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IIF Market Monitoring Group Welcomes Euro Area Agreement on Financing for Greece, Urges Further Euro Area Integration, U.S. "Fiscal Cliff" Resolution

New York, New York, November 29, 2012 — Members of the IIF’s Market Monitoring Group agreed today to release the following statement:

The June 29 EU Summit and the ECB’s September’s announcement of the framework for Outright Monetary Transactions (OMT) represented important progress on Europe’s efforts to overcome the sovereign debt crisis. Some additional progress has been made since that time, including with regard to Greece’s adjustment program. However, momentum in some respects is dissipating: key details on establishing a single supervisory mechanism for Euro Area banks have yet to be agreed, and negotiations over the 2014-2020 EU budget reflect worrisome underlying strains among EU members. With relatively stable market conditions in recent months anticipating tangible steps forward on Euro Area integration as well as ECB activation of the OMT program, further near-term progress is imperative—particularly against the backdrop of a worsening outlook for Euro Area economic growth and jobs.

  1. Meeting participants welcomed the November 27 package for Greece, in particular the reduction in bilateral lending rates, the extension of maturity on EFSF loans, and the turning over of ECB and Euro Area national central banks’ profits on their holdings of Greek government bonds to the Greek government. However, uncertainty remains. Continued strong efforts by the Greek government should help ensure that necessary reform measures are implemented, but the next round of funding is also conditional on other factors, including the outcome of the Greek debt buyback. A voluntary debt buyback is assumed by the Euro Area to be instrumental to reducing Greece’s debt-to-GDP ratio, allowing program disbursement. However, it is critical that any buyback be conducted on a purely voluntary basis. At present, the outcome of the buyback—and the final decision on the next disbursement—remains uncertain. In any event it is increasingly clear that meaningful progress towards debt sustainability can only be achieved with a return to economic growth.
  2. The emphasis on aggressive short-term fiscal contraction in the Euro Area does not fully address the fundamental challenge. In the case of Greece, a greater emphasis on structural reform in program design, including privatization and tax reform, acceleration of Euro Area investment funds, further support and concessions by official creditors—including the IMF—involving especially further reductions in interest charges, and a more moderated path of fiscal adjustment, on cyclically adjusted terms, is urgently needed to restore economic growth.
  3. It is important to sustain the momentum on the ambitious plan for a single supervisory mechanism (SSM) for Euro Area banks. Otherwise, direct bank recapitalization could be delayed, putting recent bond market stability at risk. MMG participants underscored the importance of reaching timely decisions on key elements of the single supervisory mechanism and potential future plans so as to be in a position to de-link including its scope, treatment of EU members outside the Euro Area, and potential future plans including a single resolution mechanism. De-link sovereign and banking risk should be primary objective. This would mitigate against the fragmentation of financial markets, Foster free flow of liquidity and capital credit.
  4. The prospect of a U.S. “fiscal cliff” has already affected business confidence and willingness to invest. MMG participants reiterated the need for swift and determined political action by the U.S. authorities, not only to avoid the “fiscal cliff,” but also to implement credible fiscal consolidation in a medium-term framework to bring both the U.S. deficit and debt positions under control.
  5. Investors’ unremitting search for yield has been given more impetus by QE3. Against the backdrop of a lack of supply in many categories of high-yielding assets (including in particular some securitized products and smaller emerging market equity and debt markets), this has led to significantly higher prices, tighter spreads, some weakening of investor protections and greater flows to a range of risk assets. These developments should be closely monitored.
  6. An efficiently functioning OTC derivatives market is critical to businesses that use derivatives to manage the risks they face. Reliance on central counterparty clearing houses (CCPs) for OTC derivative products has increased substantially in recent years, and will continue to do so as reforms requiring mandatory clearing are implemented globally. MMG members noted the need to ensure the sustainability and robustness of CCPs. Although non-standardized products will not require central clearing, it is proposed that they be subject to initial margin requirements—a development which could exacerbate existing collateral shortages, especially when considered in conjunction with Basel liquidity rules. For end-users of OTC derivatives, reforms could impair market liquidity, increase the cost of derivatives, and negatively impact cash flow planning which will increase the cost of, and act as a constraint on, hedging activities. While margin requirement reduces counterparty risk, it should not be seen as the solution to all perceived problems in derivatives markets—sound risk management and robust infrastructure are equally important. Furthermore, margin requirement should be put in the broader context of all regulatory reforms so that the cumulative impact of all the changes on market liquidity, efficiency and end users can be adequately assessed.
  7. MMG members also highlighted concerns about risks associated with emerging markets:

  8. Emerging market and transition economies face a range of strains associated with recent financial market developments, in particular low interest rates which have affected emerging market banks in particular:
    • Many emerging market countries continue to see strong capital inflows, posing policy challenges including currency appreciation and potential loss of external competitiveness. The “risk-on/risk-off” nature of investor sentiment in recent years has contributed to market volatility and abrupt swings in capital flows for some countries. Furthermore, a wave of rate cuts across much of the emerging market world in recent years (prompted by concerns about global growth) has put many countries at risk of price pressures, notably in Latin America where inflation remains near cyclical peaks. In addition, a possible “plateauing” of commodity prices may create adjustment problems for economies, firms and investment positions that are predicated on a continued rise in commodity prices.
    • Low rates have also supported credit growth, which is still running near 15-20%yoy in some emerging market countries, including Brazil, China, Indonesia and Russia—highlighting the risk of deteriorating bank asset quality. Vigilance on the part of investors, risk managers and emerging market policymakers is called for, including in traditional areas such as prudential supervision (e.g. requiring lower loan-to-value ratios and adequate provisioning).

Note to editors:
The Institute of International Finance’s Market Monitoring Group (MMG) is an independent forum of private-sector leaders in international finance and experienced market practitioners. The purpose of the MMG is to consider and identify potential systemic risks and alert market participants and policymakers to these risks. The MMG is co-chaired by Jacques de Larosière, Chairman of Eurofi, former Managing Director of the International Monetary Fund and former Governor of the Banque de France, and by David A. Dodge, Senior Advisor of Bennett Jones, LLP and former Governor of the Bank of Canada.

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Gary Mead
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