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p. 11 of 58 BACK | NEXT Purpose and Structure of the Toolkit Part One: Introduction and Overview I. The Financial Sector: An Overview II. International Financial Standards and Standard-Setting Organizations A. Coordination of International Regulatory Standards B. Standard-Setting and Standard-Setting Organizations C. Compendium of Standards D. G20 Summit Communique (April 2009) III. Implementation and Monitoring Part Two: Preconditions and Infrastructure for Financial Sector Development Part Three: Financial Regulation and Supervision Part Four: Regional Financial Integration Part Five: ADB's Intervention in the Financial Sector Bibliography Glossary and List of Abbreviations Acknowledgements

Financial Sector Legal and Regulatory Toolkit : Part One: Introduction and Overview : II. International Financial Standards and Standard-Setting Organizations

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D. G20 Summit Communique (April 2009)

On April 2, 2009, the G-20 leaders met a second time in London to address issues relating from the financial crisis and resulting economic crisis. In their communique, The Global Plan for Recovery and Reform (Apr. 2, 2009) the leaders revisited many of the issues discussed in November 2008, stating: “We face the greatest challenge to the world economy in modern times . . . A global crisis requires a global solution.” To address the financial and economic crisis and prevent future crises, the leaders pledged “to do whatever is necessary” to:

• restore confidence and growth
• repair the financial system
• strengthen financial regulation to rebuild trust
• fund and reform the international financial institutions
• reject protectionism and promote global trade and investment
• build an inclusive, green, and sustainable recovery

If the Washington communiqué provided the outline of the content of international financial regulation going forward, the London communiqué provides the outline of the system of international financial regulation as well as additional detail regarding content. At the same time, details of the reform of the international financial institutions such as the IMF is left for the next leaders’ summit in September 2009.

1. Leaders’ Statement and Financial Regulation

In relation to financial regulation and supervision, the leaders committed to “build a stronger, more globally consistent, supervisory and regulatory framework for the future financial sector, which will support sustainable growth and serve the needs of business and citizens.” In this regard, the leaders argued that regulation and supervision must be designed to: “promote propriety, integrity and transparency; guard against risk across the financial system; dampen rather than amplify financial and economic cycle; reduce reliance on inappropriately risky sources of financing; and discourage excessive risk-taking.” Regulators and supervisors are tasked to:

• protect consumers and investors
• support market discipline
• avoid adverse impact on other countries
• reduce the scope for regulatory arbitrage
• support competition and dynamism
• keep pace with innovation

Significantly, the leaders extended their commitments in nine major areas, with finance ministers responsible for implementation and the IMF and FSF / Financial Stability Board monitoring and reporting at the next G-20 Finance Ministers’ meeting to be held in autumn 2009. There are:

• The G-20 agreed to rename and reconstitute the FSF as the Financial Stability Board (FSB), including all G-20 countries, FSF members, Spain, and the European Commission. As discussed further below, this is the foundation of reform of the system of international financial standards as opposed to their content, the focus of the Washington meeting.
• The FSB and IMF were directed “to provide early warning of macroeconomic and financial risks and the actions needed to address them.”
• The G-20 committed “to reshape our regulatory systems so that our authorities are able to identify and take account of macro-prudential risks.”
• Regulation is to be extended to “all systemically important financial institutions, instruments and markets,” including systemically important hedge funds. While the first part of this statement is a reiteration of the agreed approach from November 2008, it is significant that the commitment (and with it, regulation) has now been explicitly extended to hedge funds.
• The leaders endorsed the FSF Principles for Sound Compensation Practices (Apr. 2009) which provides new principles on pay and compensation: and committed to supporting “sustainable compensation schemes and the corporate social responsibility of all firms.” The result is a globally agreed approach to financial sector compensation and its regulation – potentially one of the most far-reaching consequences of the credit crisis.
• In the context of eventual recovery, the leaders agreed to “improve the quality, quantity, and international consistency of capital,” including with regulation to “prevent excessive leverage and require buffers of resources to be built up in good times.”
• The G-20 committed “to take action against non-cooperative jurisdictions, including tax havens,” standing ready “to deploy sanctions to protect our public finances and financial systems.”
• The G-20 called on “accounting standard setters to work urgently with supervisors and regulators to improve standards on valuation and provisioning and achieve a single set of high-quality global accounting standards.”
• The G-20 agreed “to extend regulatory oversight and registration to Credit Rating Agencies to ensure that they meet the international code of good practice.”

2. G-20 Declaration on Strengthening the Financial System

In one of two annexes to the G-20 Leaders’ Statement, the G-20 provided additional detail in respect of their major commitments in the area of financial regulation. Specifically, the G-20 Financial System Declaration provides additional detail in eight major areas:

• Financial Stability Board
• international cooperation
• prudential regulation
• scope of regulation
• compensation
• tax havens and non-cooperative jurisdictions
• accounting standards
• credit rating agencies

a. Financial Stability Board

As noted above, the G-20 leaders agreed to reconstitute the FSF as the FSB. According to the G-20 Financial System Declaration, the FSB will:

• assess vulnerabilities affecting the financial system, and identify and oversee required actions
• promote co-ordination and information exchange among authorities responsible for financial stability
• monitor and advise on market developments and their implications for regulatory policy
• advise on and monitor best practice in meeting regulatory standards
• undertake joint strategic reviews of the policy development work of the international Standard Setting Bodies [such as the Basel Committee, IOSCO, etc.] to ensure their work is timely, coordinated, focused on priorities, and addressing any gaps
• set guidelines for, and support the establishment, functioning of, and participation in, supervisory colleges, including through ongoing identification of the most systemically important cross-border firms
• support contingency planning for cross-border crisis management, particularly with respect to systemically important firms
• collaborate with the IMF to conduct Early Warning Exercises to identify and report to the IMF’s International Monetary and Financial Committee and the G-20 finance ministers and central bank governors on macroeconomic and financial risks and the actions required

In turn, FSB members, subject to FSB elaboration and reporting, commit to:

• “pursue the maintenance of financial stability”
• “enhance the openness and transparency of the financial sector”
• “implement international financial standards”
• “agree to undergo periodic peer reviews”

b. International Cooperation

In relation to international cooperation, the G-20 leaders agreed:

• to establish the remaining supervisory colleges for significant cross-border firms by June 2009, building on the 28 already in place
• to implement the FSF principles for cross-border crisis management [FSF Principles for Cross-Border Cooperation on Crisis Management (Apr. 2009)] immediately, and that home authorities of each major international financial institution should ensure that the group of authorities with a common interest in that financial institution meet at least annually
• to support continued efforts by the IMF, FSB, World Bank, and Basel Committee to develop an international framework for cross-border bank resolution arrangements
• the importance of further work and international cooperation on the subject of exit strategies
• that the IMF and FSB should together launch an Early Warning Exercise at the 2009 Spring Meetings of the IMF

In this context, the most significant element is the increased focus on mechanisms to address failure of financial institutions operating on a cross-border basis – a problem that is not easy to solve and one which will probably require significant time and effort to agree any sort of workable approach.

c. Prudential Regulation

In respect of prudential regulation, the G-20 made eight specific commitments, with four of these addressing capital. Specifically, until economic recovery becomes certain, the current 8 percent minimum international capital adequacy ratio standard will remain unchanged. In addition, capital levels above that level “should be allowed to decline to facilitate lending” as required in the context of poor economic conditions. However, “once recovery is assured, prudential regulatory standards should be strengthened”, specifically with capital requirements above the current minimum standards and also (returning to the reality that in the context of the crisis, equity capital has become far more important) that “the quality of capital should be enhanced.” Significantly, the G-20 also committed to implementation of Basel II: “all G-20 countries should progressively adopt the Basel II capital framework”, although in a revised form reflecting experiences and lessons of the credit crisis.

Beyond capital, the FSB, the Basel Committee, the BIS Committee on the Global Financial System, and the IASB are tasked to implement recommendations to address procyclicality [Report of the Financial Stability Forum on Addressing Procyclicality in the Financial System (Apr. 2009)] by end 2009. Further, in addition to capital and aspects of procyclicality, for the first time, the G-20 committed to “a simple, transparent, non-risk based measure which is internationally comparable, properly takes into account off-balance sheet exposures, and can help contain the build-up of leverage in the banking system”, essentially a leverage ratio to restrict overall leverage across the financial system. Returning to themes relating to securitization from the November statement, the Basel Committee is tasked to develop a framework by 2010 to improve “incentives for risk management of securitization, including considering due diligence and quantitative retention requirements.” Finally, in addition to capital and leverage standards, the G-20 committed to a new liquidity standard, with the Basel Committee tasked to develop “by 2010 a global framework for promoting stronger liquidity buffers at financial institutions, including cross-border institutions.”

d. Scope of Regulation

Following the November 2008 G-20 Declaration agreeing all systemically important financial institutions, markets and instruments be subject to appropriate regulation, in April 2009, the G-20 Financial System Declaration provides a much greater level of detail. Specifically, the April Declaration includes eight aspects. First, regulatory systems will be reformed “to ensure authorities are able to identify and take account of macro-prudential risks across the financial system including in the case of regulated banks, shadow banks, and private pools of capital to limit the build up of systemic risk,” with the FSB, BIS and international standard setters tasked to develop specific “macro-prudential tools” and report by autumn 2009. Second, a statement that “large and complex financial institutions require particularly careful oversight given their systemic importance”. While seemingly self-evident, this reflects an important shift in emphasis from the pre-crisis (in which such firms were viewed as better able to address the risks they faced than regulators) to the post-crisis period (in which financial institutions’, especially large financial institutions’, internal risk management systems will be closely monitored by regulators). In support of this, G-20 national regulators will have the powers necessary to gather “relevant information on all material financial institutions, markets, and instruments in order to assess the potential for their failure or severe stress to contribute to systemic risk.” In addition, “in order to prevent regulatory arbitrage, the IMF and the FSB will produce guidelines for national authorities to assess whether a financial institution, market, or an instrument is systemically important by the next” G-20 finance ministers and central bank governors meeting in autumn 2009.

Beyond traditionally systemically significant firms, as noted above, “hedge funds or their managers will be registered and will be required to disclose appropriate information on an ongoing basis to supervisors or regulators, including on their leverage, necessary for assessment of the systemic risks that they pose individually or collectively.” At the same time, supervisors will require “institutions which have hedge funds as their counterparties have effective risk management,” including “mechanisms to monitor the funds’ leverage and set limits for single counterparty exposures.” In relation to credit derivatives, “standardisation and resilience of credit derivatives markets, in particular through the establishment of central clearing counterparties subject to effective regulation and supervision,” will be promoted with industry tasked to “develop an action plan on standardisation by autumn 2009.” Finally, in relation to keeping pace with future innovation, G-20 members “will each review and adapt the boundaries of the regulatory framework regularly to keep pace with developments in the financial system and promote good practices and consistent approaches at the international level.”

e. Compensation

As noted above, the G-20 April communiqué contained a strong commitment on compensation, which has been supported by the release of related principles from the FSF. According to the G-20 and the FSF, the principles require: “firms’ boards of directors to play an active role in the design, operation, and evaluation of compensation schemes; compensation arrangements, including bonuses, to properly reflect risk and the timing and composition of payments to be sensitive to the time horizon of risks,” with payments not finalized “over short periods where risks are realised over long periods; and firms to publicly disclose clear, comprehensive, and timely information about compensation” to stakeholders, including shareholders.” Significantly, the G-20 committed that national supervisors implement the principles in order to be effective for 2009 compensation arrangements, with the Basel Committee integrating the principles into guidance by autumn 2009, with supervisors assessing firm compensation and inventing as necessary.

f. Tax Havens and Non-Cooperative Jurisdictions

Building on statement from November, the G-20 made strong commitments regarding tax havens in the April 2009 communiqué. In respect of actions, the G-20 Financial System Declaration includes a “toolbox” of six measures:

• increased disclosure requirements on the part of taxpayers and financial institutions to report transactions involving non-cooperative jurisdictions
• withholding taxes in respect of a wide variety of payments
• denying deductions in respect of expense payments to payees resident in a non-cooperative jurisdiction
• reviewing tax treaty policy
• asking international institutions and regional development banks to review their investment policies
• giving extra weight to the principles of tax transparency and information exchange when designing bilateral aid programs

In addition to tax haven issues, the G-20 Financial Systems Declaration also tasks the FSB and IMF to develop a similar mechanism for international prudential regulatory standards. This latter indicates that the existing system of international financial standards for the first time will be given an effective enforcement mechanism, based on those previously used in the context of money laundering and now tax havens.

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