EU's 'regulation' agenda may not prevail

ANALYSIS: There is a growing realisation that a new "Bretton Woods" style agreement is unlikely

SIX MONTHS have passed since French president Nicolas Sarkozy – at that time also holder of the EU presidency – called on world leaders to join Europe in reshaping the global financial system to ensure the current economic crisis could never be repeated.

“We must rethink the financial system from scratch, as at Bretton Woods,” said Sarkozy, referring to the 1944 agreement that created the current regulatory framework and led to the establishment of the World Bank and International Monetary Fund (IMF).

With the global banking system teetering on the brink of collapse, British prime minister Gordon Brown and German chancellor Angela Merkel backed the energetic French president’s initiative and persuaded other world leaders to embrace the G20 as the forum for talks.

Next week, the second G20 summit in six months will attempt to lay the groundwork for a new financial architecture and plot a course towards economic recovery. European leaders continue to express optimism publicly that a deal can be done, although privately there is a growing realisation that a new “Bretton Woods” style agreement is unlikely.

“The G20 is a process, not an event, and this summit is a political exercise, not a technical one,” according to a recent analysis of the prospects for the G20 summit by Katinka Barysch, deputy director of the Centre for European Reform. “No one should expect an unwieldy group of 25 or so heads of state to discuss the minutiae of capital adequacy ratios or cross-border supervision,” she says.

Four-and-a-half pages of financial proposals were agreed by EU leaders at a summit in Brussels last week as a common position. If implemented, they would create a new global financial supervisory system. It would subject all financial markets, products and participants that “may present a systemic risk” to the system – including private equity, hedge funds, credit ratings agencies and alternative investment vehicles – to regulation. It also proposes establishing international colleges of supervisors for all major cross-border financial institutions before the end of 2009 to improve supervisory co-operation.

The European proposals on financial regulation mirror those contained in a report published last month by former governor of the Bank of France Jacques de Larosière, which has proposed reshaping the EU financial supervisory and regulatory architecture.

But they could face opposition from the US, which has traditionally opposed proposals that would subject US banks and companies to regulation by foreign supervisors. Some EU states – such as Britain and the Czech Republic – are also uneasy about the finer detail of some of the proposals in the report and may seek to water down particular elements.

“The EU will give it a go at the G20 to extend its better regulation agenda, possibly as a trade-off for more stimulus. But if it doesn’t succeed, then I think it will introduce the de Larosière reforms and try to push them as a model sometime later in the future,” says Antonio Missiroli, director of the Brussels-based think tank, the European Policy Centre. The biggest threat to a successful G20 is probably the very different emphasis placed on the need for more public spending to boost recovery by the US and EU.

“We call upon our partners to join us with a sense of urgency and common purpose,” wrote US president Barack Obama this week in an article advocating additional economic stimulus efforts.

Germany, France and the Czech Republic – the current holder of the EU presidency – have all ruled out any further stimulus efforts for fear of boosting public deficits to a point where it could threaten the stability of the euro and impose a burden on future generations. Czech prime minister Mirek Topolanek colourfully described Obama’s stimulus efforts as a “road to hell” in a speech this week that won’t help the G20 talks.

Gordon Brown, who is chairing the G20, has left the door open to further economic stimulus, suggesting he may seek a deal between the EU and US. But, with a German election due in the autumn, Angela Merkel – one of the few EU leaders capable of spending more – probably has little room for manoeuvre.

The third component of the EU’s G20 strategy is to call for a doubling of the funding supplied to the IMF to enable it to bail out states that get into financial difficulty during the current economic downturn.

The EU will offer €75 billion and call on other leading economies such as China to provide the rest. In return, it will support reform of institutions such as the IMF and the World Bank to give developing states more voting weight, and the possibility for their own nationals to lead the financial institutions.

China will be a key player and will fight hard to increase its influence at the G20. This was underlined by comments from Zhou Xiaochuan, governor of the Chinese central bank, this week.

He called for a new international reserve currency to replace the dollar – a proposal swiftly rejected by the EU and one that is sure to raise political concerns in the US.

But despite the complexity of the issues on the G20’s agenda, some success has already been recorded, for example in tackling offshore tax havens. Combined EU and US pressure has already forced Switzerland and several other jurisdictions with “banking secrecy” to sign up to OECD rules to exchange information to help curb tax evasion. The EU remains hopeful the crisis will help to concentrate minds in London, although no one expects the G20 to produce a magic solution to the current economic problems.