Global Finance in Crisis

The Politics of International Regulatory Change

Eric Helleiner, Stefano Pagliari, Hubert Zimmermann

• Publisher: Routledge
• Year: 2010
• eBook ISBN: 9781135157616
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

From the vantage point of the key powers in global finance including the United States, the European Union, Japan, and China, this highly accessible book brings together leading scholars to examine current changes in international financial regulation. They assess whether the flurry of ambitious initiatives to improve and strengthen international financial regulation signals an important turning point in the regulation of global finance. The text:

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• Examines the kinds of international reforms have been implemented to date and patterns of international regulatory change.

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• Provides an analysis of change across a number of financial sectors, including the regulation of hedge funds, derivatives, credit rating agencies, accounting, and banks.

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• Offers an explanation of contemporary regulatory developments with reference to inter-state power dynamics, domestic politics, transgovernmental networks, and/or transnational non-state forces.

Providing the first systematic analysis of the international regulatory response to the current global financial crisis, this ground-breaking volume is vital reading for students and scholars of international political economy, international relations, global governance, finance and economics.

1
Crisis and the reform of international financial regulation¹

Eric Helleiner and Stefano Pagliari

What began in the summer of 2007 as a problem in a relatively unknown segment of the US housing finance market has very quickly turned into the most severe global financial crisis since the 1930s. The impact of this crisis has escalated far beyond its point of origin, affecting countries around the world, and spilling over from the financial system into the real economy. The implications of this shock are wide-ranging and still difficult to fully understand. In this book, we explore one of the most important consequences so far: the influence of the crisis on the international regulation of financial markets.

The severity of the global financial crisis has revealed major weaknesses in the international architecture for prudential financial regulation that has been constructed since the mid-1970s.² Policymakers have responded with a flurry of ambitious initiatives to reform international standards and strengthen the international financial regulatory regime. How has international financial regulation changed in response to the crisis to date? What explains the blitz of international regulatory initiatives we have witnessed to date in response to this crisis? Are we facing an important turning in the regulation of global finance?

This book brings together scholars of the politics of international financial regulation to address these questions from a number of different perspectives. The first part of the book analyzes change across a number of sectors of global finance, including the regulation of banks, credit rating agencies, accountancy, hedge funds, and derivatives. The second part examines the international regulatory response from the vantage point of key powers in global finance in Europe, the US, and Asia. The contributors to both parts also embrace a number of distinct theoretical approaches for understanding international financial regulatory change. Taken together, the book presents the first detailed political analysis of the international regulatory response to the global financial crisis which started in 2007.

We begin this introductory chapter by describing in broad brush strokes three key patterns of international regulatory change witnessed so far in response to the crisis: (i) an expansion of the perimeter of international regulation, (ii) efforts to strengthen its institutional architecture, and (iii) a departure from a trend over the past decade or so of delegating regulatory and supervisory responsibilities to private market actors. We then outline three distinct analytical lenses which the contributors to this volume use to explain these international regulatory changes: inter-state power, domestic politics, and transnationalism. We conclude by outlining the disagreement among the authors about the broader significance of the international regulatory initiatives launched so far.

What has changed?

How has international financial regulation changed in response to the crisis to date? To answer this question, it is helpful to first review the evolution of international regulation from the mid-1970s up until the current crisis. There was no founding act setting the basis for the existing international prudential regulatory architecture; it evolved instead in an incremental and ad hoc manner, and usually in response to various crises. The story of this evolution has been told expertly elsewhere and we will not repeat it here (see for example Davis and Green 2008). Instead, our objective is to summarize three key themes of the story in order to establish benchmarks against which to measure change since the current crisis began.

Evolution from the mid-1970s to the current crisis

The first theme has been a gradual expansion in the range of issues covered by the international financial regulatory regime. International regulatory coordination first took place in the banking sector in the mid-1970s through the creation of a committee of national banking supervisors that came to be called Basel Committee on Banking Supervision (BCBS). After formalizing the division of responsibilities in the supervision of international banks in the 1975 Basel Concordat, the BCBS created the Basel Capital Adequacy Accord of 1988 (Basel I) to define minimum capital standards for international banks, and then updated it between 1998 and 2004 (Basel II). Regulatory coordination soon extended to securities markets and related sectors such as credit rating agencies via the International Organization of Securities Commissions (IOSCO) created in 1983, as well as to insurance markets via the International Association of Insurance Supervisors (IAIS) created in 1994. In 1990, central banks of the same G10 countries that constituted the membership of the Basel Committee also created the Committee on Payment and Settlement Systems (CPSS) which produced some core principles for “systematically important payments systems” as well as (jointly with IOSCO) for securities settlements systems and central counterparties.

In the wake of the international financial crises of the late 1990s, the perimeter of the prudential financial regulation expanded further to include corporate governance, accounting, and auditing standards. The Organisation for Economic Cooperation and Development (OECD) drafted in 1999 its “Principles of Corporate Governance”. In the accounting sphere, the International Accounting Standards Board (IASB) – a private body created in 2001 – established the International Financial Reporting Standards (IFRS) that have been now been embraced by over 100 countries, including the European Union (since 2005) and increasingly the US. Another private sector body – the International Auditing and Assurance Standards Board (IAASB) – emerged as the most relevant standard-setter in the auditing sphere. The standards of these three bodies – as well as those of the BCBS, IOSCO, IAIS, and CPSS – were increasingly promoted across the world by the G7 and international financial institutions after the late 1990s.

A second important theme in the evolution of the international prudential regulation has been that the setting of these standards has taken place in a relatively fragmented, weak, and exclusive institutional context. While postwar multilateral trade negotiations have been conducted under the single framework of the GATT/WTO, international financial regulation developed within the much more fragmented alphabet soup of institutions noted above. To be sure, there were some efforts to address the fragmentation before the current crisis. In 1996, the BCBS, IAIS, and IOSCO created the “Joint Forum” to discuss issues of overlapping concern across banking, insurance, and securities markets. Three years later, the Financial Stability Forum (FSF) was created to bring together in one place for the first time all the relevant international standard setters (the BCBS, IAIS, IOSCO, IASB, CPSS), international economic organizations (the IMF, WB, OECD, BIS, the ECB, the Committee on the Global Financial System), as well as key national financial authorities. The Bank for International Settlements (BIS) has also played an increasingly central position within the patchwork of sectoral regulatory bodies, housing the BCBS, the IAIS, the CPSS, the Joint Forum, and the FSF. Despite these developments, the fragmentation of the institutional context of international financial regulation remained considerable.

The international financial regulatory regime also lacked supranational institutions with the kind of power that the WTO has. Proposals to create such institutions have been consistently rejected by policymakers in favor of international institutions whose formal roles are confined primarily to facilitating networks of informal cooperation, information-sharing and consensus formation. The implementation of financial regulation and supervision continues to be firmly located at the national level, with most international financial regulatory agreements simply taking the forms of “best practice” standards, “memorandum of understanding”, general “framework”, and “principles” which are not legally binding between regulators, do not require ratification by legislatures, and allow significant flexibility of implementation at the national level (see for example Kahler and Lake 2009). While the trade regime has been characterized by a trend towards greater “legalization” since the Uruguay Round, international financial regulatory agreements remain examples of “soft law” – with the important exception of financial regulation within the European Union (Goldstein et al. 2000; Singer 2007: 9–10).³

International financial regulation has also been developed in an institutional context which has been more exclusive than that for international trade. To be sure, some of the international financial standard-setters, such as IOSCO, have a broad country membership which comes close to matching the WTO’s. But others, such as the BCBS, CPSS, and FSF, were very narrowly constituted before the current crisis. Despite the adoption of its standards around the world, the BCBS included only industrialized countries as of 2007: the G7 countries plus Benelux, Spain, Sweden, and Switzerland. The CPSS’s membership was restricted to the G7 countries, Belgium, the Netherlands, Singapore, Hong Kong, Sweden, and Switzerland, while the FSF included just the G7 countries, Australia, Hong Kong, the Netherlands, Singapore, and Switzerland. Even within the more widely representative IOSCO, the key regulatory initiatives stem from its Technical Committee that had members from only the G7 countries, Australia, Hong Kong, Mexico, the Netherlands, Spain, and Switzerland. In short, the financial regulatory regime remained characterized by a clear distinction between “rule-takers” and “rule-makers”.

The third important theme in the evolution of international prudential regulation relates to a change in its content in the decade or so before the crisis: the assignment to private market actors of an increasingly significant role in the regulation and supervision of financial markets. In some contexts, this trend manifested itself through the endorsement and legitimization by the FSF and G7 of standards set by private actors, such as the accounting and auditing standards drafted respectively by the IASB and IAASB, or the codes of best practices for the hedge fund industry set by hedge fund managers’ groups. Another manifestation was that regulators began to shift part of the responsibility for monitoring markets into the hands of private investors themselves by requesting private and public actors to publicly disclose more information regarding their activities. The Basel II agreement even elevated this “market discipline” to one of its three pillars of regulation, alongside formal capital requirements and supervision. That agreement also allowed large banks to use their own information and risk-management schemes to determine the amount of reserve capital to put aside for credit risk and assigned credit rating agencies a formal role in credit risk assessment for banks of all kinds. In sum, in the words of the former head of the BIS Andrew Crockett, a “paradigm shift” in the thinking behind prudential policies led authorities to “increasing efforts to work with, rather than against, the grain of market forces” (Crockett 2002: 977).

Change since the crisis began

How has the post-2007 crisis influenced these trends and patterns of international financial regulation since the mid-1970s? Very soon after the outbreak of the crisis, a plethora of reports and regulatory initiatives offering diagnoses of the crisis and presenting recommendations were published by national regulatory agencies, financial industry associations, and international standard-setting bodies (see Eleni Tsingou’s discussion in Chapter 2). The Financial Stability Forum coalesced this extensive body of work into an internationally-coordinated response, releasing in April 2008 a road-map of international regulatory reform involving more than 60 recommendations (FSF 2008a). This wide-ranging policy agenda was quickly endorsed by the G7 and then subsequently refined by the FSF and other standard-setting bodies in the lead up to the first-ever G20 leaders summit in November 2008 (FSF 2008b).

At the Washington summit, the G20 leaders made the issue of international regulatory reform the most prominent issue on their agenda (G20 2008). In addition to endorsing much of the work of the technocrats, they set out priorities for the reform agenda with a tight deadline of 31 March 2009. These priorities were largely met by the time of the second G20 leaders summit in London in early April, which then set further priorities with specific deadlines for the various technocratic bodies to meet (G20 2009). Many of the London summit’s priorities on regulatory issues had been developed by two G20 working groups, each co-chaired by a developed and developing country representative, which presented very detailed reports and recommendations, alongside those of the FSF (FSF 2009a; G20 Working Group 1 2009; G20 Working Group 2 2009).

Various changes to international prudential regulation have been implemented as of mid-2009 as a result of these developments. Since banks were at the centre of the current crisis, policymakers have devoted much attention to bank regulation, including the reform of risk management calculations, the development of liquidity management rules, and higher capital requirements on trading books, securitized products, and off-balance sheet activities (see Tony Porter in Chapter 4). But there has also been an important extension of the perimeter of international regulation into new issue areas. At the London summit, the G20 leaders endorsed for the first time a set of international principles – developed by the FSF – for pay and compensation for significant financial institutions, and financial supervisors were tasked with their enforcement (FSF 2009c). Derivatives and hedge funds – two sectors whose regulation had been left to the private sector – were also brought under the official international regulatory umbrella for the first time (see our discussion in Chapter 5). Before the crisis, the regulation of credit rating agencies had been only a marginal issue, but the G20 leaders now insisted that all agencies whose ratings are used for regulatory purposes would be subject to a regulatory oversight regime consistent with a revised IOSCO code which had previously been only voluntary (IOSCO 2008a; see Porter in Chapter 4). More broadly, the G20 leaders have also tasked the IMF and FSF with the job of producing guidelines for national authorities “to assess whether a financial institution, market, or an instrument is systemically important” in order that regulation and supervision be extended to these entities (G20 2009: 3).

In addition to further extending the perimeter of international financial regulation, the G20 leaders attempted to strengthen its institutional basis. They did this partly by establishing collaborative “supervisory colleges” for all major cross-border financial institutions. Much more dramatic, however, was the announcement at the London summit of a major reform of the FSF – now renamed Financial Stability Board (FSB) – to transform it into one of the central pillars of global financial governance. The FSB was assigned the job of collaborating with the IMF in conducting early warning exercises as well as setting guidelines and supporting the creation of the supervisory colleges. It was also tasked with undertaking “joint strategic reviews of the policy development work of the international Standard Setting Bodies to ensure their work is timely, coordinated, focused on priorities, and addressing gaps” (G20 2009: 1). The standard setting bodies were also required to report to the FSB on their work in order to provide “a broader accountability framework” for their activities (FSF 2009d: 2). Finally, all FSB members agreed to implement twelve key existing international standards and codes, and to undergo periodic peer reviews. To perform all these tasks, the FSB has been created with a somewhat more complex structure than the FSF, including new institutional layers above the informal discussion occurring in the plenary meetings. The FSB has been given an enlarged secretariat in Basel, promised a full-time Secretary-General, and a Steering Committee and three Standing Committees (for Vulnerabilities Assessment, Supervisory and Regulatory Cooperation, and Standards Implementation) have been created.

The institutional foundations of the international regulatory regime have also been made somewhat more inclusive of developing countries (see Table 1 and Walter in Chapter 10). One sign of this change was the simple fact that the G20 leaders as a whole were now setting priorities for international regulatory reform, in contrast to the aftermath of the East Asian crisis when this role was undertaken by the G7. With the G20’s encouragement, IOSCO’s Technical Committee, the BCBS, and CPSS also invited a number of systematically important developing countries as new members.⁴ The IASB also guaranteed geographical diversity on its Board for the first time in a manner that guaranteed developing country representation.⁵ Most important, however, was the expansion of the membership of the FSF/FSB just before the London Summit to include all G20 c...

Table of contents

• Routledge/Warwick Studies in Globalisation
• Contents
• Contributors
• Preface
• List of abbreviations
• 1 Crisis and the reform of international financial regulation1
• Part I Issues and structures
• Part II Countries and regions
• Bibliography
• Index