A hope for audacity

Buoyed by his success in pushing healthcare reform through the US Congress last month, Barack Obama, the US president, has identified financial reform as the next major goal of his administration. He has called on Congress to complete work on a sprawling bill by the end of May, at the same time threatening to veto any text that does not bring trading in risky financial instruments into the open.

Last week’s decision by the US Securities and Exchange Commission to charge Goldman Sachs, an investment bank, with using complex derivatives to defraud investors has been seized on by Obama as evidence of the need to outlaw practices that led to the financial crisis.

Obama’s new sense of urgency on financial reform – stimulated by his desire to secure another legislative victory before congressional elections in November – presents potential benefits for Europe, but also significant threats.

European leaders expected, until recently, to go to the next summit of the G20 group of developed and emerging economies in June on a mission to convince the US to bolster up its efforts on reform, for fear that Europe would be left at a competitive disadvantage by reforming in isolation. Now, they have a transatlantic partner that is raring to go.

This was demonstrated by a letter sent last week by Timothy Geithner, the US treasury secretary, to Michel Barnier, the European commissioner for internal market, pushing for common action on reform of the derivatives market. Geithner’s proposals, timed to coincide with a meeting of G20 finance ministers on Friday (23 April), go beyond both a set of general principles agreed by the G20 and a policy paper presented by the European Commission in October.

Herein, however, lies the threat: Obama’s push for reform, unless very well calibrated with his European counterparts, could lead to the US adopting reforms different enough from those crafted in the EU that scope for regulatory arbitrage may emerge.

Signs of division between the EU and US reform agendas have been apparent for several months. Obama in January said that he wants retail banks to be banned from trading on their own account (the co-called Volcker rule), an idea dismissed by EU finance ministers as incompatible with Europe’s universal banking model (the Dutch are lone advocates). A separate idea, also announced in January, to impose a levy on the banking sector has gained currency in Europe, although member states have widely differing opinions about which sorts of banks should be charged and how any levy should be calculated. The chances are low that any common EU position on this that might emerge would chime with developments in the US. Geithner has also complained that EU proposals to regulate alternative investment funds (such as hedge funds and private equity funds) would discriminate against funds based in the US.

There is also a difference of approach. The Obama administration plans to tackle financial reform in one, giant bill (the current draft is more than 1,000 pages long) and deals with issues as diverse as financial supervision, regulation of alternative investment funds, and corporate governance reform. This is the polar opposite of the EU approach, which has been to draw up a multi-annual programme of financial reform, dealing with different problems in order of priority. The EU could be left facing a giant fait accompli by the US if it completes its reforms in May.

This is all the more problematic because – in the eyes of many experts – the US bill is not very good. It does too little to reform financial supervision, still leaving banks with a lot of scope to decide who regulates them (a fundamental problem, as regulators effectively end up competing for business). It also does too little to prevent future bail-outs of banks by taxpayers. A proposal by the bill’s author, US Senator Chris Dodd, for a €50 billion fund, financed by the banking sector, to wind up failing banks is likely to be scrapped because of Republican opposition. This would probably create another point of divergence with the EU – Barnier is vigorously pushing every member state to set up such a fund.

Faced with this situation, the European Union should not be thrown from its current path. Its ability to shape the near-finalised US reform bill is slim. What it can do is ensure that its own reforms fully reflect the lessons learnt from the crisis. There are promising signs this may happen, notably Barnier’s push for a ‘crisis resolution mechanism’ to prevent failing banks from having to be messily broken up along national lines. Barnier has said that banks will want to be based in jurisdictions where regulation is sound. It is a good principle, and a far better guide than a sense of paranoia about the possibility of scaring away businesses by regulating too much.

Europe’s taxpayers have put 13% of Europe’s gross domestic product on the line in order to save the banks. They deserve a package of reforms that is as good as their policymakers and politicians can produce. It is better to engage the US in a race to the top than a race to the bottom.