Recent Efforts Aimed at Fostering Financial Stability
The establishment of the De Larosiere Group was announced by the Commission in a move aimed at “considering the organization of European financial institutions to ensure prudential soundness, the orderly functioning of markets and stronger European cooperation on financial stability oversight, early warning mechanisms and crisis management (including the management of cross border and cross sectoral risks), as well as looking at cooperation between the European Union and other major jurisdictions to help safeguard financial stability at the global level” (Eur-Lex, 2008). Other more recent moves aimed at fostering macro financial stability as well as “contributing directly to achieving the objectives of the Internal Market”, include the establishment of the European Systemic Risk Board (ESRB) and a working group1 comprised of international standard setters and authorities responsible for the translation of G20 commitments into standards. Purpose of the establishment of the Working Group being to make recommendations on the implementation of objectives2 aimed at “improving transparency in the derivatives markets, mitigating systemic risk, and protecting against market abuse.” The establishment of the De Larosiere Group, the ESRB and the Working Group not only highlights the importance attached to aims directed at fostering and promoting financial stability, but also the paramount importance attached to the need to manage systemic risks – as well as the need to regulate the OTC (Over - the- Counter) derivatives markets.
The significance of shadow banking - as well as the channels through which shadow banking activities are carried out, will also be introduced under this chapter - followed by a section dedicated to a consideration of efforts aimed at addressing regulatory arbitrage before a conclusion is derived.
In order to ensure financial stability, the Commission should review and report on measures to enhance the transparency of OTC markets, to mitigate the counterparty risks and more generally to reduce the overall risks, such as by clearing of credit default swaps through central counterparties (CCPs). The establishment and development of CCPs in the EU subject to high operational and prudential standards and effective supervision should be encouraged. The Commission should submit its report to the European Parliament and the Council together with any appropriate proposals, taking into account parallel initiatives at the global level as appropriate. (EC, 2009)3
Principal Contributory Factors to Financial Instability
Weaknesses in OTC derivatives markets that had contributed to the build-up of systemic risk, as revealed during the recent Crisis included:
The build-up of large counterparty exposures between particular market participants which were not appropriately risk-managed; and contagion risk arising from the web of interconnectedness of market participants created by bilateral clearing of OTC derivatives products; and the limited transparency of overall counterparty credit risk exposures.