International Finance Regulation

The Quest for Financial Stability

Georges Ugeux

• Publisher: Wiley
• Year: 2014
• Print ISBN: 9781118829592
• eBook ISBN: 9781118829615
• Edition: 1
• Topic: Commerce
• Subtopic: Finance

As the global market expands, the need for international regulation becomes urgent

Since World War II, financial crises have been the result of macroeconomic instability until the fatidic week end of September 15 2008, when Lehman Brothers filed for bankruptcy. The financial system had become the source of its own instability through a combination of greed, lousy underwriting, fake ratings and regulatory negligence. From that date, governments tried to put together a new regulatory framework that would avoid using taxpayer money for bailout of banks. In an uncoordinated effort, they produced a series of vertical regulations that are disconnected from one another. That will not be sufficient to stop finance from being instable and the need for international and horizontal regulation is urgent. This challenge is the focus of Georges Ugeux's book.

International Finance Regulation: The Quest for Financial Stability focuses on the inspirations behind regulation, and examines the risks and consequences of fragmentation on a global scale. Author Georges Ugeux has four decades of experience in the legal and economic aspects of international business operations. He created and run the New York Stock Exchange'sinternational group in charge of developing the NYSE's reach to non-US companies, including relationships with regulators and governments. Ugeux teaches European Banking and Finance of the Columbia University School of Law. Ugeux is uniquely positioned to provide recommendations and suggestions from the perspective of a top global authority. In the book, he explores international regulation with topics such as:

• Laws, regulations, and risks of overregulation
• Transformation of the U.S. market and creation of the Eurozone
• Development of a global framework and stability of the banking system
• In-depth examination of Basel III, the Dodd-Frank Act, the European Banking Union, and the Volcker Rule

The book also contains case studies from real-world scenarios like Lehman, CDS, Greece, the London Whale, and Libor to illustrate the concepts presented. Finance consistently operates within an increasingly global paradigm, and an overarching regulation scheme is becoming more and more necessary for sustainable growth. International Finance Regulation: The Quest for Financial Stability presents an argument for collaboration toward a comprehensive global regulation strategy.

CHAPTER 1
The Multiple Objectives of Financial Regulation¹

“Globalization requires us to act in consistent ways. If we don't do that, we have fragmentation, we have regulatory arbitrage and in the worst cases a race to the bottom. We have just agreed . . . to look much more deeply at how we can coordinate our regulatory efforts on a global level.”

—IOSCO Director General David Wright

The scope of this book is those regulatory issues that threaten the mere existence of financial institutions, and even more crucial, the areas where finance threatens the stability of the world economy. It does not look at all the aspects of regulation of financial institutions.

The number of legal disciplines and regulations that affect financial institutions creates a unique level of complexity. One can understand that, being at the center of the circulation, and even the creation, of money, their impact needs to be tempered and their activities have to be legitimate.

Laws and regulations that apply to financial institutions are structured to achieve many purposes, and that explains why they are sometimes perceived to be overreaching. The recent evolution has focused on the consequences of the financial crisis that developed in several parts of the world since 2008. In Europe, it additionally included the complex regulation issues raised by the sovereign crisis, making it even more complex.

However, in order to understand the dynamics of those regulations, it is important to look at some of the key objectives of regulation. At this stage, let's look at the key elements of the financial regulation by focusing on the diversity of objectives pursued by the authorities.

In an article published by Professor Alan Binder of Princeton University, he summarized the key objectives of financial regulation:

I suggest the following four main reasons for (different kinds of) financial regulations, all of which play major roles in this paper:

1. Consumer protection: To protect customers from anti-competitive behavior (and hence from excessively high prices), from fraud, from deceptive practices, and perhaps even—though this is far more controversial—from their own foolishness and gullibility.
2. Taxpayer protection: To limit the costs to taxpayers of the government's safety net for financial institutions. The huge bailout costs that taxpayers in many countries are now bearing are spectacular examples. Ex ante taxpayer protection often involves guarding against or limiting moral hazard. Ex post taxpayer protection involves, inter alia, such things as least-cost resolution.
3. Financial stability: To protect the financial system against various sorts of systemic risks that might be triggered by contagious runs, breakdowns of the “financial plumbing,” or failures of large institutions that are either too big or too interconnected with others to fail—or, rather, to fail messily.
4. Macroeconomic stability: To limit the adverse spillover effects of financial shocks on the real economy and/or to limit the financial propagation and magnification of shocks that originate outside the financial sector—in short, to mitigate booms and busts.²

STOP (AB)USING TAXPAYER MONEY

The main objective of the new banking regulation is to provide a resolution mechanism that provides for a recovery of financial institutions without using taxpayer money. The outrage created by the interventions of U.S. and European governments to rescue their banks during the subprime crisis led most of them to adopt policies that aim at resolving banking problems within the system (bail-in rather than bailout).

As President Obama put it in his State of the Union address in 2009:

I intend to hold these banks fully accountable for the assistance they receive, and this time they will have to clearly demonstrate how taxpayer dollars result in more lending for the American taxpayer. This time, CEOs won't be able to use taxpayer money to pad their paychecks, or buy fancy drapes, or disappear on a private jet. Those days are over. . . . Our job is to govern with a sense of responsibility. I will not spend a single penny for the purpose of rewarding a single Wall Street executive, but I will do whatever it takes to help the small business that can't pay its workers or the family that has saved and still can't get a mortgage.³

As noble as this objective is, regulation will not be sufficient to reach it. It will create the framework within which financiers will operate, and how to rescue financial institutions when they fail. Governments and central banks will have to take emergency measures if they have not been able to anticipate the imbalances that led to the collapse of the institution(s).

The Global Stability Report, published twice a year by the International Monetary Fund (IMF)⁴ looks at the developments in this field and, among others, the stability of the financial markets. Its preface states that:

If these policy challenges are properly managed, and if reforms are implemented as promised, the transition toward greater financial stability should prove smooth and provide a more robust platform for financial sector activity and economic growth. But a failure to implement the reforms necessary to address the many policy challenges highlighted above could trigger profound spillovers across regions and potentially derail the smooth transition to greater stability.⁵

The Congressional Budget Office (CBO) released a report with what seemed like good news: the bailout of 2008, which fronted $700 billion in taxpayer funds to prop up the financial institutions that brought the economy to the brink, ended up with a profit. The estimated cost of the General Motors bailout to American taxpayers was $10 to $12 billion cheaper than expected. The price tag of the $700 billion TARP was revised down to $21 billion from $42 billion.⁶

PROTECT RETAIL AND SMALL INVESTORS AND DEPOSITORS

History tells us that unscrupulous financiers have always been trying to defraud retail and small investors. The objective of investor protection goes beyond shareholders who are inevitably the first victims of problems in financial institution bankruptcy. It first and foremost provides depositor protection through the creation of some form of insurance for retail deposits. This objective, despite its own legislation, was clearly broken recently in Europe. In the case of the Cyprus rescue, the European Council publicly broke the sanctity of insured deposits and its own regulation by proposing a haircut on deposits below the 100,000 euros guarantee. They had to backtrack immediately in front of the uproar that such a precedent was raising.⁷

In the United States, regulation is aiming at protecting retail investors. Accredited investors are allowed to access other financial instruments. They include:

• A natural person who has individual net worth, or joint net worth with the person's spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person.
• A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same in...

Table of contents

• Cover
• Series Page
• Title Page
• Copyright
• Dedication
• Preface
• CHAPTER 1 The Multiple Objectives of Financial Regulation
• CHAPTER 2 A Quarter Century of Banking Crises and the Evolution of Financial Institutions
• CHAPTER 3 The Lessons of the Recent Financial Crises: The Explosion of Balance Sheets
• CHAPTER 4 Global Financial Regulation: The Institutional Complexities
• CHAPTER 5 Capital Adequacy, Liquidity, and Leverage Ratios: Sailing toward the Basel III Rules
• CHAPTER 6 Assessing Likely Impacts of Regulation on the Real Economy
• CHAPTER 7 Regulating the Derivatives Market
• CHAPTER 8 The Structure of Banking: How Many Degrees of Separation?
• CHAPTER 9 Banking Resolution and Recovery
• CHAPTER 10 Banking and Shadow Banking
• CHAPTER 11 Rating Agencies and Auditors
• CHAPTER 12 Central Banks as Lenders of Last Resort Have a Conflict of Interest with Their Regulatory Role
• CHAPTER 13 Financial Institution Governance (or Lack Thereof)
• CHAPTER 14 Was It a Global Crisis? The Asian Perspective
• CHAPTER 15 The Challenges of Global Regulation
• CHAPTER 16 Regulation and Ethics
• Conclusion What Can We Expect?
• A Few Books I Read and Found Helpful . . .
• About the Author
• Index
• End User License Agreement