On Monday, the timing of the press briefing held by the Group of 30, a lobby group comprised of formerly revered monetary policymakers, was particularly apt: it coincided with news of the shock resignation of Pope Benedict XVI. All is not well in the church of infallibility, both in the religious and central banking realm.
The chief proclamation from the high priests of monetary policymaking, led by ex-ECB chief Jean-Claude Trichet, was stark: investors must hike long-term financing – principally capital investment – in the world’s largest economies by $7.1 trillion by 2020 or risk a global slowdown.
Drawing heavily from McKinsey analysis and based on consensus growth forecasts, the G30 estimated that need for long-term capital would increase to $18.8 trillion by 2020 on areas as diverse as infrastructure, R&D, housing and education.
Its diagnosis of the principal challenge of bank and non-bank intermediaries to embark on liquidity and maturity transformation was on the money: shifting industry practices – such as safe asset hoarding and shrinking bank balance sheets – combined with a bombardment of new regulatory standards has created a perfect storm.
In short, banks and capital markets can no longer supply the long-term financing to meet global demand.
The panel said: “There is mounting evidence that the post-crisis financial system is not well structured to provide the level of long-term financing that is required to support global economic growth.”
The report, produced by a G30 Working Group, was led by a steering committee chaired by Guillermo Ortiz, former Mexican finance minister, with Lord Adair Turner, outgoing chair of the UK Financial Services Authority, and Axel Weber, Chairman of UBS and former ECB governing council member, among others.
At every stage of the briefing, the panel was at pains to emphasize its agreement with the philosophical and operational thrust of global bank-regulation. “We are not arguing for a roll-back of regulatory measures,” said Ortiz.
However, a decrease in the provision of long-term financing is an intentional consequence of supporting the restrictive capital and liquidity frameworks at the Basel level.
In short, higher risk-weighted charges and the jump in cost of long-dated liabilities have served to reduce banks’ appetite and ability to provide long-term financing, let alone their stomach for construction risk in project finance loans.
Turner was the most intellectually honest about the trade-off between regulation and the provision of long-term finance, and spent little time trying to square the circle: “The unavoidable consequence is there will be some curtailing long-term finance and that makes it essential that regulation, accounting and incentives ... enable intermediaries to finance infrastructure investment.”
Curiously, in the report, the G30 flirted with two hugely controversial policy views that received little media attention, while it's not clear whether they represent concrete recommendations the group will now lobby for or simply ideas for debate.
Firstly, the report proposes that “national policymakers should consider steps [to weigh] the pros and cons of phasing out the preferential treatment of sovereign debt in insurance and bank regulation over an extended time horizon. This would remove the distortion that favors allegedly ‘safe’ assets, such as government bonds, and increase insurers’ incentives to invest in corporate bonds, equity and other long- term instruments.”
In other words, the G30 echoes the Basel Committee’s fears that the zero-risk weighting applied to triple-A rated sovereign assets has encouraged complacency in EU banks’ accounting procedures, encouraging banks to load up on sovereign debt at the expense of other assets.
Turner explained: “From the perspective of insurance companies and banks, sovereign funds [from an accounting perspective] are favoured and, therefore, this disfavors infrastructure bonds.”
Nevertheless, the jury will surely be out on whether making sovereign benchmarks riskier and more expensive from a bank-accounting perspective would make the cost of long-term capital cheaper and in, absolute terms, boost the quantum of infrastructure finance, in particular.
Asked whether this proposal risks triggering the ire of European governments and a divide at the G30 level, Ortiz told Euromoney: “We brought up the point because it’s not currently being debated by regulators. This [proposal] is very controversial. But we phrased this very cautiously and drafted it a number of times.”
However, the next proposal is the bombshell: “In advanced economies with mature debt markets, policymakers should consider changing the tax treatment of debt and/or equity in order to remove the bias ... One option would be to eliminate the tax deductibility of interest payments at the same time.”
It adds, rather ambitiously, that the policy bid to equalize the tax treatment of equity and debt should be revenue-neutral.
Trichet added: “This idea is to really look at the overall [regulatory] framework to remove any bias against equity,” arguing that boosting the competitiveness of taxes on equity versus debt would help primary equity capital-raising and, in this way, the supply of long-term finance. This is possibly the first time a senior lobbying group of eminent former policymakers has attacked head-on the debt bias in western tax systems, even though the proposal would surely trigger a massive wave of deleveraging.
Asked why this nuclear option had not garnered more prominence in the report, Ortiz told Euromoney: “This is controversial and people would be concerned about disorderly deleveraging.” Indeed.
Asked whether he was in favour of removing the deductibility of tax interest payments for corporate income tax purposes in line with equity returns, Weber told Euromoney: “I have my personal views. We are calling for a debate rather than advancing specific policy proposals.”
Other proposals
The group’s other policy prescriptions probably fall short of the transformational shift that is needed to catalyze long-term financing, and the panel spent most of the time supporting reforms at the non-bank intermediary level.
It recommended that public pension funds, sovereign wealth funds and insurers take a longer view in their asset/liability horizons, aided by guidelines from the Financial Stability Board. It also called on fund managers to refrain from cutting exposures to equities in anticipation of Solvency II regulations – but the panel of experts refused to say whether the fundamental review of the capital adequacy regime for the European insurance industry should be diluted, citing a desire to support the global regulatory push.
It said bonuses to fund managers should be paid with a minimum three-year investment horizon and called for the expansion of public-private partnerships and dedicated long-term financing multilaterals. Some of these developments are already in the offing – such as growing infrastructure partnerships between multilaterals in emerging markets – or would only help at the margin, such as fund mangers’ compensation.
The group also called for the development of the corporate bond market in Europe and emerging markets, and gave the green light to the “prudent” nurturing of the securitization market, even while calling for the Basel Committee to strongly regulate the shadow banking system.
In sum, the report deserves credit for its vision, and the focus on boosting equity investments. But, underscoring the ambitious focus of the report and its mixed objectives, two of the biggest proposals – reducing the debt-bias and the treatment of government benchmarks in bank accounting – aim to reform the global financial system, rather than directly boosting long-term investment, such as infrastructure.
At the heart of the G30’s challenge is the de facto lack of independence of its panel members – the grouping includes Draghi and Carney – and the diverse views of its membership.
In this context, perhaps its chief mission should be to serve as a more-aggressive shadow G20, serving as a check-and-balance body to scrutinize the surveillance and policy ideas of the newly revamped grouping, ideally led by former, rather than serving, fiscal and monetary policymakers.