Hearing before the Committee on Economic and Monetary Affairs of the European Parliament

Introductory statement by Mario Draghi, Chair of the ESRB,
Brussels, 12 November 2015

Mr Chair,

Honourable Members of the Economic and Monetary Affairs Committee,

Ladies and Gentlemen,

It is a great pleasure to update this Committee on the work of the European Systemic Risk Board, in my capacity as Chair of that body.

Since we last met, the ESRB has published its Annual Report, which covers the period between 1 April 2014 and 31 March 2015. This Report not only presents the ESRB’s risk outlook, but also offers the first institutional overview of the discretional policy actions under CRD IV/CRR, summarises the findings of the ESRB report on the regulatory treatment of sovereign exposures and includes the follow-up to the previous ESRB recommendations.

In my remarks today, however, I will refrain from repeating the content of the report and will instead put the recent activities of the ESRB in the wider context of what has been accomplished in the five years since its establishment.

Second, let me also highlight the ESRB’s ongoing work on the extension of the macroprudential framework beyond banking. This work is becoming even more important in the light of the plan being put forward by policy-makers to develop the capital markets union.

Five years of macroprudential policy in the European Union

When the ESRB was established at the end of 2010, its field of competence was largely uncharted territory. Its first task was to build a coherent EU-wide system of national macroprudential frameworks.

If we fast-forward to 2015, the institutional set-up, with clearly defined macroprudential mandates, is now in place. Note that in 2014 when the ESRB assessed compliance with the ESRB Recommendation on the macroprudential mandate of national authorities, it concluded that the Recommendation had been implemented either in full or to a large extent by an overwhelming majority of Member States. The only exceptions were a small number of jurisdictions that were hampered by insufficient progress in the legislative process. Since then the ESRB has closely followed developments in these jurisdictions and is pleased with the progress that has been made. Spain, Italy and Romania are urged to complete their work on setting up the legal basis for the macroprudential institutional framework.

With the help of the ESRB recommendations, the macroprudential authorities were able to identify clear intermediate financial stability objectives and establish a set of specific macroprudential instruments to achieve them. The instruments are now in active use: Member States notified the ESRB of around 100 policy measures they had taken in the year following the introduction of the CRD IV/CRR. Although the ECB was assigned “topping-up powers” when the Single Supervisory Mechanism entered into force a year ago, it has not yet complemented any national macroprudential measures, there is an institutional and policy framework to do so in the future.

Developing policy instruments and assessing their effectiveness and efficiency is a continuous task. As such, the ESRB recently added a macroprudential perspective to the leverage ratio requirements. The ESRB Handbook on Operationalising Macroprudential Policy in the Banking Sector was expanded in June to offer instrument-based advice on the macroprudential add-ons to the leverage ratios. Given that the design and calibration of the microprudential leverage ratio is being taken forward by the Basel Committee on Banking Supervision and the European Banking Authority, the ESRB’s analysis can inform their discussions.

At our last meeting, I referred to the ESRB’s work on the relationship between the features of and developments in national real estate markets and financial stability. I am pleased to announce that this work has been completed and the reports will soon be published. Significant data gaps continue to hinder effective risk monitoring and macroprudential policy-making for the real estate markets. The ESRB is playing an active role in tackling this and I will update you on this work at our next meeting.

Since we last met, the ESRB has also made substantial progress on the framework for the coordination of national macroprudential policy, which is essential in order to limit the scope of possible cross-border spillovers and regulatory arbitrage. When I last appeared before this Committee, I raised the concern that the national authorities only rarely analyse the potential cross-border effects of national measures in sufficient detail, and that the use of reciprocity remains very limited.

Consequently, in order to hardwire the voluntary reciprocation procedures into the national jurisdictions, the ESRB has been developing a comprehensive methodology to assess the possible cross-border dimension of national macroprudential measures. This will result in an update to the ESRB Handbook on cross-border issues. Lastly, the ESRB is preparing a recommendation to foster reciprocity, in particular by setting up a procedural framework. This work will be finalised by the end of the year.

Another area of coordination in which the ESRB made significant progress relates to counter-cyclical capital buffer rates for third countries. In the aim of achieving consistency in the setting of such rates across the Member States, the ESRB will finalise its recommendation under Article 138 of CRD IV by the end of the year.

Bridging risk assessment and policy assessment – macroprudential stance

I have talked a lot about the establishment of the macroprudential policy framework in its various layers at the national and European levels. Over the past year, the ESRB has also devoted energy to assessing the stance of national macroprudential policies. I see the ESRB as being the body within the European Union that is responsible for developing a conceptual framework for assessing macroprudential actions taken across the EU and making use of its own soft law instruments (warnings and recommendations) to mitigate any potential inaction biases where the risks to financial stability are either building up or receding. To this end, the ESRB bridges its own risk identification and assessment with the risk and policy analyses of its member institutions. In the terminology used during our preparatory meetings, we discuss whether inconsistencies may be identified by comparing potential financial stability risks and policy measures. We increasingly use analytical tools, such as country and market-specific heat maps, which provide signals of a potential build-up in vulnerabilities that might require changes in policy stances when country-based and market-based indicators breach pre-defined thresholds. The heat maps have not been made public so far, although in my view, they could be incorporated into the ESRB Risk Dashboard in due course.

Looking ahead – macroprudential policy beyond banking

In line with the ESRB’s broad remit of preventing and mitigating risks, the scope of macroprudential policy must be extended to the financial system as a whole. This brings me to the ESRB’s work on macroprudential policy that goes beyond banking.

Let me start with financial market infrastructures.

The regulatory reforms within the EU – and in particular the European Market Infrastructure Regulation (EMIR) legislation – have significantly strengthened the resilience of central counterparties (CCPs). Nevertheless, a failure of a CCP can never be completely ruled out. In line with the European Commission’s roadmap, I consider setting up a common EU recovery and resolution framework for CCPs to be crucial, including from a macroprudential perspective.

The ESRB’s General Board agrees that a recovery and resolution regime should ensure that an orderly decision-making process is in place. In fact, if a CCP enters into serious distress, there is a lot at stake for the financial system as a whole, which justifies the need for far-reaching resolution instruments. It is therefore important for the resolution authority to be provided with a flexible toolkit. Necessary resolution tools, such as uncapped cash calls, additional default fund replenishments and initial margin haircutting, may nevertheless create considerable exposure for clearing members, potentially triggering unexpected contagion effects. Here, I see the need for a macroprudential view. To ease the pro-cyclical effects of these measures, I suggest that clearing members should be given sufficient time before they are called on to replenish their initial margin or default fund contributions.

The recovery and resolution framework is also important in the light of the clearing obligation for over-the-counter interest rate swaps, which is expected to enter into force in 2016. The ESRB has expressed strong support for this clearing obligation, as well as for extending it to other instruments, in order to reap the benefits of a broad application of mandatory central clearing, in line with the G20 agreement. When assessing the rationale for clearing obligations, it is important to consider the positive impact they might have in reducing systemic risks not only at the EU level, but also at the regional and national levels. The financial system is very interlinked, and financial shocks may travel easily across borders. For this reason, it does not seem useful to exempt small-sized or regionally limited market segments from the obligation owing to their limited scale. For this reason, the ESRB would have liked to see more progress made on mandatory clearing at this stage, in line with the policy stance expressed on several occasions in 2014 and 2015.

Let me also add that, as discussed recently by the General Board, an adequate recovery and resolution regime for insurance companies would also constitute an important building block in sound financial stability architecture. The EIOPA stress tests, which were based on two adverse financial market scenarios, developed in cooperation with the ESRB, showed that a significant part of the insurance sector would be severely hit by a simultaneous sharp fall in asset prices and prolonged low risk-free interest rates (the “double hit” for the insurance sector). The ESRB will soon publish a full report on macroprudential issues in the insurance field.

Finally, this summer the ESRB flagged the potential of using margins and haircuts as a macro-prudential instrument. In order to avoid sudden and large pro-cyclical increases in collateral requirements for securities financing transactions and derivatives, authorities could be granted the flexibility to set permanent and time-varying minimum requirements. These floors would reduce the risk of liquidity spirals and further enhance the robustness of the system by decreasing or limiting financial and synthetic leverage. However, it is not straightforward to implement margin and haircut requirements as a macroprudential instrument. Indeed, some of the problems associated with their implementation could be better addressed if a global framework were in place. The ESRB is actively engaged in facilitating international discussions, while continuing its analytical work on the principles that would govern a new macroprudential instrument. With this in mind, it might be worth considering an ad-hoc revision clause in the forthcoming EMIR review in order to adequately reflect the progress made at the international level.

Thank you very much for your attention. I am now available for questions.