U.S., Europe fall out of step on global financial reform

By Anthony Faiola and Brady Dennis
Wednesday, May 26, 2010

LONDON -- The global campaign to harmonize rules for financial firms is swerving off course, threatening efforts to curb the risky bets that rocked the world economy two years ago.

As U.S. Treasury Secretary Timothy F. Geithner lands in Europe on Wednesday, differences are growing among world leaders over how to keep the promise they made at the height of the financial crisis: that they would work together to reshape how finance is governed. Their aim was to avoid another upheaval by making financial rules consistent across borders and closing loopholes.

But the United States and Europe are increasingly pursuing their own -- sometimes clashing -- paths to reform, potentially undermining the regulatory overhauls taking shape on both sides of the Atlantic.

If this continues, a resulting patchwork of reforms could allow companies to continue exploiting national differences by moving operations to countries where conditions are most favorable and thwart the efforts of regulators to spot financial threats early on. The outcome, for instance, could be very different ways of banking in New York and the financial capitals of Europe, prompting leading American firms to shift their riskiest activities overseas beyond the purview of U.S. regulators.

The evolving divide, analysts say, is spooking investors and contributing -- along the European debt and euro crisis -- to the sharp losses in recent days on stock markets from New York to Frankfurt to Tokyo.

"Each nation has said to the other they would work together on this," said Angela Knight, chief executive of the British Bankers' Association, "but in fact, we don't see that happening."

As Geithner arrives for talks with his counterparts in Britain and Germany, for instance, Europeans are expressing dismay about parts of the regulatory overhaul bill approved by the U.S. Senate last week.

European diplomats are alarmed by a measure, introduced by Sen. Susan Collins (R-Maine), that they say could force European financial companies to shift significant amounts of capital to their U.S. subsidiaries to cover potential losses.

Dispute on derivatives

The Europeans are also worried about a provision that could force U.S. banks to spin off their lucrative trade in financial instruments known as derivatives. The Europeans, who have a one-stop-shopping banking culture that allows firms to conduct a vast array of businesses under one roof, are ready to resist any effort at setting a global precedent excluding banks from the derivatives business. Even in the United States, the derivatives provision sponsored by Sen. Blanche Lincoln (D-Ark.) has powerful adversaries in government and industry, and it may be eliminated from the final bill.

The derivatives rule, along with a separate provision that would restrict financial firms from trading with their own money, could encourage U.S. firms to shift some trading overseas. Although the Europeans could win jobs and market share in financial services, "the U.S. would be exporting its risk to Europe or Asia," said a European diplomat involved in the reform effort.

U.S. officials, in turn, are upset by a German move last week to crack down on a form of speculating known as naked short selling. In unusually harsh terms, a senior U.S. Treasury official on Tuesday described the German action as damaging to the markets and counterproductive. U.S. officials are also taking issue with Europe's push to increase oversight of hedge funds and say this could impede American funds from courting European clients.

In addition, U.S. officials are accusing the Europeans of failing to force banks to beef up their balance sheets with more capital. The United States has made this demand on its banks.

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