Euro stability and (labour) market reform

Yesterday I was reading online some newspapers, and I found a short article on the Wall Street Journal Europe.

The writer was stating that the weak Euro is an escape route from the lack of structural reform.

Probably, this could have been appropriate at the beginning.

But, also due to the issues since last Autumn, some significant structural reforms are being introduced all across European Union.

And this does not include just reforms in the welfare state (anyway, the WSJE is still the WSJE), but also to update other structures that were created well before the CECA (1951).

Today Brussels saw another summit- the official announcement was referring to the development plan, the accession of Iceland, and the entry of Estonia inside the Euro from 2011-01-01.

But yesterday and today there were other significant announces, ranging from the labour market reform in Spain, to the complete redesign of the banking oversight in UK.

Reforming the market

If you are not from the EU- for historical reasons, UK has a significant role in the European financial markets, well beyond the relative size of the UK market.

Reallocating the functions of the FSA between the Bank of England and new entities will bring the banking oversight model closer to the one adopted in Continental Europe and most Euroland countries, i.e. leaving to the Central Bank monetary policy, financial stability and banking oversight.

But a side-effect of the current situation in the EU was quite unexpected: increased transparency.

The lead was taken yesterday by the Banco de España: it was announced that the “stress tests” done on the Spanish banks will be published.

Thereafter, UK announced the same decision, and today France asked a country by country and bank by bank disclosure, joined by Germany.

The aim is to improve the oversight and accountability, while softening the blow by allowing economic recovery (the bank funding issued last year, the new fund recently announced).

The flip-side of the coin is the labour market.

By chance (the current economic situation) and by design (Spain is holding the rotating Presidency until the end of the month), after the interventions on Greece with the technical support of the IMF, Spain is adopting a more systemic approach, with changes of long-term impact.

A sign of the times is that, while still formally sticking to the usual mantra of refraining from delivering state aid, after the banking industry, the Spain labour reform reduces the number of days covered by the current system, but shifts from a definition of clear company distress to a more fluid identification, open to interpretation.

As the the expansion of the number of companies to be supported could not be sustained by expanded allocations, the number of days is shifting from 45 to 33, supposedly only for new contracts.

If the final version of the new rules will be adopted, a small loophole has been left in place, adding a further flexibility: new contracts include employees switching companies.

Expect more joint-ventures, as I saw in the early 1990s in Italy to circumvent local rules, by transferring personnel to new entities created to allow using new market rules also for existing employees.

The times to come

After initial calls from the President, Mr. Van Rompuy, for a joint accountability on economic policy, the current wave of reforms is showing a de-facto convergence.

The Spanish rotating presidency will be probably be remembered few years from now notably for ground-testing some significant changes during the first serious assessment of the structural stability of Euroland.

From doing some further steps to implement the Lisbon’s Treaty (e.g. the European Citizens’ Initiative), to a significant change in the way the labour market is structured, and an increased transparency, with the first steps toward the development of a joint economic and labour market policy.

But convergence on the approach does not imply convergence in the structure or organization of the economy within each member state, as EU is still composed of sovereign states.

As reminded by Italy recently, “debts” represent an approach to the economy management, and while some countries concentrate the debt in the government sector (e.g. Italy), other countries shifted the debt mainly in the private sector.

In the past, non-EU countries and creditors complained about the differences, as for example it was not clear if the debt of State holding companies (such as the IRI in Italy) was to be considered guaranteed by the State or not.

Eventually, adopting a systemic view implies an holistic view: the overall debt in each country is an aggregate whose composition is dictated from the legal and social framework of each member state.


As for transparency, while laudable, it can have some unintended market distortion consequences.

Disclosure of stress tests by country and, within each country, by bank, would de facto disclose the potential ways to influence the financial activities of banks operating just in the local market.

Some European banks have a global outreach- and, therefore, also a Eurozone or EU-wide disclosure would not be enough to remove the potential distortion of competition of a selective disclosure.

On the side-effects issue, it is, in the end the same concept of BaselII: stating that it applies only to some banks in some countries does not remove the opportunities to circumvent the rules.

And therefore: shift the risk, by concentrating it in unregulated markets/banks/entitities.

Today Iceland started the path to become soon a full-fledged member of the EU- after the banking issues and the refusal of the Icelanders to fund the Icesave debt (a bank with depositors in UK and The Netherlands): a blatant case where this principle applied.

Iceland is a EU trading partner already intertwined with EU27 more than some of the existing members (in 2008, 54% of imports and 75% of exports; data from

The best way to avoid a further recurrence and to ensure the stability of Iceland was, in the end, in expanding the membership.

In Italy, the Bank of Italy started long ago to require not just risk information, but also some operational KPIs.

This allows each bank to benchmark itself vs the market- and enables focusing on the differences.

In our computer-based world, disclosing information is never neutral.

Any new data source enters decision models, and becomes part of the information used to optimize investment decisions- influencing markets by its mere presence.

Therefore, any disclosure should be carefully assessed in terms of potential distortion effects, if the disclosure is not generalized.

Probably a global transparency could bring about a Basel III, expanding the risk control from the capital adequacy (Basel I), to the operational risk (Basel II), to, eventually, a weighing of the lack of transparency in the counterparts.

Basel II allows already banks to define their own model- but an enforced transparency should be balanced by levelling the playing field- and creating a reference model that any institution doing any financial activity is required to use (or feed).

Risk and stability

Again, coming from Italy: at first the risk data bank (managed by the Bank of Italy) was limited only to the bank industry.

Few more crises, and eventually any organization that carried out financial activities on behalf of others is required to disclose risk information to part of the central data bank.

And as proposed now in the UK, any financial institution operating in Italy has to comply with the same disclosure rules that are applied to local banks.

I am just an observer with a couple of decades of experience- and I think that there are around already too many indexes and models.

In the private as well as in the public sector, whenever asked I discussed more in terms of objectives, policy/guidelines, and KPIs- not the other way around.

And KPIs should evolve and be monitored, to allow predictive risk management, not simply identifying what happened ex-post.

But an interesting side-effect of global disclosure is the potential shift that it will force in two traditional actors of the financial markets: rating agencies and auditors.

But there are further effects: years ago in Italy I heard more than once from SMEs that they had been requested from their banks more information than what they usually disclosed for tax purposes, all justified by Basel II (and each bank had a different form to fill).

While the current disclosure will be limited to banks, eventually similar requirements could be indirectly extended across all the economic sectors- worth considering as a way to streamline the relationship between government and (corporate) taxpayers, to allow a better but less time-intensive (for the companies) monitoring of the status of the economy.

If we assume that the Spanish disclosure and labour market reform will spread across the EU, probably, as a German bank suggested on the columns of The Economist, a European Monetary Fund will be set up after assessing the results of the current interventions.

The upside will be that the risk of a “competition to the bottom” aspect of the original Bolkenstein directive (full implementation due by Summer 2010, after missing the 2009 deadline in most states) will be reduced, and probably a real EU-wide labour market will slowly develop.

Since the mortgage crisis, the reforms proposed in various EU members are getting EU closer to a flex-security system, like the one adopted in Denmark.

A future EMF will certainly benefit from the IMF expertise.

But the economic policy setting traditions of Europe will require a consensual involvement of all the parties involved- from the financial industry, to the business users of financial instruments, to consumers and trade unions, to ensure both financial and social stability.


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