BRUSSELS — The European Commission Monday proposed new rules aimed at reducing the risks that complex financial products pose to the financial system, as well as new restrictions on pay policies that might encourage excessive risk-taking at banks.
The rules would require banks holding re-securitized assets to keep extra capital on their books as a buffer against potential losses. These investment products — which include collateralized debt obligations, or CDOs, and other bundles of asset-backed securities — have been a major cause of the financial crisis.
E.U. officials said the rules reflect the view that CDOs and other re-securitized products are significantly more complicated to value and therefore more risky than the underlying asset-backed securities on which they are based. In addition to setting aside more capital, financial institutions will have to be able to explain to regulators that they did proper due diligence when buying one of these assets.
"The investor who buys a re-securitized position has to be able to prove to the supervisor that he has processes and procedures in place to analyze the investment he has made," said Kai Spitzer, a banking regulation expert at the European Commission, the E.U.'s executive arm.
Commission officials said they expect this requirement would prevent the CDO market, which has been largely closed since the financial crisis, from returning to anything close to its size before the crisis.
The Commission said it's aiming for the rules to take effect in 2011.
European Union policy makers have been calling for new financial-market rules since last autumn, following the collapse of Lehman Brothers Holdings Inc. and escalating problems among the bloc's own banks. Legislative proposals have followed slowly, since E.U. policy makers and banking groups want to insure international cooperation, particularly with the U.S.
E.U. finance ministers, meeting in Brussels last week, called for new bank-capital standards that would help curb boom-and-bust cycles in financial markets. The E.U. likely will raise this issue at a September meeting of the Group of 20 nations in Pittsburgh.
The ministers also called for a stronger link between performance and pay, reflecting both a popular outcry against lucrative pay packages and specific worries that bankers might take excessive risks if large bonuses are at stake.
The European Commission proposed new powers for national regulators to penalize banks with compensation policies that reward excessive risk-taking.
"Banking supervisors will be given the power to sanction banks with remuneration policies that do not comply with the new requirements," the commission's proposal said.
A spokeswoman for the European Banking Federation, an industry lobby group representing about 5,000 banks, said the principles of the commission's pay proposal were acceptable, but warned that banking supervisors shouldn't determine the level or the type of remuneration bankers receive. The group also wants these pay guidelines to be adopted in the U.S., to preserve "a level playing field."
The commission's proposal will also require banks to review a broader range of risks to their trading books. Banks hold a range of financial instruments for short periods before reselling them to other investors. The financial crisis saw banks stuck with large inventories of risky assets on their books that they were then unable to sell, forcing them to take large losses.
The rules will also require more public disclosure from banks about their holdings of securitized assets.
E.U. national governments and the European Parliament must approve the commission's proposals before they can become law.