For almost two years the financial world has been experiencing a stream of bad news. Owing to colossal losses arising from structured financial instruments, many banks are now showing a net worth close to zero, and requiring the backing of their national governments. Jean-Pierre Wellens, the International Capital Market Association's chief representative in Brussels and formerly chairman of the International Primary Market Association, one of ICMA's predecessor organisations, gives his personal opinion of the crisis, its causes and implications for the future

It's not just the banks suffering post-crunch, large insurance companies are also undergoing substantial losses and pension funds are suffering too, although they are not obliged to publish their figures. And finally, private portfolios have lost a substantial part of the value of their assets as well. We have only to look at the latest Forbes rich list to see the truth of this.

It is recognised that the origin of this situation is closely linked to the proliferation of structured products which were created on the basis of quantitative theories and distributed very widely throughout the world to banks, insurance companies, pension funds and private portfolios. These instruments have become progressively more illiquid since mid-2007. To add to this, the complexity of their product structure has made them very difficult to unwind.

Unlike the period 1929-1934, the last massive crash, governments have injected a very large amount of liquidity into the system this time, trying to simultaneously support the banking system in the West and to reflate the real economy in the three main economic zones of North America, Europe and Asia. Today, western banks are surviving on a short-term lifeline provided mainly by the Federal Reserve and the European Central Bank.

Confidence in the world banking system is at an historical low. Most banks have had their lending capacity reduced and the interbank market has come almost to a standstill. The world economy, which had been leveraged for more than twenty years by a low interest ratio policy and an abundant money supply, is now undergoing a huge deleveraging phenomenon, making the life of the real economy much more difficult.

Next steps
What could be the possible next steps to restore the real economy to normal? First of all, confidence in the banking sector should be rebuilt. The banking system is the equivalent of the blood circulation system in the human body. Where there is no blood circulating, there is no life. Bank balance sheets should become totally transparent again. The total outstanding amount of structured products today represents a multiple of the value of the real economy. Transparency is key for these products. When you buy packaged food products, you receive a clear description of the ingredients. It should be the same for all financial products. Many structured products should be listed and traded on central exchanges and cleared and settled through a central counterparty clearing system. Some welcome regulatory and market moves are already underway to try and make this a reality.

Accounting rules should be (temporarily) smoothed a little. Under pressure from the European Commission, the International Accounting Standards Board (IASB) has recently shown some flexibility in its attitude. To sort out toxic products in the banks' balance sheet, the possibility should be considered of ring-fencing those products in a 'bad bank' within each bank's balance sheet. The 'bad bank' could be financed either by the 'good' part of the bank, or by a government guarantee system, such as has already been enacted in some countries. A flexible equity ratio could be applied to the 'bad bank' - for instance, three or four per cent.

Another subject of great importance is transparency in asset management. Many individual portfolios have been filled with synthetic products. Today, valuation of those products appears very difficult. The liquidity of many instruments is under strong pressure. Respecting investors' profiles is more important than ever. Sooner or later, authorities are going to focus on those matters too. ICMA has instituted a major initiative to represent investors' concerns through its Asset Management and Investors Council (AMIC), which represents the buy-side and seeks to establish better channels of communication with the sell-side [see our website for more].

The short-term bonus busting 'trading culture' of today's banking world should be replaced by the concept of servicing the real economy. By adopting this longer-term approach, bank profits will be somewhat more modest, but much more stable.

The excellent EU de Larosière Report provides us with a good financial framework for the medium term future. The FSA Turner Review, G20 proposals and other regulatory moves, such as the establishment of the Financial Stability Board and new liquidity requirements, are all good pointers to the future as well. But action will be needed for many months to come. The consequences of this crisis will continue for many years to come.

• For more information about the International Capital Market Association please go to http://icma-group.org.

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