JOINT COMMITTEE ON EUROPEAN SCRUTINY debate -
Tuesday, 3 Nov 2009

Scrutiny of EU Legislative Proposals: Discussion.

Chairman

The first item relates to adopted measures.

COM (2009) 365 is a proposal for a Council decision amending the Council decision of 20 January 2009 providing Community medium term financial assistance for Latvia. It is proposed to note this adopted proposal. Is that agreed? Agreed. COM (2009) 413 is a proposal for a Council decision on the Community position on a decision of the joint committee established under the Agreement between the European Community and the Swiss Confederation on co-operation in the field of statistics, amending annex B to the agreement. It is proposed to note this adopted measure. Is that agreed? Agreed.

COM (2009) 437 - FON is a follow-on note to Early Warning Note LI 7-19, considered at the JCES meeting of 17 February 2009 with no further scrutiny agreed. It involves a proposal for a Council regulation terminating the "new exporter" review of Regulation (EC) No. 1174/2005 imposing a definitive anti-dumping duty and collecting definitively the provisional duty imposed on imports of hand pallet trucks and their essential parts originating in the People's Republic of China, re-imposing the duty with regard to imports from one exporter in this country and terminating the registration of these imports. It is proposed to note this measure. Is that agreed? Agreed.

COM (2009) 450 - FON is a follow-on note to Early Warning Note L97-17, considered at the JCES meeting of 26 May 2009 with no further scrutiny agreed. It involves a proposal for a Council regulation imposing a definitive anti-dumping duty and collecting definitively the provisional duty imposed on imports of certain aluminium foil originating in Armenia, Brazil and the People's Republic of China. It is proposed to note this measure. Is that agreed? Agreed.

COM (2009) 463 - FON is a follow-on note to Early Warning Note L94-48, considered at the JCES meeting of 26 May 2009 with no further scrutiny agreed. It involves a proposal for a Council regulation imposing a definitive anti-dumping duty and collecting definitely the provisional duty imposed on imports of certain seamless pipes and tubes of iron or steel originating in the People's Republic of China. It is proposed to note this measure. Is that agreed? Agreed.

COM (2009) 276 is a proposal for a Council regulation amending Regulation (EC) No. 733/2008 on the conditions governing imports of agricultural products originating in third countries following the accident at the Chernobyl nuclear power station. It is proposed that this proposal does not warrant further scrutiny. Is that agreed? Agreed.

COM (2009) 328 is a proposal for a Council recommendation on smoke-free environments. Given the information provided by the Department and the existing Irish legislation in this area, it is proposed to note the proposal. Is that agreed? Agreed.

COM (2009) 340 is a proposal for a Decision of the European Parliament and of the Council amending Decision No. 1672/2006/EC of the European Parliament and of the Council establishing a Community Programme for Employment and Social Solidarity - Progress. It is proposed that this proposal does not warrant further scrutiny. Is that agreed? Agreed.

COM (2009) 345 is a proposal for a Council decision on the procedure concerning derogations from the rules of origin set out in the Origin Protocols annexed to Economic Partnership Agreements with ACP States. It is proposed that this proposal does not warrant further scrutiny. Is that agreed? Agreed.

COM (2009) 348 is a proposal for a regulation of the European Parliament and of the Council on labelling of tyres with respect to fuel efficiency and other essential parameters. Given the information provided by the Department, it is proposed to note this measure. Is that agreed? Agreed.

COM (2009) 357 is a proposal for a Council decision on the conclusion of an agreement in the form of a protocol establishing a dispute settlement mechanism applicable to disputes under the trade provisions of the Euro-Mediterranean Agreement establishing an association between the European Communities and their member states, of the one part, and the Republic of Tunisia, of the other part. It is proposed that this proposal does not warrant further scrutiny. Is that agreed? Agreed.

COM (2009) 364 is a proposal for a Council decision authorising the Federal Republic of Germany to continue to apply a measure derogating from Article 168 of Directive 2006/112/EC on the common system of value added tax. It is proposed that this proposal does not warrant further scrutiny. Is that agreed? Agreed.

COM (2009) 367 is a proposal for a Council decision relating to the position to be taken in the co-operation committee established by the Agreement on Cooperation and Customs Union between the European Economic Community and the Republic of San Marino in order to adopt the "omnibus" decision. It is proposed that this proposal does not warrant further scrutiny. Is that agreed? Agreed.

COM (2009 ) 381 is a proposal for a Council decision on the position to be adopted by the Communities and its member states within the Cooperation Council established by the Partnership and Cooperation Agreement establishing a partnership between the European Communities and their member states, of the one part, and Ukraine, of the other part, with regard to the adoption of a recommendation on the implementation of the EU-Ukraine Association Agenda and of a decision on the establishment of a joint committee. It is proposed that this proposal does not warrant further scrutiny. Is that agreed? Agreed.

COM (2009) 382 is a proposal for a Regulation (EC) No. 72009 of the European Parliament and of the Council amending Regulation (EC) No. 1080/2006 on the European Regional Development Fund as regards the eligibility of housing interventions in favour of marginalised communities. It is proposed that this proposal does not warrant further scrutiny. Is that agreed? Agreed.

COM (2009) 389 is a proposal for a Council decision revoking the agreements between the European Coal and Steel Community and the Swiss Confederation. It is proposed that this proposal does not warrant further scrutiny. Is that agreed? Agreed.

COM (2009) 392 is a proposal for a Council Decision on the Community position to be taken on the joint committee decision authenticating the agreement between the European Community and its member states on the one part, and the Swiss Confederation on the other, on the free movement of persons in the Bulgarian and Romanian languages. It is proposed that this proposal does not warrant further scrutiny. Is that agreed? Agreed.

COM (2009) 424 is a proposal for a Council directive amending Directive 2000/29/EC as regards the delegation of the tasks of laboratory testing. It is proposed that this proposal does not warrant further scrutiny. Is that agreed? Agreed.

COM (2009) 439 is a proposal for a Council regulation fixing the fishing opportunities and associated conditions for certain fish stocks and groups of fish stocks applicable in the Baltic Sea for 2010. It is proposed that this proposal does not warrant further scrutiny. Is that agreed? Agreed.

COM (2009) 441 is a proposal for a Council decision on the conclusion by the European Community of the Agreement on the Accession of the European Community to the Convention concerning International Carriage by Rail (COTIF) of 9 May 1980, as amended by the Vilnius Protocol of 3 June 1999 (Text with EEA relevance). It is proposed that this proposal does not warrant further scrutiny. Is that agreed? Agreed.

COM (2009) 126 is a proposal for a directive of the European Parliament and of the Council on combating late payment in commercial transactions (Recast) - Implementing the Small Business Act. Given the information provided by the Department, it is proposed to note the measure and send a copy for information to the Joint Committee on Enterprise, Trade and Employment. Is that agreed? Agreed.

There are no CFSP measures. The next item deals with Title VI (TEU) and Title IV (TEC) measures. COM (2009) 456 is a proposal for a decision of the European Parliament and of the Council of amendment Decision No. 673/2007/EC establishing the European Refugee Fund for the period 2008-13 as part of the general programme, "Solidarity and Management of Migration Flows" and repealing Council Decision 2004/904/EC.

COM (2009) 447 is a communication from the Commission to the European Parliament and the Council on the establishment of a joint EU resettlement programme. It is proposed that this proposed Decision and related Commission communication be forward to the Joint Committee on Justice, Equality, Defence and Women's Rights for information, in advance of consideration of an opt-in motion by the Oireachtas with respect to COM (2009) 456. Is that agreed? Agreed.

10964-09 is an initiative of the kingdom of Sweden and the kingdom of Spain with a view to adopting Council Framework Decision on accreditation of forensic laboratory activities. It is proposed that this proposed Framework Decision be forwarded to the Joint Committee on Justice, Equality, Defence and Women's Rights for information and consideration, in advance of consideration of an opt-in motion by the Oireachtas in accordance with Article 29.4.6° of the Constitution. Is that agreed? Agreed.

There are no early warning notes.

The next item deals with proposals proposed for further scrutiny. COM (2009) 217 is a proposal for a directive of the European Parliament and of the Council on aviation security charges. The objective of the proposal is to set common principles for the levying of security charges at Community airports and to establish a common framework regulating the essential features of security charges and the way they are set. The Commission states that a directive is the most appropriate means to regulate security charges as it will set clear but basic principles with regard to security charges that must be respected by airport operators when applying and levying their security charges. The transposition of the directive into national law will allow member states to take into account the specific situation with regard to airports in that member state, always provided that the provisions of the directive are fully applied.

The airport sector welcomes the renewed focus on security charges but believes that the draft directive fails to address the most urgent problems, for airports and airlines alike, in the area of aviation security. ACI Europe states that, in its current form, the draft directive does not solve the long-standing problem of inadequate public financing of aviation security and, in particular, national security measures going beyond EU requirements. Instead, it feels that the draft directive imposes additional administrative burdens on airports, without taking into account the compromise reached between the European institutions on the recently adopted EU directive on airport charges.

In the UK, a consultation process was undertaken on the directive. Among the views worth highlighting are those of the Air Transport Users Council. It noted that the principal purported objectives of the proposal are already taken care of in the airport charges directive, ACD, which will come into force in March 2011. Separate provision for any single element of airport charges should be consistent with the provisions of the ACD. A more proportionate approach might be to amend the ACD to encompass any specific requirements.

It is not clear from the Department's information note what level of consultation has taken place with stakeholders in Ireland to assess the impact of the proposal. It may be that some of the concerns raised by the committee in its fifth scrutiny report on the airport charges directive are still relevant. These would include the possibility of an excess of regulation; the use of a "one size fits all" approach to the European aviation market, which may be to the detriment of a small island nation like Ireland; and the compliance of the proposal with the principle of subsidiarity, which requires that decisions be taken at the lowest level consistent with effective action.

It is proposed that the directive warrants further scrutiny by the committee in light of the committee's fifth scrutiny report on the directive on airport charges. The Department should be requested to provide further details in writing on the consultations it has engaged in, the relevance of the concerns expressed in the committee's fifth scrutiny report and the latest position being adopted in the negotiations at Council level. The committee may also decide to seek written observations from the stakeholders who gave evidence for the last report. Is that agreed? Agreed.

COM (2009) 384 is a proposal for a Council regulation amending Regulation (EC) No. 1083/2006 concerning general provisions on the European Regional Development Fund, ERDF, the European Social Fund, ESF, and the Cohesion Fund as regards simplification of certain requirements and as regards certain provisions relating to financial management. This proposed regulation forms part of the Commission's response to the economic crisis. The December 2008 European Council agreed a European economic recovery plan, EERP, which envisages the initiation of priority action to enable European economies to adjust more rapidly to current challenges. In the framework of this recovery package, the Commission proposed a number of regulatory changes to simplify the implementation rules for cohesion policy and to increase the pre-financing or advance payments to European Regional Development Fund and European Social Fund programmes.

It is hoped that further simplification measures will enable the ERDF and the ESF to help mitigate the effects of the job crisis in Europe and increase the impact of funding under these Cohesion Funds on the economy as a whole. The purpose of this proposal is to simplify the implementation of Structural Funds regulations and to speed up the delivery of Structural Funds projects.

One of the major innovations proposed in this draft regulation is a financial measure. It would introduce a temporary option for member states to request that the Commission make a 100% reimbursement under Cohesion Fund projects during 2009 and 2010. This would obviate the need to provide national co-financing during this period. This option would apply to member states which face severe cashflow difficulties in financing labour market measures necessary to combat unemployment and which are eligible under the ESF. The aim of this proposed measure is to speed up the implementation of projects to support employment. The adoption of this proposal would complete the series of regulatory and non-regulatory adjustments aimed at stimulating the implementation of cohesion programmes on the ground. It would provide national, regional and local authorities with clearer and less bureaucratic rules, allowing for more flexibility to adapt the programmes to new economic realities and challenges.

The Department's note indicates that the proposal is of a technical nature. However, it also indicates that Ireland cannot support the proposed amendment dealing with financial issues whereby Community co-financing of ESF projects would be 100% for 2009 and 2010. The reason for this opposition is budgetary. The Department also indicates that most of the member states do not support this proposed amendment. The Department's analysis of the payment appropriations available in the budget for 2009 and the draft EU budget for 2010 show that the additional payment credits to be paid under the 100% reimbursement option in 2009 and 2010 for the ESF programmes would represent approximately €6.6 billion overall if the proposed amendment is accepted.

Given the significance of this proposal in the context of the EU's response to the economic and employment crisis and given that the Department has indicated its opposition to a particular aspect of the proposal, it is proposed that the draft regulation warrants further scrutiny. To this end, it is proposed that the joint committee write to the Department of Finance seeking further clarification on its reasons for opposing the provision of the proposal dealing with co-financing and further information on the state of negotiations. On the basis of this clarification, the committee can assess whether further examination of the proposal is required. It is also proposed that the proposal be forwarded to the Joint Committee on Finance and the Public Service and the Joint Committee on Enterprise, Trade and Employment for information. Is that agreed? Agreed.

There are no proposals proposed for forwarding to sectoral committees for observations.

There are no proposals proposed for referring to sectoral committees for detailed scrutiny.

The next item is the scrutiny of a proposal for a directive of the European Parliament and Council amending directives 2006/48/EC and 2006/49/EC as regards capital requirements for the trading book and for the resecuritisations and the supervisory role of the remuneration policies. On behalf of the committee, I welcome Mr. William Beausang, assistant secretary, Mr. Frank Maughan, assistant principal, and Mr. Michael Taggart, administrative officer at the Department of Finance; and Mr. Derek Fulham, Financial Regulator. I draw attention to the fact that while members of the committee have absolute privilege the same privilege does not apply to witnesses appearing before it. Members are reminded of a long-standing parliamentary practice to the effect that Members should not comment on, criticise or make charges against a person outside the House, or any official by name in such a way as to make him or her identifiable. I ask Mr. Beausang to make his presentation.

Mr. William Beausang

I thank the joint committee for the invitation to the Department of Finance to brief it on this latest set of proposed amendments to the capital requirements directive, CRD. I am joined today by colleagues from the Department and the Financial Regulator.

Before setting out the main elements of the current set of amendments, it might be useful if I provided some context on the legislative framework of which this proposal is an important part. The legislative framework for financial regulation in Ireland is largely based on a comprehensive framework of directives which apply throughout the European Union, of which the CRD is an integral part. The CRD applies to the regulation and supervision of banks or credit institutions in the European Union. It is therefore a critical element of this legislative framework and provides a vital underpinning for the EU Single Market in financial services.

The CRD implements the Basel II capital framework in the European Union. Basel II, adopted in 2004, builds on the earlier Basel I accord and its aim is to better calibrate the level of capital required to the level of risk assumed in credit institutions and mirroring the way the larger, more sophisticated banks calculate their risk. The main aims of the capital requirements directive are to enhance financial stability; to safeguard the interests of creditors, including depositors; to promote a stronger culture of risk management by industry; and to ensure the international competitiveness of the EU banking sector.

In response to the financial crisis there is urgent ongoing work by the Basel Committee on Banking Supervision to revise the Basel II framework in several further areas. These include measures to ensure banks are required to build up both capital and liquidity buffers above the minimum requirements during periods of economic growth to enable them to better cope with future economic downturns; the imposition of restraints on the overall size of banks' balance sheets through mechanisms such as a leverage ratio that would limit the total amount of both on and off-balance sheet exposures to a fixed proportion of a bank's regulatory capital; improving the overall quality and consistency of banks' regulatory capital, including a harmonised definition of tier one capital; and the development of appropriate principles for mutual institutions in this regard. These measures, when agreed, will be incorporated into the CRD legislation.

I will now outline the main elements of the proposal before the committee. It is based upon and aligned with work being undertaken at the international level by, among others, the Basel Committee on Banking Supervision, the Financial Stability Board and the G20. Four specific areas are targeted, namely, capital requirements for the trading book, capital requirements for re-securitisations, disclosure of securitisation exposures, and remuneration policies and practices within banks.

The first set of amendments concerns the trading book part of the operation of banks and investment firms. A trading book consists of positions in financial instruments and commodities held by an institution with the intention of trading them for their clients or on the institution's own account. In the past decade there has been a tendency for banks to trade more in credit risk, in contrast to the previous position where the risks associated with the trading book were more equity and default-free interest rate risks. This trend was already recognised when the CRD was agreed in 2006, with that directive requiring banks to phase in a new capital charge for default risk in the trading book, calibrated at a standard of soundness similar to that applying to the banking book. However, it has become clear from experience, particularly in the past decade as trading in credit risk instruments such as credit default swaps increased significantly, that banks may lose significant amounts if an instrument in the trading book deteriorates in credit quality, short of actual default.

The proposal seeks to address this problem by requiring banks to hold capital for credit quality-related losses short of an instrument's default. The proposed requirements are aligned with proposals from the Basel Committee on Banking Supervision. There is a requirement for institutions modelling specific risk to hold capital against default risk which is incremental to any default risk captured in the bank's internal risk evaluation model, known as the value at risk, VAR, model. This is to capture situations where there may not be an actual default but instead a significant impairment brought about, for example, by a credit rating downgrade.

There is also a requirement for institutions using internal risk evaluation models to consider the potential losses over a protracted period of adverse conditions to improve the estimation of the capital that must be set aside in such circumstances. Institutions will be required to set aside a specific capital charge for securitisation exposures held in the trading book, equivalent to the charges that apply to securitisation positions held in the banking book. Institutions will also be required to disclose, under the third pillar, the risks associated with such positions. Re-securitisations are securitisations that have underlying securitisation positions as part of their composition. Given the complexity of such products and their sensitivity to losses in individual securitisation positions, re-securitisations, under this proposal, will be assigned a higher capital requirement than other securitisation positions to reflect the higher risk of unexpected impairment losses.

These changes build on measures introduced in the previous set of amendments to the CRD which are aimed at ensuring alignment of the interests of investors in such products and the originators of such products through the introduction of a requirement to maintain a net 5% interest in the product. Those changes introduced enhanced due diligence requirements and monitoring requirements for such products. The proposal also introduces several additional disclosure requirements on banks with respect to re-securitisations in order to better inform investors as to the exposures banks have to such instruments.

The proposal will oblige credit institutions and investment firms to put in place remuneration policies consistent with effective risk management and which do not encourage or reward excessive risk-taking. The starting point for this element of the proposal is a recognition that remuneration policies in institutions must be consistent with effective management of risk and not act as an incentive to excessive risk-taking by specific individuals whose role has a material bearing on the risk exposure of an institution. This proposal builds upon Commission recommendations, adopted in April of this year, on the remuneration of directors in listed companies and, separately, on remuneration policies in the financial services sector. The proposed obligation is directed at staff whose professional activities have a material impact on the risk profile of the bank or investment firm. Supervisory oversight of these remuneration policies will include the power to sanction credit institutions and investment firms with remuneration policies that are not consistent with sound risk management given the nature of the institution's business.

Since the proposal was introduced, the G20 group of countries has, at its summit in Pittsburgh, agreed to implementation standards on remuneration which have been developed by the Financial Stability Board. These implementation standards have been incorporated in the current proposal with a view to ensuring that performance assessment is undertaken on a multi-annual basis so that payment of performance-related elements of remuneration will take account of the longer-term performance of an institution. In line with the standards, the total amount of variable remuneration should not limit the ability of an institution to strengthen its capital base, and supervisors will be given the power to limit variable remuneration as a percentage of the total net revenues of an institution. The standards also specify that the payment of guaranteed variable remuneration should take place only in exceptional circumstances; at least 50% of variable remuneration should be paid in shares or equivalent instruments in the institution; and at least 40% of variable remuneration should be deferred over a period of three years, rising to 60% where variable remuneration is a particularly high proportion of overall remuneration.

The primary impacts of the proposal for regulated credit institutions in Ireland will be in respect of the amount of capital they must hold for the activities covered by this proposal. The proposed changes to the trading book in terms of incremental default risk will not have much impact on Irish banks as they all apply the standardised approach to calculate specific risk and so do not perform risk assessments based on their own models. The requirement to put in place remuneration policies that are consistent with and promote sound and effective risk management will have general application and will therefore impact on all credit institutions regulated in Ireland. In that context, among the recommendations of the Covered Institution Remuneration Oversight Committee, CIROC, was a requirement that "a focus on short-term targets should be avoided and the amount available for bonus payments should be based on realistically calculated risk adjusted measures that take account of the risks to shareholders' capital." While its recommendations are only addressed to those institutions under the Government guarantee scheme, CIROC had clearly already sought to articulate the link between compensation and risk-taking now under consideration in this proposal.

There will also be an impact in regard to securitisation as credit institutions will have to develop policies and procedures to implement the changes to the CRD. It is difficult to determine the impact of the requirements such as a net 5% retention requirement due to the significant changes to the securitisation market as a whole following the financial crisis. This issue is being examined by the Committee of European Banking Supervisors as part of a call for advice from the European Commission to inform its future policy initiatives.

In addition to the elements of the proposals I have outlined, the Council working group is expected to propose to ECOFIN the extension of transitional arrangements on minimum capital levels to be held by institutions when moving from Basel I capital calculation methodology to Basel II. Given that Basel II provides for increased sensitivity to the calculation of capital requirements by individual institutions related to the risks that each institution faces, individual institutions could, depending on the risk profile of their activities, end up requiring less capital to be set aside under Basel II. The CRD therefore provides a mechanism to prevent capital levels falling below a certain level when institutions change their capital calculation methodology. Given the current situation in the banking sector, the Council working group will propose the extension of the transitional floors until 31 December 2011.

Chairman

This is an important proposal in light of the financial crisis and the problems in the economy. It must be considered against the backdrop of the failure of regulation in the banking sector that facilitated the accumulation of debt by banks and led ultimately to the establishment of NAMA. Has the Department had consultation with European colleagues on the impact of the proposed directive, particularly in regard to the 5% retention requirement? It is important to note the connection to the bonuses given to bank employees in respect of short-term selling in light of the fact that the bank book was sold on for other security dealings on behalf of the banks.

Mr. William Beausang

This proposal has not been contentious at EU level because the measures introduced in it reflect strongly the views of all member states regarding the need to strengthen the regulatory framework for credit institutions and to ensure the capital requirements directive fully meets its objectives.

With regard to consultation requirements, there was extensive consultation through the European Commission with various parties on the proposals included in the directive. The timeframe for the introduction and progression of the proposal is such that there have been limited opportunities for national authorities to consult. However, given perhaps the most significant issue in the directive relating to remuneration policies is closely aligned in its objectives and principles with what is included in the bank guarantee scheme and is reflected in the work of the CIROC committee, we are confident the approach reflected in the directive is fully aligned with national priorities and objectives.

The issue of the retention of the 5% interest in securitisation products has been more contentious on account of various views held by industry that it would have a detrimental impact on the securitisation market. However, in practical terms, given that securitisation has been strongly affected by the financial crisis, it is probably not at the present time a hugely material issue. However, for the future the Commission and member states will monitor closely the extent to which the securitisation market improves, as financial conditions normalise.

Mr. Derek Fulham

With regard to the 5% securitisation, the objective is to try to align the interests of investors in securitisations with the originators of them. One of the lessons of the financial crisis has led to an appreciation that in a market where one could originate certain products without having residual exposure to them, a moral hazard argument would be created. The European committee of bank supervisors has examined this 5% retention and how it might better align the interests of investors with those who originated securitisations but it is a complex piece and to understand its impact is equally more difficult because the securitisation market as was prior to the financial crisis has been significantly disrupted by the crisis and, therefore, to determine in advance what the impact would be in the steady state that may resume is a difficult challenge.

Chairman

Banks were selling their own loan books. Will payments to bank employees be ring-fenced? Regardless of the profitability of the institution, payments and incentives were given to dealers to sell short-term loans which, in turn, the bank sold to another bank as the security portion of a portfolio. Will a retention clause be provided in regulation requiring banks to hold a portfolio for a period before they can sell it? Banks gave massive incentives and bonuses to staff to make short-term sales even though management knew the loan portfolio was being sold as part of a bigger deal to a European institution. Is there any timeframe over which banks will be obliged to hold a contract?

Mr. Derek Fulham

SEB in examining the 5% retention has looked at the duration for which those assets should be held prior to onward distribution but it has not reached a conclusion on that matter.

Chairman

This is important in the context of the level of security held by banks, the time the securitisation is held, the bonuses paid to employees, the loss making capacity of the banks, the impact on investors, depositors and shareholders and the recurring bank charges and legal fees resulting from law suits. Will there be a caveat that a retention will apply to the legal charges of financial institutions?

Mr. Derek Fulham

With regard to SEB's consideration of the 5% and where there should be a minimum retention period for an institution, it is examining the moral hazard associated with no retention, as was the case in the past, but it has not gone into all the aspects outlined by the Chairman regarding fees. It is addressing the moral hazard inherent where there is no retention.

Chairman

Is it not time for total transparency? This could be lost in the fine print. Transparency and openness are critical for business people to make a deal in light of the compound interest they may be charged for default on a loan.

Mr. William Beausang

We agree with the assessment. An important part of the proposal we are discussing is aligning pay incentives with avoidance of excessive risk taking and ensuring in situations where there are bonuses and performance-related pay, that they are related to the long-term performance of the institution-----

Chairman

Yes, not the short-term gain.

Mr. William Beausang

-----and that they are delivered in a way which avoids the situation that prevailed in the financial sector in recent years where significant pay and bonuses were made available to people in regard to the short-term performance of the institution and themselves, which was a dangerous and negative incentive in ensuring effective risk management in the institution. The CRD proposal, which has been brought forward, will result in implementation of those requirements and will make a significant difference to those incentives.

Chairman

Is a default mechanism built in whereby substantial bonuses would be repaid by both the institution and the employee if there was a catastrophic loss?

Mr. William Beausang

Given a large proportion of variable remuneration and bonuses will be paid in shares, a deterioration in the long-term performance of the institution will be reflected in the size of the variable remuneration the individual receives.

Deputy Michael P. Kitt

I agree with CIROC that short-term targets should be avoided. The committee also stated the amount available for bonus payments should be based on "realistically calculated risk adjusted measures". Why should bonus payments be paid? One of the problems with the financial crisis is that the public is annoyed and frustrated that banks are paying bonuses while CIROC says they should be paid using "realistically calculated risk adjusted measures".

Deputy Seán Connick

I thank the delegation for the presentation. Financial regulation is largely based on a comprehensive framework of directives which apply throughout the Union. Did the lack of implementation of regulations in recent years lead us into some of the difficulties we are experiencing? Are the regulations being reviewed in light of the financial crisis and the way the banks operated?

The Basel II capital framework was adopted in 2004. Was a slow march applied to its implementation? What happened in this regard?

I have major concerns about the build up of capital and liquidity to buffer the minimum requirements within banks. While I understand where they are coming from, will we have an economy if the banks succeed in achieving that? It is difficult for small businesses and individuals to secure loans from banks but if they are buffering their own capital, will that have a detrimental impact on wider society? Should we encourage them to take less risk when considering the areas in which they invest? The Commission made recommendations on the supervisory review of the remuneration policies. Will Mr. Beausang comment on how that will work in practice? In regard to incremental default risk, it was stated that the Irish banks apply a standardised approach and do not perform risk assessment based on their own models. I question whether they should perform risk assessment.

When the ordinary punter invests, say, €10,000 or €100,000 in a pension scheme, he or she is usually charged for the privilege of investing that money. I normally refer to managed funds as unmanaged funds. If one were to look at the 20% fall in pension funds, surely a red flag should have been raised when they fell by 5%, yet those managing the funds allowed them to continue in the higher risk funds which were continuing to fall rather than diversify. At what stage should the investments have been moved to secure funding such as cash?

Who monitors the staff who manage the investment portfolios? Are there means of sanctioning the people who watch the share price on a daily basis? In regard to the bonus schemes, is there a relationship between performance and the level of bonus paid?

Chairman

I will ask Mr. Beausang to respond to questions from Deputies Michael Kitt and Connick as I do not want to bank up too many questions, and then I will call on Senator Leyden.

Mr. William Beausang

I will respond to the questions on the bonus. It is important that CIROC recommended that performance related bonuses for CEOs and executive directors should not lead to payments in respect of performance in 2008 and 2009 and for the period of the Government guarantee. Members will not be surprised to hear that. Under the terms of the subscription agreement, no annual bonus calculated on the basis of, or related to the performance of any individual team, department or division of a company or group should be paid to senior executives in respect of those financial years.

Turning to the general issue of bonuses, it has been a major priority both at national and EU level to make rapid progress in strengthening the safeguards against excessive risk taking through remuneration policies. A Commission recommendation, separate and in advance of this proposed legislative proposal, has been issued which contains a number of very detailed recommendations in terms of remuneration policy, including the capping of bonuses, power for companies to withhold bonuses, deferral of the payment of bonuses, based on future performance, and addressing the issue of golden handshakes and the possible repayment of bonuses. The Department, having received that recommendation from the European Commission, formally issued it to the financial regulator and requested the financial regulator's advice as to how the recommendation should be implemented in the case of financial institutions in the Irish financial system. Those measures will be important in addressing the types of issues that have been raised today and are over and above the controls that are in place under the CIROC scheme, but that is only for banks that are participating in the guarantee scheme.

That is a summary of the approach taken in the directive on remuneration.

Deputy Seán Connick

Have we the power to impose those conditions on the banks or will the banks be able to counter this by stating that they are governed by a board which decides what each bank will do? Is legislation required to force the banks to comply with the regulations we are discussing?

Chairman

That is a very good question, because the point was made that the banks may opt in and that participation is voluntary.

Mr. William Beausang

There is a number of mechanisms that could be examined to assess how to implement the Commission's recommendations. Ultimately it is down to a legal assessment of the powers of the financial regulator and whether it is necessary for the Minister to seek to ensure that he has sufficient powers to ensure that remuneration policies in financial institutions in Ireland are properly monitored and subject to appropriate oversight.

In the case of the Commission recommendation, we pointed out to the acting chief executive of the financial regulator that there is a code-making power available to the financial regulator under section 117 of the Central Bank Act 1989. This was the power that was used to implement the consumer protection code and give it statutory force. We have asked the financial regulator to consider whether that may be an appropriate mechanism to implement these recommendations. If it is the case that it does not give the regulator the necessary statutory authority, although it is ultimately a policy decision, the requirement for additional powers to put in place what would be considered best practice in the EU would have to be considered.

Mr. Frank Maughan

May I add to that point? The issue we are discussing is to give the contents of that recommendation legal force through the capital requirements directive as regards banks and credit institutions and investment firms, whereas the recommendation is addressed more generally to the entire financial services sector, not just banks, depending on the level of sophistication, complexity, risk they take and so on. It is not the case that banks would ever be in a position to choose to apply the requirements of the recommendation as the Capital Requirement Directive, CRD, and the amendments we are discussing will take legal effect from the end of 2010.

Chairman

On that point, with regard to the range of products sold by banks such as insurance and related products, will that be regulated in light of the fact that the lack of controlbecame evident with the level of reckless lending? Will new proposals for capital requirement and the supervision of the trading book apply? There was lack of ability to clearly identify the risk associated with the trading book, which is now a risk for the taxpayer. Do you, as regulator, have the power to study the trading book and establish its valuation and the other risks of insurance and assurance on loans, the securities on bonds and derivatives?

Mr. Derek Fulham

Specifically on CRD, the focus has been to strengthen risk management and the degree to which it is evident from a review of the operations of an institution, whether it is the trading book or the banking book that the institution has evident in it a weakness in controls or associated measurement of the capital required, the regulator can act under the current powers available to it. The CRD seeks to enhance risk management in the institutions and arguably one of the lessons learned from the financial crisis is that certain risks were underestimated and certain liquidity risk was not given the importance that it subsequently transpired to have. Some of those things are only ascertainable after the event, but to the degree that they can be ascertained - I noted the previous question on the supervisory review of remuneration and how we will go about it - we undertake reviews of the financial institutions based on the legal framework.

To the extent that there are new measures on remuneration policy we will endeavour to review the legal requirements and take account of general guidance to build them into our supervisory review process involving the banks. We will examine whether the Financial Regulator will have the powers it currently has in respect of activities such as short-termism or excessive risk-taking, enabling it to instruct the banks to lower risk. The internal control framework of a bank may be such that a regulatory capital add-on should apply to that institution until its operations are consistent with prudent management.

Chairman

Can the profit margin of a bank be quantified? Has the regulator any input into the issue of profiteering on the part of banks?

Senator Terry Leyden

I thank the officials from the Department of Finance for attending. Much of this appears to be locking the doors after the horses have bolted. The deposit guarantee scheme was a great decision by the Minister for Finance and the Government. I do not think that just one economist, in the shape of David McWilliams, was responsible for it and it must be galling for officials from the Department to read that one chat over a cup of tea had changed the course of Government policy. The book is a great betrayal of the trust of the Minister for Finance, Deputy Brian Lenihan.

We were all very keen for a guarantee scheme because money was flying out of the banks. The Joe Duffy show was inundated with calls and people queued up at banks to take out their money. One did not need to be an economist to know that, without the guarantee scheme, the banks would have collapsed. I presume the scheme will be renewed after its initial term in 2010. We do not need David McWilliams to advise the Minister or the Government on that matter and I would advise them to extend the guarantee forthwith to give security for people's deposits.

The banks have sold virtually all their properties. In the boom times they capitalised their properties and used the money to finance crazy projects such as those in Ballsbridge and at the Irish Glass Bottle Company site. I do not know what they have left after re-mortgaging them.

Chairman

They have freehold properties.

Senator Terry Leyden

I cannot understand how the Regulator and the Department of Finance sat idly by and allowed it to happen.

Chairman

This is outside the terms of the directive.

Senator Terry Leyden

It is relevant to the situation we are in. If it was not for the fact that we are in the European Union and the eurozone we would be like Iceland.

Chairman

What is the Senator's question?

Senator Terry Leyden

My question is on the deposit guarantee scheme. It is one thing to sort out financing, remuneration and bonuses but AIB cannot get a chief executive at the moment because it is not offering enough money for outsiders. I am worried about the ordinary depositor and the guarantees over their money.

Mr. William Beausang

Before I reply to that question I will return to Deputy Connick's questions on the review of regulation. An extensive and exhaustive review process has been undertaken at EU level. EU legislation is important for our system of financial regulation and the review has looked at how supervisory structures failed to perform during the financial crisis and at other weaknesses in the regulatory framework. The proposal in the capital requirements directive is a result of that process of examination.

On the supervisory side some very important proposals are being progressed for adoption by ECOFIN in due course. There will be a new system of financial supervision in the EU. One of the main weaknesses in international financial supervision was the failure to become aware of risks arising in the whole sector, as opposed to the risks which arose in individual financial institutions. A European systemic risk board will be established. It will be composed of central bank governors to scan the horizon for risks to financial stability. It is intended that it will have the power to issue warnings or recommendations. This will not be a binding power but the board will be an authoritative body and will warn individual regulators, member states and firms as to their risks.

The approach at EU level mirrors, to a significant extent, the reforms introduced into our regulatory system, such as the establishment of a new structure for the Central Bank of Ireland. In this respect the Minister has promised legislation early next year, which will create a body with single unitary responsibility for macroprudential supervision of the sector and the soundness of individual institutions. A much more integrated and co-ordinated approach to financial supervision, both nationally and at EU level, will address the more significant weaknesses revealed by the financial crisis. My colleague from the Financial Regulator will discuss the implementation of the Basel II framework.

Mr. Derek Fulham

Basel II may have been agreed in 2004 but the capital requirements directive implementing Basel II was transposed in October 2006. The process whereby banks move from the Basel I framework takes some time. The US system did not move to Basel II until later than the European system. It was introduced as quickly as it could be in the circumstances. Amendments being made to the Basel II framework and implemented through the amendments to the CRD will also take time.

I was also asked about incremental risk and whether institutions should be required to introduce measures in that regard. In some cases the capital required under the standardised approach may be higher than in the ratings-based approach. The institutions which have the scale and sophistication to introduce a risk-based approach to their assessments are expected to do so. The standardised approach is the default position but as they build up skill sets, resources and ability they are expected to move to the ratings-based approach. They are encouraged to adopt the ratings-based approach to address the incremental risk in their portfolio from such things as credit migrations, where there is a drop in the quality of the credit of underlying names, and reflect that in their capital assessment.

Mr. William Beausang

Deputy Connick raised the issue of the requirements on which regulatory and supervisory bodies focus to increase liquidity and capital buffers in financial institutions. I agree with the Deputy that it is important that a balance be struck between the goals of maintaining financial stability and making sure institutions are well funded and capitalised and those of ensuring banks meet the needs of the real economy and support lending to households and small businesses. There is a keen awareness, on the part of regulatory bodies in the EU and nationally, that the balance will need to be carefully managed over the coming period to ensure we do not end up with very onerous capital requirements on banks which impact the role they are able to play in the economy. Having said that, the appetite of the markets to provide funding and to support the financial system will depend on the credit ratings of the banks and on an assessment of how strong they are. Obviously investors do not wish to put money into weak financial institutions. An issue we need to bear in mind is that it is not fully within the control of the regulatory authorities to set a level of capital and assume the market will fall in behind it. The market will have its own views which will have to impact on how the supervisory bodies assess the requirement for capital ratios and liquidity levels in financial institutions going forward. It is a very sensitive and delicate issue to be managed through to ensure that given all the support the financial institutions have received from the taxpayer they are supporting economic recovery and small business.

Chairman

What about Senator Leyden's point on the guarantee?

Mr. William Beausang

On Second Stage of the NAMA Bill, the Minister announced that a new guarantee scheme was close to finalisation. We are still working on it with the European Commission to secure State aid approval. Under the revised guarantee scheme, it will be open to financial institutions participating in the scheme to guarantee their debt and the deposits beyond September 2010. The main purpose of the guarantee scheme is to encourage financial institutions to fund longer term because an excessive reliance on short-term funding is not consistent with financial stability, given the impact of unexpected shocks on the provision of liquidity to financial institutions during the past year. Under the new guarantee scheme, it will be possible for institutions - if they so choose - to issue a guaranteed five-year debt for as long as the scheme is open. That is expected to play an important part in helping to build the financial strength of our financial institutions and to rebuild market confidence in those institutions.

Another important aspect of the scheme is that it will allow banks to issue debt that is not guaranteed if they choose to do so because obviously that reflects the improvement in financial market conditions. Some of our financial institutions have been successful in issuing debt that is not guaranteed into the market during recent weeks, which was seen as a positive development in terms of market confidence in the Irish banks. The plan of our banks is to increase the amount of their unguaranteed issuance. From the authority's point of view, that kind of exit from the support provided by the State is considered very important. It is hoped, subject to State aid approval, to introduce the new scheme into the Oireachtas for approval during the second half of November or in early December.

Chairman

That is very good news on the issue of unguaranteed debt. Does the Government have any concerns on this directive or does it wish to have it amended? Did other countries have concerns and, if so, did they amend it?

Mr. William Beausang

No. Nationally and across all member states there was a positive and constructive response to this proposal. It was seen to strengthen the capital requirements directive in addressing some weaknesses that had been identified in the CRD framework by virtue of the financial crisis. The changes are very much in line with what the Basel Committee on Banking Supervision would recommend and with what is happening internationally at G20 level. No major issue arose for us. We did not have any issues in regard to the final shape of the directive. However, this is very much a work in progress because it is clear that a significant number of legislative initiatives are coming down the tracks from the European Commission with a view to addressing a whole range of issues which it believes is necessary to ensure the financial system is properly supervised and the regulations are in place for the future to address significant risks to the financial sector.

Chairman

Is the level of compliance within Europe on financial regulation stronger than in the euro currency countries from the point of view of compatibility? Does Mr. Beausang see any other spin-off from this in other areas that would not be included in this directive?

Mr. William Beausang

Echoing the Chairman's point, as we look at the development of our financial sector and, in particular, the international financial services sector, we are in a position to say that we operate within an EU framework for financial regulation. Increasingly, we will operate within a more co-ordinated and integrated approach to financial supervision in the EU. Obviously one of the major risks identified to "financeability" across the whole of the EU, through the financial crisis, is the position of large cross-border financial institutions which would operate in many different member states. If, as has happened in some instances, they experience difficulties, what system is in place to manage and resolve that crisis given that one is talking about an institution that operates on a pan-European basis but obviously a single member state would be its home regulator? That entity would operate in several member states. Therefore, there is need for a more joined-up and integrated approach between supervisors and in particular situations between finance ministries to ensure the issues that emerge with a large financial institution can be worked through without causing border instability.

Chairman

Some 13,000 to 14,000 people work in the IFSC, a centre where the mainstream banking would have damaged the perception of Ireland. For example, the commercial trading bank, the street bank, compared to the IFSC would be a different line of banking. Does Mr. Beausang see Ireland's reputation being enhanced having been damaged by a small number of bankers given the level of irresponsible lending? What timeframe does he envisage for the credence of Ireland in banking circles and will this regulation go some way to enhancing its reputation internationally for bankers coming in who are not in mainstream banking?

Mr. William Beausang

I mentioned the reforms to our system of financial regulation and the proposals approved by Government that will be reflected in legislative changes early in the new year. It was announced recently that a new head of financial regulation will be appointed to the new structure. That, alongside the changes in the regulatory and supervisory framework at EU level, provides a good basis for the restoration and rebuilding of the reputation of the financial sector.

Chairman

On the payments to staff, does the staff include directors, chief executive officers, branch bank managers, investment managers and so on? Is the regulator satisfied in regard to the staff grades included or would he wish to see the inclusion of more staff? Is there a mechanism in place to indicate the level of payments made and in respect of shares given to bank employees is there a period during which they cannot cash them?

Mr. Derek Fulham

The CRD specifically provides that the remuneration policy should cover those individuals who have a material impact on the risk profile of the institution.

Chairman

How does one identify that person?

Mr. Derek Fulham

It will be for the institution to identify which individuals have a material impact. Arguably, in a trading portfolio, it would look at whether they took on a certain level of risk for that institution which is deemed to be material. Equally, it looks at the remuneration policy of those in control functions which themselves may not add risk to the balance sheet of the institution but are there as a control function.

Chairman

Ultimately it is the customer who pays for everything. This is all part of the stacked-up cost of doing business, which is determined by the customer who ultimately pays the price. Is it not the case that, at the lowest level of subsidiarity, Joe Bloggs pays for all these benefits and bonuses?

Mr. Derek Fulham

The directive is prudential in nature, rather than consumer focused. Clearly, the costs associated with our adherence to that directive will at some point be passed on either to the consumer or in a reduction of the profitability of the institution. On the bonuses paid, where it is clear and evident that the bonus policy, as a whole or in relation to those involved, has a material impact on the risk profile, is abhorrent to the capital requirements directive or to the general principles on remuneration - i.e. that they incentivise short-termism to the detriment of the long-term sustainability of the institution - in that context, the regulator can act, but it is very much prudentially.

Chairman

Banks can sell off short-term risks or split the risks, while not selling all of them. Is there a percentage that can be sold, like hedge funds?

Mr. Derek Fulham

It will come down to whether the activity in the particular credit institution can be found to be unsound or imprudent.

Chairman

Does this directive control hedge funds as well?

Mr. Derek Fulham

The CRD is specific to credit institutions and investment firms.

Chairman

I know it is in the commercial end of things, but does this directive have any application to credit unions or does the Office of the Financial Regulator have any remit in that regard?

Mr. Derek Fulham

It is very specific to credit institutions and investment firms, and does not cover credit unions.

Chairman

I thank Mr. Fulham for that clarification. We are conscious of time and that another meeting is scheduled. I thank the representatives of the Department of Finance, Mr. Beausang, Mr. Maughan and Mr. Taggart, as well as the Financial Regulator, Mr. Fulham, for attending the joint committee. The committee will formulate a report on this mater and we will send it to the witnesses in due course. If they have any observations on this meeting on issues that may not have been discussed but which they feel are relevant to the completion of the report, it would be appreciated if they could send them to the committee secretariat within ten days.

The joint committee adjourned at 1.25 p.m. until 11.30 a.m. on Tuesday, 17 November 2009.