the last crisis the consumers wouldn’t have had an easy route to credit but on another hand they wouldn’t be in this mess."

Benefits and drawbacks

Much has been written on risk, most of it very technical stuff on capital ratios and risk calculations.

Mr Fell said: "However, there is also a lot of new thinking on macro supervision of the market as a whole.

"Banks will become much more stable as a result of all this."

However, Basel III will not produce a 'no failure' regime – banks could still collapse, warned Mr Fell.

He said: "As a result, the impact of failure is critical, and this is where Basel scores.

"In short, the regime focuses on making 'systemically important financial institutions' safer, but also on ensuring the plumbing of the market is robust."

Mr Edmondson claimed that the rosy picture that emerged from last year's EU stress-test exercise has been shown to be hopelessly optimistic and highly misleading.

He said: "There is a worry that EU implementation of Basel III will not resolve the problem, and there are important financial issues which Basel is still to address - such as the trading book.

"More broadly, there will be measures which are entirely new – in particular the new focus on regulating firms so as to minimise the impact that their failure would have on consumers and the broader financial system."

Mr Boulger believes that Basel III will be a double-edged sword for consumers.

He said: "It will clearly make it more difficult for banks to lend. They will have less capital and so they will have to set aside more capital for lending and this will push up the costs of money.

"Basel III will make getting a loan more expensive and more difficult. But the benefits, that there will be more consumer protection if the banks go bust, won't be so obvious to consumers."

FSA/EU

Mark Godyer, founder-director at Tomorrow's company believes that Basel III can work on a global level. But Basel III and proper stewardship with a long-term remuneration package will work.

He said: "If you have differential interpretation with different regulation, that does pose a risk to UK banks.

"The FSA should not get out of step with international camps. The emerging framework needs to be global and on a consistent level."

Mr Boulger claimed that improving regulation needs to happen on a global scale and not just by individual countries.

He said: "But in saying that, we don’t want the UK authorities to go crazy.

"The whole point of regulation is to make a level playing field and we don’t want the UK authorites to gold-plate this otherwise cost of business for banks will increase.

"We would have the option to impose stronger regulation but not weaker as the EU rules are the minimum regulatory requirement."

Mr Fell added: "Basel III and similar changes will not eliminate financial ups and downs, but they will limit the times when the downs turn into crises."

By Lionel Laurent and Julien Ponthus

PARIS, Jan 12 (Reuters) - French banks cannot afford to lose out on billions of euros of regulated savings if they are to meet tougher Basel capital and funding rules, the French Banking Federation's head told a parliamentary hearing Wednesday.

The French government is reviewing whether to divert a bigger chunk of regulated, tax-free "Livret A" savings accounts to the state for public-sector spending, a move that banks say would hurt their own ability to fund France's economic recovery.

Losing more deposits to the state would also rob the banks of easy liquidity at a time when Europe's lenders are battling to get into shape for incoming Basel III rules, which will force them to find trillions of euros to bolster their capital.

"The funding environment for banks is going to be turned upside down (with Basel)," Francois Perol, head of the French Banking Federation, said in a finance committee hearing at the National Assembly.

French banks have so far avoided the funding jitters seen in other European markets, thanks to the healthy state of household balance sheets. But some bankers warned recently that a deposit war may break out as lenders become thirsty for liquidity.

At the hearing, Socialist lawmaker Jean-Pierre Balligard derided the banks' position as "holding savings accounts at gunpoint."

Perol, a former adviser to French President Nicolas Sarkozy and current chairman of BPCE, parent of the French bank Natixis (CNAT.PA), said it was not a question of holding savings at gunpoint but of raising warning flags. He said if Livret A was made less attractive for banks, it would remove incentives to promote the product.

About 65 percent of Livret A deposits are currently redistributed to state bank Caisse des Depots, which then reinvests them in social housing and other public-sector projects. Caisse des Depots supports an increase in the redistribution rate to 70 percent, phased in gradually over five years.

"Long-term (state) financing needs have multiplied over the past few years ... The French banking sector is not easily able to meet them," Caisse des Depots chief Augustin de Romanet told the hearing.

Adding a dose of political colour to his position, Romanet added, "Either the savings are housed at the Caisse des Depots, where they bring returns to the state, or they are housed with the banks, where they bring returns to the banks." ($1=.7665 Euro) (Editing by John Wallace)

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