Like motherhood and apple pie, transparency sounds like one of those things you can’t possibly object to. Honesty, openness, candour: surely, these are qualities we all admire and which we would like to see infuse every aspect of public life. Transparency is good.
If only things were quite that straightforward. Transparency should be a fundamental requirement for the efficient operation of markets: all participants are assumed to have access to the same information; and as a general principle, the more information the better. If I am weighing up whether to buy shares in a particular company, for example, I expect to know the price at which others are buying. Armed with that information, I know whether the person on the other side of the deal – the seller – is trying to rip me off by asking for a price higher than others are paying.
So far, so simple. But consider a particular case. Imagine that Italy is auctioning government bonds. I am an investment bank, I enter that auction and I end up buying a large chunk of the issue. I am not buying with the aim of holding the securities forever: I buy with the intention of off-loading them in smaller chunks to other investors. But if information about the auction were completely transparent and available to all, then others in the market would know that I am holding a big chunk of the bonds.
That would put me at a disadvantage, because the rest of the market would know that I have a big holding and want to get rid of it. I’m at a disadvantage: the price I’m likely to secure will be lower than if the market didn’t know the size of my holding. And step back a stage: if I believe that I risk being caught in that position with the market knowing how much I bought, I will feel more inhibited in bidding in the primary auction. So demand for the bonds will be less and the Italian government will receive a lower price for the issue.
Scrutinising the regulators
How to deal with this, when one would think that the general principle of transparency should be the aim? This was considered carefully ahead of the introduction of MiFID – the Markets in Financial Instruments Directive that regulates investment services across the European Economic Area. Broadly, it was decided that there need be no disclosure of bids and offers ahead of an auction of government bonds. Information about trades should be made available after they had been made – but importantly, only after a delay. Transparency? Yes. But call it transparency lite. Or transparency postponed.
Take another example. Last year, an issue came up for consideration by the European Systemic Risk Board (ESRB), the EU’s macro-prudential authority where I sit on the General Board.
Staff flagged up concerns about the price of residential property in a number of countries - Austria, Belgium, Denmark, Finland, Luxembourg, the Netherlands, Sweden and the UK. In these places, the housing markets appeared to be in danger of overheating. And historically, housing market crashes are the single most important precursor of broader financial crises.
The Board agreed that letters should be sent to these countries to seek their views about their housing markets, asking what possible danger any overheating might present, and suggesting that they might consider appropriate macroprudential measures. That much was easy.
Rather more contentious was whether the letters should be published. This triggered a spirited debate.
The argument in favour of publication was pretty straightforward: why should the simple fact that the ESRB had flagged up a potential problem be kept from public view? Why not be transparent? People in the markets – banks, households and so on – should know about the regulator’s fear that prices were getting out of line. Market participants should have access to the maximum possible amount of information, and the views of authorities are part of that information. It was therefore wrong to withhold it.
The counter-argument ran along these lines: the very publication of the letters might itself contribute to the exactly the sort of sudden market movement about which the ESRB was concerned. Publication could force the hand of national regulators, which might itself have a direct impact on the market. And if buyers, sellers and lenders knew that the regulator was worried the market was overheating, that could have a potentially destabilising effect.
In the end, the transparency argument won – but there was no consensus.
So, it’s pretty obvious – transparently clear, one might say – that complete transparency is not always going to be universally welcomed and embraced. As a broad, guiding principle, it is attractive. But in particular circumstances, there are perfectly valid arguments against complete transparency. And nowhere is that more true than in setting monetary policy.