Golden rules for the eurozone | European Voice

This article – by Harold James, and published in the European Voice, is worth paying attention to!

Golden rules for the eurozone | European Voice.


Payments on the go

Advertising the M-PESA service in Tanzania
Advertising the M-PESA service in Tanzania. Photo from sociate on Flickr

Some time ago I had looked into the development of mobile money for a Maltese news magazine. It was, then, a hot topic. At least, I thought so and with luck, you may agree with me.
Now the European Union is drawing close to a rework of its eMoney Directive. In place since 2000, this was a prescient piece of regulation. It aimed to put so-called “e-money institutions” on to a firm footing, hopefully thereby getting the services off to a flying start.
In that, it failed. The idea did, in fact, catch on. The problem was, it did not use the provisions of the e-money directive. In Malta, for example, there were exactly ZERO registered e-money institutions; across the EU I believe the number did not top 30.
Yet services doing some if not all the things an e-money provider was supposed to, sprang up and became extremely popular. Just look at PayPal. What went wrong?
That was, it turned out, a relatively simple question to answer. The market developed in a very different direction to that imagined by the Directive. This, I suppose, will always be a problem when trying to anticipate needs.
One of the main problems was that, despite the very different types of organisation that could be offering e-money, and the relatively low values when compared to traditional financial services, e-money institutions were to be required to adhere to solvency and capital rules more suited to traditional banks.
The new incarnation of the Directive, which is set to come into effect over the next couple of months, deals with this; it should therefore succeed.
This is a very exciting development. E-money is a pretty broad, ill-defined term. But the promise it holds is enormous. The most exciting end of it is the way mobile telephony operators have adopted it, talking about “mobile money”, a subset of the broader e-money.
As it happens there is now experience of what this sort of service can mean. I do not want to go into the discussions of the variety of technologies that are being proposed – compatibility with NFC (near field communication) sim cards is one. This, because in fact the technology is secondary. Effective mobile money services have and are being run on nothing more complex than SMS.
What is important is what this sort of service allows people to do, and how it can empower them. Safiricom (in which Vodafone has a 40% stake) has been running its M-Pesa service for years now. It has extended simple banking services to rural areas that no traditional, bricks and mortar bank could service cost-effectively. By doing so, it is allowing poor farmers to manage their cash flows more effectively, allowing them to invest in new equipment and seeds. It is thus proving a powerful force for development, a lot more effective at getting people out of the poverty cycle than many other development initiatives.
The M-Pesa service has evolved since 2007 and continues to develop (read this news story, and this one as well). It has spread beyond Kenya, as Vodafone has taken this service to Afghanistan and Tanzania, and since 2008 has been running regular screening on its millions of clients according to anti-money laundering regulations.
This is what good technology should do. It is not, ever, about the technology itself. That is contingent. What it is all about is the things it allows people to do. I personally look forward to seeing this develop.

Integrity revisited

I had touched upon integrity and ethics in financial services a post or two ago; I believe it bears emphasizing. I may end up boring people by this – even so, I will repeat. It is important.

The rather cursory treatment of ethics in business in the MBA course I did 12 years ago disappointed me; I had expected a little more than a list of ethical positions, beginning with a constructed caveman ethic and ending, via a whole range of different positions including utilitarianism, with a variant on Kant. This took all of 15 minutes to go through (well, maybe half an hour). Quite a condensation of 20,000 years of ethical thought and practice.

The rest of the programme in ethical business shifted to a treatment of organisations like Body Shop, essentially looking at what now gets called “corporate social responsibility”. Don’t get me wrong, these are good and useful initiatives. But they miss the point: ethics at its most essential is how people deal with people. Business, a part of society and a nexus of human interaction, is a part of that. Ethics in business is therefore no different to ethics anywhere else in life.

Thus I would have wanted to see a discussion of the sort of decision making that goes into the way employers treat employees, for example. Similarly, the way employees behave towards their employers. A vast number of other situations will undoubtedly spring to mind. This would fall under the general class of practical ethics – and really would not seek to impart hard and fast rules but the ability to work through the issues, reach a decision and, especially if it turns out to be the wrong one, to learn from that mistake and do better next time round.

Talking to friends still involved in providing business education, including an MBA programme, I recently found that the situation has not really changed much. Hence I was very pleasantly surprised to find myself meeting a man who runs a programme to help people develop integrity.

The organisation is the UK’s Chartered Institute for Securities & Investment (you can find them at, with their Integrity Matters. Simon Culhane, their CEO, was in Malta to introduce the Integrity Matters programme to Maltese practitioners. He set out a few difficult situations, then got his audience to discuss the options. Finally, he asked participants, in groups of two, to reach a decision and vote jointly.

This is the sort of education/training that really can help people move towards a more ethical pattern of behaviour, one that involves thought, commitment and the exercise of choice.

I was unfortunately unable to attend myself. However, friends of mine did go – too few, sadly. The reaction of those that made it was very good: this was, they told me, a very useful (and enjoyable) exercise.

The regulation puzzle

If nothing else, the financial travails of the past couple of years have demonstrated the central necessity of effective regulation – that is, regulation that encourages integrity in business. Nowhere is this more important than in financial services!

If nothing else, the financial travails of the past couple of years have demonstrated the central necessity of effective regulation – that is, regulation that encourages integrity in business. Nowhere is this more important than in financial services!

The world’s governments have reacted fast to this message, without a doubt. Both in the US and in Europe, new regulations followed hard on the heels of massive bank rescues. All in all, what started as the fall out from imprudent bankers’ and mortgage lenders’ bad practices managed to depress the world economy to a devastating extent.

It could be argued that even the European debt crisis is a result of this. The debt crisis is at its worst in Greece, though Ireland and now Portugal are suffering as well; the national finances in Greece were shaky, admittedly, but it could be argued that the problems with credit and the costs of rescuing the international financial industry are what finally pushed it over the edge.

The cost has been enormous. Europe has come together to protect its own, a good thing. This does mean, however, that the costs are that much more widely spread and the potential damage even wider. More than ever before, it has become clear that no country is an island (even little ones like Malta, a real, physical island which has contributed its fair share to the rescue pot).

So what has the response been? New regulation – needed, beyond a doubt. It became clear that deregulation had gone too far. Worse, it had left space for a very dangerous misalignment of incentives masquerading (ironically) as a reduction in risk. As Joseph Steiglitz (in Freefall) and others have pointed out, some of the multilayered securitization of mis-sold mortgages actually managed to amplify risk.

Clearly, this needed to be put right. I have only a vague idea of the way the US went about this, but in Europe the drive was relentless. The first thing the EU did was propose, discuss, agree and put into place a new, multi-level regulatory structure. First, a layer of three pan-European bodies which oversee and coordinate the actions of the national regulators. Second, a top layer that watches out for emerging systemic risk.

This approach is definitely a step in the right direction. As financial services become more internationalized, more complex and more intertwined, the risk that emerging problems may get lost in the cracks between different national regulators becomes ever larger. This new structure addresses that.

The EU has taken action in other areas as well. Revised capital requirement rules for banks (under Basle III) are one; the new Alternative Investment Fund Managers (AIFM) Directive is another. On the face of it, there is nothing to disagree with in this. Looking at the detail, you may begin to have misgivings.

I will not go into the day-to-day issues of specific national interests, though there could be a lot of intriguing stories there. No, what I do begin to worry about is the general picture that emerges. Start by asking yourself: what is it we need from regulation? Foremost, quite clearly, is the protection of clients from unethical practices by financial services providers. This means we need regulation to encourage integrity, to incentivize ethical behaviour if you will.

Note this is the opposite of what happened in the years up to 2008. The gut reaction has been to reduce the freedom of action enjoyed by a variety of actors in the financial field. The question to be asked here is: will this incentivize ethical behaviour? Will this foster integrity?

My fear is that it will not. Ethical behaviour is a result of a value judgement translated into a choice, which is then put into action – the experience of which then feed back to the value judgement/choice nexus and develops integrity and a strong ethical sense. Restrict the scope of action too far, and you remove the possibility of choice; in so doing, the entire cycle is short circuited and paradoxically, the basis of ethics disappears.

This is worrying. The only long-term protection against abuse in a changing environment is a sense of integrity. This may sound like a boast, but I’ll say it anyway: Malta’s banks sailed through the crisis almost unscathed, because they stuck to prudent core banking principles despite the temptation to go after the same skewed profits that sent so many banks into a tailspin.

Note that this is not an argument against regulation. It is an argument for the right sort of regulation.This means regulations that encourage ethical choices. I do not believe that proscriptive regulation will manage to achieve this.

Yes, there are dangers in this approach. Inevitably, this will lead to a number of wrong choices being made, some inadvertently and others willfully. The issues need not  always be clear-cut, and there will always be room for debate about which course of action was the correct one; the answer may at times be “none, absolutely”. But at least, the process of ethical thought was there, leading to a stronger base of integrity which will protect customers and the economy (and society) so much better.

SPVs and Solvency II dominate discussions

The new regulatory regime for insurance promises to make capital requirements more responsive to actual risk but the question arises: how much will it cost? And how will SPVs be introduced to Malta? They can be dangerous!

The MFSA is preparing to introduce so-called Special Purpose Vehicles (SPVs) and incorporated cell companies (ICCs) to the Malta as risk management tools, Joe Bannister, MFSA Chairman announced in his overview of the Maltese insurance market for the Malta Insurance Rendezvous held on 4 and 5 March 2009.


Discussing insurance
Discussing insurance

Since the first Rendezvous in November 2007, there have been substantial changes in the sector in Malta. There are now three protected cell companies, from the first one, Atlas Insurance PCC which had only just completed its conversion to the innovative structure. What is more, there are now 10 licensed cells in operation. The number of managed insurers has grown substantially, from fewer than 20 to more than 30 now – with more in the process of obtaining their licenses.

But some things have not changed: most of the insurers are direct writers, not pure captives as in other captive insurance jurisdictions. That is, they cover risks for organisations and people who are not their owners or parent.

One other thing had not changed: the new regulatory regime governing an insurer’s capital requirements, Solvency II, continues to command a lot of attention. This represents a risk-based approach to the determination of the capital an insurer needs to cover the risks it has underwritten, modeled on the Basel II capital regime now being applied to banks.

Like Basel II, Solvency II works on three pillars: the core quantitative requirements, a second strand of qualitative requirements related to internal control and management and a third pillar focused on reporting and disclosure.

The system was explained in detail by Dr Marisa Attard, Director of Insurance at the MFSA and Michaela Koller, the Director General at CEA, the organisation representing the European insurance and reinsurance industry. Solvency II is not, however, a carbon copy of Basel II. It does pick up some of the same principles, seeking to accurately value each risk covered and taking into account a variety of organisational and environmental risks that may affect an insurer. This calculation will work through three basic modes: a standardised approach taking the industry average as its baseline, a fully internal model developed for a specific insurer and an intermediate model. This is, again, similar to Basel II, subject to the proviso that risks in insurance are very different to those faced by banks.

The processes Solvency II will demand of insurers are complex and potentially expensive, a point made by the third person speaking during the Solvency II session, Jeanette Rödbro, Executive Manager of ECIROA, representing European captive insurance owners. Part of the solution lies in simplifications that smaller insurers can apply to the core Solvency II requirements; this is one of the issues being negotiated furiously at the moment, according to Ms Koller.The other is the treatment of multinational group reporting.

The framework directive paving the way for Solvency II to be in place by 2013 must be approved by the European Parliament before it stops work for the European Elections. That was just 15 days away – and the price of failure, the real possibility that the entire framework would need review by the new Parliament.

Ms Rödbro pointed out a number of issues captive insurers have with the Solvency II regime. Many of these apply equally to Europe’s smaller insurers, representing some 80% of the market and including Malta’s insurance companies. Organisational changes could be necessary. But the cost of compliance in itself could be steep.

In preparation for Solvency II and to test the various structures and provisions, a series of quantitative impact studies (QIS) have been carried out. The latest was QIS4, and Europe’s insurers have participated strongly, certainly more than Europe’s banks did during the equivalent phase for Basel II. According to Ms Rödbro, completing the QIS4 reporting cost somewhere between €4,000 and €20,000 and took two weeks. A number of Malta’s leading insurers, talking after the

Malcolm Cutts Watson explains the use of SPVs in risk management
Malcolm Cutts Watson explains the use of SPVs in risk management

presentation, expressed surprise: they had spent much more, despite sharing the cost by jointly securing the services of specialised consultant for the purpose. While wary of the potential costs, they were broadly in favour of the new regime: it has the potential to improve risk management and to better match capital requirements to the actual risks carried. This, in turn should reduce the cost of capital and allow keener pricing of risk and thus of the premiums due. Good for the insurer, but also for the insured.  


In the current economic climate, a number of speakers made the case for captive insurance and other so-called alternative risk transfer (ART) tools. And Malcolm Cutts Watson and Dominic Wheatly, both from Willis, illustrated how the SPVs Prof Bannister spoke about in his presentation could, through securitisation, be used to effectively cede insurance based risk to the capital markets and spread more widely.