Energy crisis should spur regulatory overhaul

It is a measure of quite how jittery the world feels right now that we have been awash with “Lehman moments” in recent months. The implosion of China’s Evergrande late last year was portrayed by many observers as a potential Lehman moment for the overleveraged Chinese property sector. The crypto collapse in March was another.

Yet it is noteworthy, alarming even, when a government minister makes the analogy. Last weekend Finnish economy minister Mika Lintilä compared today’s energy crisis in Europe to Lehman Brothers’ role in the financial meltdown of 2008, as he unveiled a €10bn loan and guarantee package to safeguard his country’s energy sector.

Hyperbole or not, he was almost certainly right on one point. Without intervention, an existential crisis loomed for many energy companies, putting pressure on the banks that lend to them, or the clearing houses known as central counterparty (CCP) exchanges that intermediated those finance contracts. Such are the sky-high prices and the market dysfunction, triggered by Vladimir Putin’s invasion of Ukraine and his curtailment of gas supplies to Europe.

Though Finland and Sweden were alone in acting a week ago, others have followed. European leaders gathered in Prague on Friday to discuss a co-ordinated bailout package, including state guarantees, and a range of other measures.

“The world should remember Lehman,” I wrote back in March, “and brace for a global financial and economic shock”.

Financial policymakers insist they have absolutely been braced — not just for this shock, but for many others. They point to the robustness of the banking system in the face of Covid and now in the face of the energy meltdown and rampant inflation.

This, they say, proves the success of post-2008 financial regulation, when bank capital and liquidity rules were toughened. Elaborate mechanisms were put in place then to allow authorities to put failing banks into orderly wind-down, and most derivatives trading was routed through monitored CCPs, rather than being executed in obscure over-the-counter deals.

The banking system has indeed been robust — though largely thanks to state interventions before economic stress could reach the banks. Without Finland’s rescue package, and a similar one in Sweden the day before, the local Nasdaq clearing house, or the banks that are its members, would have been left to bear the stress. Similarly in 2020 and 2021, vast Covid relief packages granted to businesses around the world staved off the risk of mass bank loan defaults.

It is tempting to dismiss such events as unavoidable and exceptional, and deserving of exceptional government intervention. But more could still be done pre-emptively to mitigate their economic impact.

The 2008 financial crisis highlighted the critical nature of the banking system and triggered a regulatory restructuring to better safeguard it in future. But the policymaking was blinkered.

CCPs were consciously turned into systemically important structures in that post-crisis crackdown, but regulators accepted the exchanges’ argument that tough collateral management rendered high capital levels as buffers for risk unnecessary. The Nordic experience raises further doubts about that assumption.

In the core energy market itself, cues could and should have been taken from post-crisis financial regulation. Around 2008, Libor and Euribor, the borrowing benchmarks that sometimes had been casually calculated on the basis of imaginary transactions, proved dangerously manipulable and artificially costly for banks, which had products tied to them.

In a similar way now, the so-called TTF benchmark has been proven to be a flawed gas price metric for electricity markets — manipulated in effect by Putin. Given the dominant role of Russian gas in that mechanism, its manipulation could have been foreseen. Yet only now are EU policymakers discussing a change

More broadly, the weak regulation of energy pricing and hedging is damningly similar to the oversight of flawed funding models of poorly supervised banks in the run-up to 2008.

We are being punished now for not understanding the fragility of our energy systems. As well as tackling this crisis, policymakers must be proactive in ensuring that all our critical infrastructure — energy, water, the internet — is as robustly regulated as the banks were after 2008.

patrick.jenkins@ft.com

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