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Financial Sector Legal and Regulatory Toolkit : Part One: Introduction and Overview
II. International Financial Standards and Standard-Setting OrganizationsA. Policy Coordination Prior to the current global financial crisis, the G-7 industrialized countries took the lead in establishing the Financial Stability Forum and the system of international financial standards as central parts of the international financial architecture, with the G-10 playing a leading role in developing operational details.
In the current global financial crisis, the G-20 created at the same time as the Financial Stability Forum following the Asian financial crisis, now appears to be taking over this leading role in respect of international financial regulatory standards and the international financial architecture from the G-7. The G-20 leaders have reconstituted FSF to become the Financial Stability Board (FSB). The roles expected to be assumed by FSB are described in the next section of the toolkit. B. G-20 Declaration (Nov. 2008) On November 15, 2008, following two days of meetings in Washington D.C., the leaders of the G-20 released their Declaration of the Summit on Financial Markets and the World Economy. In this Declaration, the G-20 discussed the causes of the crisis, committed to supporting an open global economy and defined a range of actions to be taken (under the supervision of G-20 finance ministers) to reform financial regulation to avoid future crises. In many ways, the most significant aspects of the Declaration relate to reform of financial regulation, while at the same time avoiding over-regulation: "Recognizing the necessity to improve financial sector regulation, we must avoid over-regulation that would hamper economic growth and exacerbate the contraction of capital flows, including to development countries." The G-20 agreed the following overriding principle in reform efforts to avoid future crises:
The G-20 also established five main principles to guide reforms: i. Transparency and accountability Under the first principle, the G-20 committed to "strengthen financial market transparency, including by enhancing required disclosure on complex financial products and ensuring complete and accurate disclosure by firms of their financial conditions." The principle thus highlights two central aspects of the crisis: (1) transparency of complex financial products such as CDOs and (2) transparency of firms themselves. In addition, the principle highlights that "[i]ncentives should be aligned to avoid excessive risk-taking", another central feature of the crisis. The Action Plan contains five points for immediate action and three points for medium-term action. Four of the immediate actions address accounting and disclosure: (1) valuation of securities including complex illiquid products especially during times of stress; (2) required disclosures of complex instruments; (3) accounting and disclosure standards for off-balance sheet vehicles; and (4) review of the membership and governance of the International Accounting Standards Board (IASB). The medium-term actions address three points: first, global accounting standards bodies should "work intensively" to create a single set of global accounting standards; second, regulators, supervisors, accounting standard setters and the private sector should "ensure consistent application and enforcement" of accounting standards; and third, financial institutions should enhance risk and loss disclosures, with regulators focusing on completeness, including off-balance sheet activities. ii. Regulation Under the second principle, the G-20 committed to: (1) strengthening financial regulatory regimes, prudential oversight and risk management; and (2) ensuring that "all financial markets, products and participants are regulated or subject to oversight, as appropriate to their circumstances." In particular, the G-20 highlighted for attention (1) credit rating agencies, (2) making regulatory regimes more effective over the economic cycle while "ensuring that regulation is efficient, does not stifle innovation, and encourages expanded trade in financial products and services", and (3) a new commitment to transparent assessments of national regulatory systems. The Action Plan addresses three areas: (1) regulatory regimes; (2) prudential oversight; and (3) risk management. Regulatory regimes In relation to regulatory regimes, for immediate action, the IMF, FSF and regulators are directed to "develop recommendations to mitigate pro-cyclicality", including in the context of valuation, leverage, bank capital, executive compensation, and provisioning. In addition, the Action Plan addresses four medium-term actions. The first is a commitment by countries and regions to "review and report on the structure and principles of its regulatory system to ensure it is compatible with a modern and increasingly globalized financial system." In this context, all members of the G-20 specifically commit to undertaking a Financial Sector Assessment Program (FSAP) review. The second is a direction to regulators and standard setters to conduct two reviews, the first of "the differentiated nature of regulation in the banking, securities, and insurance sectors" and the second of "the scope of financial regulation, with a special emphasis on institutions, instruments, markets that are currently unregulated, along with ensuring that all systemically-important institutions are appropriately regulated." This point is key: regulation will be reviewed to address regulatory arbitrage and to cover existing gaps between regulators and jurisdictions. The third is a direction to address resolution and insolvency regimes in order to ensure that they "permit an orderly wind-down of large complex cross-border financial institutions." Once again, this is an issue which has been recognized for some years but which has been too complicated and politically sensitive to address. The fourth addresses capital adequacy, specifically that "definitions of capital should be harmonized in order to achieve consistent measures of capital and capital adequacy." Prudential oversight In relation to prudential oversight, the Action Plan specifies four immediate and two medium-term actions. Two of the four immediate actions address credit rating agencies, specifically that regulators and the International Organization of Securities Commissions (IOSCO) should make sure that agencies meet international standards, especially in relation to: (1) conflicts of interest, (2) increasing disclosure to investors and issuers, and (3) differentiate ratings for complex products. IOSCO is mandated to review CRA compliance. The third immediate action addresses capital, specifically that banks maintain adequate capital and international standards are strengthened for banks' securitization and structured finance activities. The fourth immediate action addresses credit default swaps (CDS) and OTC derivatives, including the launch of CDS central counterparty systems, reduction of systemic risks in CDS and OTC derivatives transactions, development of exchange-traded or electronic trading platforms for CDS, expansion of OTC derivatives market transparency, and improve robustness of OTC derivatives infrastructure. There are two medium-term actions. The first mandates the registration of CRAs. The second addresses liquidity from two angles, first liquidity supervision of cross-border banks and second central bank liquidity operations for cross-border banks. Risk management Risk management includes seven immediate and two medium-term actions. The seven immediate actions address: (1) enhanced international guidance for banks' risk management; (2) enhancing liquidity risk management and creating strong liquidity cushions; (3) timely and comprehensive measurement of risk concentrations and large counterparty risk positions across products and geographies; (4) improvement of internal risk management models and reporting; (5) Basel Committee to develop new stress testing models; (6) redesign of compensation schemes to provide appropriate incentives; and (7) effective risk management and due diligence of structured products and securitization. Under the first medium term action, standard setters and others should "ensure that regulatory policy makers are aware and able to respond quickly to evolution and innovation in financial markets and products." Under the second, "[a]uthorities should monitor substantial changes in asset prices and their implications for the macroeconomy and the financial system." iii. Integrity Under the third principle, the G-20 committed to:
In respect to the final point, the G-20 highlighted information sharing, especially with respect to bank secrecy and transparency. The Action Plan reflects this statement closely, with three immediate actions, addressing: (1) enhancement of regulatory cooperation; (2) promotion of information sharing regarding market stability and ensuring that domestic legal provisions are adequate; and (3) review of conduct rules and sanctions regimes for cross-border misconduct. Two of the three medium-term actions however go much further. The first supports the on-going work of the Financial Action Task Force (FATF) and the World Bank-United Nations Stolen Asset Recovery Initiative. The second requires national and international measures to protect the global financial system from "uncooperative and non-transparent jurisdictions that pose risks of illicit financial activity." The third directs the OECD and national authorities to promote tax information exchange but extends this much further into enforcement: "Lack of transparency and a failure to exchange tax information should be vigorously addressed." The clear objective is to bring off-shore jurisdictions to at least the same standard of regulation as existed in major financial centers prior to the crisis. iv. International cooperation Under the fourth principle, the G-20 committed to formulate national regulations in a "consistent manner." In this respect, the G-20 highlighted two aspects: (1) enhancement of cooperation and coordination "across all segments of financial markets, including ... cross-border capital flows"; and (2) as a matter of priority, the need to strengthen crisis prevention, management and resolution. Under the first immediate action, supervisors are directed to "establish supervisory colleges for all major cross-border financial institutions... Major global banks should meet regularly with their supervisory college for comprehensive discussions of the firm's activities and assessment of the risks it faces." Under the second, "[r]egulators should take all steps necessary to strengthen cross-border crisis management arrangements, including on cooperation and communication with each other and with appropriate authorities, and develop comprehensive contact lists and conduct simulation exercises as appropriate." The first medium term action requires authorities to be forward-looking in international regulatory approaches, while the second addresses the governmental interventions taken during the crisis and their eventual resolution: "Authorities should ensure that temporary measures to restore stability and confidence have minimal distortions and are unwound in a timely, well-sequenced and coordinated manner." v. International financial architecture Under the fifth principle, the G-20 committed "to advancing the reform of the Bretton Woods Institutions so that they can more adequately reflect changing economic weights in the world economy." In this respect, the Action Plan mandates six immediate actions and three medium term actions. The first immediate action directs the FSF to broaden its emerging economy membership. The second delineates responsibilities, with the IMF focusing on surveillance and the FSF focusing on standard-setting, and mandates increasing cooperation between the IMF and FSF, especially in integrating regulatory and supervisory processes into the macro-prudential framework and conducting early warning exercises. The third directs the IMF to take a leading role in drawing lessons from the crisis, in close coordination with the FSF and others. The fourth commits to a review of the adequacy of resources of the IMF, the World Bank Group and other multilateral development banks (MDBs), with increases as necessary. At the same time, these institutions are directed to review and adapt their lending instruments to meet members' needs and to revise their lending roles in the light of the crisis. The fifth is an agreement to explore ways to restore emerging market and developing country access to finance, including private capital. Finally, MDBs are directed to put in place arrangements to support countries with good records and sound policies. Under the first medium term action, the G-20 committed to comprehensive reform of the Bretton Woods institutions so that they can more adequately reflect changing economic weights in the world economy and be more responsive to future challenges, with emerging and developing economies have greater voice and representation. Second, the IMF is directed to conduct vigorous and even-handed surveillance reviews of all countries as well as giving greater attention to their financial sectors, including improving integration of the Financial Sector Assessment Program, all in support of providing improved macro-financial policy advice. Third, the advanced economies and the IMF commit to providing necessary capacity-building programs for emerging market and developing economies to support implementation of international regulatory standards. C. G20 Action Plan For each of these five principles, the leaders established a detailed action plan called the Action Plan to Implement Principles for Reform, incorporating immediate actions (to be taken by March 31, 2009) and medium-term actions. The detailed action plan establishes the core content of the refinements to international financial regulatory standards to take place. In addition, the leaders tasked finance ministers to give highest priority to six areas: (1) mitigating against pro-cyclicality in regulatory policy; (2) reviewing and aligning global accounting standards, particularly for complex securities; (3) strengthening the resilience and transparency of credit derivatives markets and reducing their systemic risks, including by improving the infrastructure of the OTC markets; (4) reviewing compensation practices as they relate to incentives for risk taking and innovation; (5) reviewing the international financial architecture; and (6) defining the scope of systemically important financial institutions and determining their appropriate regulation and oversight. In supporting the five principles, the G-20 also established a "comprehensive work plan" under the authority of the G-20 finance ministers, who are "responsible for the development and implementation of these recommendations drawing on the ongoing work of relevant bodies, including the IMF, and expanded FSF, and standard setting bodies." The G-20 tasked finance ministers to give highest priority to six areas: (1) mitigating against pro-cyclicality in regulatory policy; (2) reviewing and aligning global accounting standards, particularly for complex securities; (3) strengthening the resilience and transparency of credit derivatives markets and reducing their systemic risks, including by improving the infrastructure of the OTC markets; (4) reviewing compensation practices as they relate to incentives for risk taking and innovation; (5) reviewing the international financial architecture; and (6) defining the scope of systemically important financial institutions and determining their appropriate regulation and oversight. Office of the General Counsel
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