Paris, the 31 st of May 2012

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1 Interest Representative Register ID number: , rue Saint-Augustin F Paris Tél. : 33 (0) Fax : 33 (0) gti_contact@groupegti.com EUROPEAN COMMISSION BRUXELLES By To: markt-consultation-shadow-banking@ec.europa.eu Paris, the 31 st of May 2012 Re: Consultation on Shadow Banking We would like to thank the Commission for this opportunity to expose our views and thereby contribute to the current efforts by the Commission towards a better financial system, and particularly towards strengthening the oversight and regulation of «shadow banking system». Groupe GTI is a financial engineering firm, founded by myself in 1989, totally independent from any financial institution or insurance company. Our main activity is structured finance, and particularly securitization. Our operating subsidiary, GTI, is regulated by the Autorité des marchés financiers. I admit that I structured one of the first private label multi tranched RMBS in the US (see Bond Week- March 19, 1984) and realized the first securitization of residential mortgage loans in France in As such I am probably among the European professionals having the longest experience in securitization, and none of our deals has ever (to date) defaulted. With over 7b on of arranged transactions, and 2b on under management, we are, I believe, the largest independent firm of this type in France. However, as you will see in my responses to your questionnaire, I maintain a balanced position, keeping in mind the overall safety, continuity and usefulness of the financial system. Although the questions are reproduced hereunder, simultaneous reading of the green paper is useful. a. Do you agree with the proposed definition of shadow banking? The phrasing of this question is misleading; although there is no widely accepted definition of shadow banking, the term shadow is misleading and so is the term banking. Many people have objected to the term shadow since it has a negative connotation and some have suggested alternative financing which is probably a more appropriate expression, better reflecting the actual economic function. I also object to using the term banking: banks have a monopoly to collect deposits and savings, they benefit from emergency funding by the (or a) Central bank, and their government steps in when confidence in the banking system is threatened. Against the advantages of this monopoly, banks must abide by stringent and rigorous regulations. As such, there can be no shadow banking entity unless such entity is a bank.

2 No definition of shadow banking is offered. I see a list of shadow banking entities and a list of shadow banking activities, but no definition, per se, of shadow banking; would it be any shadow banking entity regardless of the activity? Would it be any shadow banking activity, regardless of the entity where it is conducted? Actually if one seeks to build a safer banking system, the proper definition ought to relate to this very objective and be, for example: any financial activity / entity whose failure would have a major detrimental effect on the safe keeping of deposits and savings. b. Do you agree with the preliminary list of shadow banking entities and activities? Should more entities and/or activities be analyzed? If so, which ones? Setting aside the fundamental point raised under question a), other entities and activities ought to be included: Many corporations extend credit to their customers. This can be in the form of long term financing or simply extended payment terms. Insurance companies also perform bank-like functions; granted they are regulated but should the regulations be different for similar functions? In terms of activities: o Insurance is also an activity performing liquidity / maturity transformation. o Similarly, the provision of pension or retirement benefits by corporations to their employees or past employees also involves maturity transformation, credit intermediation, and liquidity transformation. It is easy to see that almost any activity whereby money is received and should (somehow, sometimes, and somewhere) be returned could be deemed a shadow banking activity. Clearly shadow banking could not encompass the universe of all economic activities and regulation should concentrate exclusively on the risks posed to deposit-taking entities. c. Do you agree that shadow banking contribute positively to the financial system? Are there other beneficial aspects from these activities that should be retained and promoted in the future? Clearly shadow banking/alternative financing contributes many advantages to the financial system and the green paper mentions a few of them. It also provides many advantages to the economy in general, and not only to the financial system. First and foremost, it provides economic actors, such as insurance companies and retirement systems, with investment opportunities which do not include a bank risk. If one requires all or most financings to transit through bank balance sheets, all risks would be concentrated on banks, and a few large corporations. The diversification and risk spreading made possible by shadow banking should be encouraged, along with the other benefits mentioned in the green paper. d. Do you agree with the description of channels through which shadow banking activities are creating new risks or transferring them to other parts of the financial system? It is difficult to maintain that shadow banking creates risks; it simply allows (sometimes) to transfer the risks out of the banking system and what is really important are the means and conditions under which these risks may move back into, and affect the banking system. Consultation on Shadow banking May 31 st, /7

3 But this transfer creates a danger only if the risk to the banking system is not properly accounted for, or, in other words, if regulation of the banking system is inadequate. Shadow banking transfers risks to other parts of the financial system either directly or indirectly. Direct channels are simply direct links between a bank and a shadow banking entity. These should be included under and treated by bank regulations. Direct involvement also includes the purchase by banks of complex or long duration instruments whose behavior cannot be predicted with confidence. Indirect channels are more subtle and are the consequence of banks acting, to some extent, in the same field as alternative financing. For example, if banks carry portfolios of long term corporate bonds, whose value decreases (and there is no perfect hedging), the entire system will be affected, and quite acutely since banking is such a concentrated industry, and increasingly so. e. Should other channels be considered through which shadow banking activities are creating new risks or transferring them to the other parts of the financial system? Channels creating or transferring risks are mainly those mentioned above, which certainly ought to be more detailed. f. Do you agree with the need for stricter monitoring and regulation of shadow banking entities and activities? It is very difficult to disagree with the need to be stricter ; no one has ever argued for a lax approach to regulating finance. However, the extent of strictness requires first to address a fundamental question, namely where should one set the limits of banking activities? Schematically if (i) regulation addresses bank risk in a strict fashion (meaning that exposures to direct channeling of risks from the alternative financings are properly accounted for) and (ii) banks are refrained from playing in the same fields as alternative financing, then stricter regulation of shadow banking per se will not be necessary. In essence, the fundamental question is where to set the limits of activities which may be carried by deposit-taking institutions. Monitoring and regulation should be fashioned according to this fundamental decision. g. Do you agree with the suggestions regarding identification and monitoring of the relevant entities and their activities? Do you think that the EU needs permanent processes for the collection and exchange of information on identification and supervisory practices between all EU supervisors, the Commission, the ECB and other central banks? It is a prudent principle to identify and monitor all activities and entities which might create a risk to deposit-taking institutions, even if such activities/entities are performed or created by the institutions themselves. h. /i. Do you agree with the general principles for the supervision of shadow banking set out above? Consultation on Shadow banking May 31 st, /7

4 Do you agree with the general principles for regulatory responses set out above? General principles are always excellent; the devil is in the details. j. What measures could be envisaged to ensure international consistency in the treatment of shadow banking and avoid global regulatory arbitrage? Regulatory arbitrage is a very regrettable slippage. For example, securitization was created in the late 70 s to solve a financing problem in the United States: the imbalance between West coast funding needs and East coast availability of funds. The solution also required an off-balance sheet treatment, acknowledged and recognized by US Federal Insurance Corporations (FSLIC / FDIC); there was no constraining Basle regulation at the time. But some have used securitization in the pursuit of regulatory arbitrage and clearly a few have pushed the excess way too far. However regulatory arbitrage may be viewed as a two way street: banks are regulated, but may accept demand deposits and have access to unlimited short term central bank funds. If regulation is applied to a shadow banking entity, shouldn t such entity also share, at least partially the advantages enjoyed by banks? Although this approach may seem surprising at first it is amply illustrated by the events of late 2008, when all US investment banks changed their status to access Fed funds. Arbitrage occurs when an institution realizes an activity in a way which does not alleviate its exposure but nevertheless alleviates regulatory constraints. To avoid this arbitrage, regulations of banks should be stricter, should be enforced and should be identical (or similar) internationally. k. What are your views on the current measures already taken at the EU level to deal with shadow banking issues? Very rapidly and efficiently after the crisis started many measures have been taken to avoid its amplification and spreading. Maybe it is now time to review these measures and reassess whether some type of fine-turning may be useful, whereby protection is maintained but the economy is nevertheless allowed to breathe. Although the retention of the risk is a simple tool, it presupposes that all actors have the same constraints and objectives (i.e. the same risk and maturity appetite, or the same taste), unless it is clarified that retention of risk may take the form of a guarantee. Since we believe banks, as deposit-taking institutions, should not invest in excessively complex or long duration operations, the increase in regulatory capital is consistent with our position; similarly for liquidity facilities. The issue is more complex when dealing with consolidation of securitization vehicles. If the links between the regulated bank and the vehicle are adequately accounted for and counted by regulation, then consolidation would be counter-productive. The correct answer depends on the detailed facts at hand, and this is probably where regulation could be reviewed to facilitate economic growth, while containing risk spreading. Among the key issues is the treatment of securitization tranches by insurance companies under Solvency II. By discouraging banks from investing long term, and by refraining insurance companies from investing in securitization tranches, all long term sources of funds to the economy are simply Consultation on Shadow banking May 31 st, /7

5 eliminated. A particularly surprising fact, considering that securitized tranches are the major type of collateral deemed safe and acceptable by the ECB. Directions of fine-tuning which may be worth considering include inducement to better balance assets and liabilities of financial institutions; banks could benefit from lower capital requirements when investing in short term assets, while insurance companies would be encouraged to invest long term, replacing banks as financiers of safe, longer duration assets. Encouraging Secured Collateralized Financings (see below) is also a route worth investigating. Finally, as far as Credit Rating Agencies, the first step to be taken, even before their regulation is considered, is to eliminate all legal rating requirements which today remain numerous (ECB Collateral, French public placement of securitization). A rating is an opinion, and regulators, like politicians, should not grant rating agencies excessive powers, as, unfortunately, they have done in the past. To summarize, measures taken so far have achieved their purpose; it may now be time to proceed with some fine-tuning of the regulation to allow balanced breathing and growth of the European economies. l. Do you agree with the analysis of the issues currently covered by the five key areas where the Commission is further investigating options? At the outset, and as a general comment on this question, please note that sections 7.1 to 7.5 do not raise issues or concerns for documented discussion; they are simply affirmative statements reflecting decisions that seem to have been already taken. Could the question and its biased phrasing be just an attempt to justify ex-post a decision already made? On banking regulation: Again, regulation should be specifically adapted to the universe of authorized activities. Authorizing deposit-taking institutions to enter risky businesses, and trying to build adequate protection is a recipe to build a crisis. The first step should be to set some limits to the businesses banks are allowed to conduct. Conversely, imposing bank-like regulations on entities that may neither accept demand deposits nor obtain funding at the central bank window nor benefit from government support also creates a regulatory arbitrage. Although the green paper mentions (last paragraph of 7.1) that EU banking legislation is limited to deposit-taking institutions that provide credit, I believe France and a few other European countries apply a very similar legislation to (a) an institution accepting demand-deposits while not providing credit, and (b) an institution providing credit, but not accepting deposits (one side of the balance sheet is sufficient to imply bank-like regulations) Asset Management Regulations applicable to MMF have been substantially revamped recently. Constraints on investments could certainly be increased but the main issue is rather one of disclosure and eligibility of investment, which may be different for an individual and a professional, institutional investor who should be able to make informed and rational decisions Securitization Consultation on Shadow banking May 31 st, /7

6 Measures relating to securitization and implemented so far have been effective in reducing drastically (i) the volume of securitization, (ii) investor s appetite for securitized assets and (iii) effective means to finance real economic needs. At the same time, highly rated tranches of assets securitization are favored collateral by the ECB to guarantee bank borrowings. Retention and accounting requirements have already been commented above. Standardization should not necessarily be an overall objective; actually, since different types of investors have different investment objectives, and since securitization can be the ultimate carving tool, the technique ought to be exploited to create different types of products better suited to different categories of investors. At its beginnings, securitization was used as a mortgage loans financing tool (rather than a means to manage balance sheet or regulatory constraints) and tranching was used to adapt the raw material (30 years, fixed rate, constant monthly principal and interest loans) to the needs of investors with a variety of investment horizons (3 years, 5-7 years, years and over 20 years). In a nutshell, standardization is not necessarily a universal advantage. Transparency, on the other hand, is a must and no professional should ever consider purchasing or selling any securitization deal unless (i) sufficient information is available at the time of exchange, and (ii) there is a reliable commitment that sufficient information will be provided on an on-going basis. All these issues could be solved through the definition of a particular type of securitization (let s call it a Secured Collateralized Financing), which would follow specific rules to be detailed, but including the following: (i) the assets should be direct loans to economic agents (no square securitization), (ii) the assets should be diversified, (iii) the issuer should commit to provide specific statistical information on a regular basis, in order to clearly illustrate pool behavior, etc. The rules would build upon current ECB requirements on eligible collateral. And the features of this type of securitization should ultimately be included in local law; hence local authorities would be charged with monitoring, control and enforcement. For example, in France, the Code monétaire et financier would provide for the creation of Financements Collatéralisés et Sécurisés (FCS), as a subset to the articles dealing with securitization. The FCS ought to be better treated by regulation, and they should be authorized - even encouraged - investments for Insurance Companies, Pension Funds, etc. And similar legislative changes should take place in Europe Other shadow banking entities An objective inventory of all possible sources of risks to the financial system is certainly a very useful step. Regarding the effects and effectiveness of Solvency II, one should keep in mind that Insurance Companies need instruments in which they may invest, and if banks are the sole investment, one has simply moved the issue from the banking sphere to the insurance sphere. m. Are there additional issues that should be covered? If so, which ones? The issues mentioned above seem to cover all the ground. Consultation on Shadow banking May 31 st, /7

7 n. /o. What modifications to the current EU regulatory framework, if any, would be necessary properly to address the risks and issues outlined above? What other measures, such as increased monitoring or non-binding measures should be considered? As stated above, emergency regulatory measures have been effective in stopping a potentially dramatic evolution; it is now time to review whether these regulations should be fine-tuned to maintain an iron clad protection of public savings, while simultaneously providing for a flexible, safe and efficient means to fund economic needs. In summary we advocate unequivocally that a preliminary question ought to be addressed: to what extent should deposit-taking institutions be authorized to take risks and be active in maturity or liquidity transformation? As we express doubts about the effectiveness of any regulation against the powerful thirst for profits, we favor a situation where deposit-taking institutions have very little latitude to take risks, or to engage in maturity or liquidity transformation. Once this limit is established, then the proper degree and type of regulation can be defined; however regulation should protect the deposit-taking function and public savings, without strangling most alternative financing means. A review and fine-tuning of recent emergency regulations would certainly be appropriate. Concerning securitization in particular and this is our main area of activity and concern the current situation where banks find it harder and more expensive to fund on a long term basis, while other institutional investors (most notably insurance companies) are reluctant or are not allowed to invest in securitized assets is a situation conducive of economic standstill. A specific subtype of securitization should be created, with legal constraints being imposed on underlying assets, structure, transparency and the dissemination of information. ************************************* Tight and strict regulations are a necessity to maintain trust in the banking system and avoid excessive budget deficits; but ensuring that economic agents find the funding they need to grow the economy should also be an objective. Should you wish that we develop any of the points summarized herein, we would gladly expose them in greater detail to the Commission. We would like to thank the Commission for the opportunity to express our views, and look forward to a safe financial system, including banks and alternative financing channels providing long term funding for better economic growth. For Groupe GTI Interest Representative Register ID number: Richard Weiss r.weiss@groupegti.com Consultation on Shadow banking May 31 st, /7