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TG-309Thank you for this opportunity to engage with international bankers and regulators on the global response to the financial crisis.
Financial regulation continues to be essentially a national activity – grounded in domestic laws, cultures, and history – and the responsibility for sound regulation begins at home. But firms and markets are now global in scope and benefits are derived from open, interconnected financial markets. Further, different national standards open the possibility for regulatory arbitrage, gaps in oversight, and a race to the bottom. As the crisis highlights, these pitfalls must be avoided.
So, how do we square this circle? A global regulator surely is not a realistic or feasible answer in the day and age in which we live. Instead, major international financial centers must work together to make national laws and practices more consistent and convergent with high quality standards of regulation across the world.
This is an enormous challenge, and it would be naïve to believe that a fully seamless global financial system could be achieved. Nevertheless, I believe that good progress is being made in strengthening the system, and today I will discuss how this process is proceeding in the G-20 and US-EU dialogues.
G-20 Cooperation and Progress Made
In the wake of the crisis, policy-makers and regulators from across the globe have redoubled their efforts to repair financial systems and put in place a stronger regulatory and supervisory framework to help ensure that a crisis of the magnitude we have witnessed does not occur again, to strengthen our financial systems so they are more robust in the face of duress, and to create a culture of greater integrity and responsibility in financial markets.
Last year's Washington G-20 Summit produced a 47 point Action Plan to strengthen regulation. The London Summit in April advanced that work. Before the G20 Summit in Pittsburgh, much had already been achieved. For example:
· Prudential oversight had been strengthened. Capital requirements had been increased for risky trading activities, some off-balance sheet items, and securitized products. Principles had been developed for Effective Deposit Insurance Systems and for sound compensation practices to better align compensation with long-term performance and risk management. Banks were acting to put in place strengthened liquidity risk management principles.
· Agreement had been reached to extend the scope of regulation to all systemically significant institutions, markets, and products. Non-bank financial institutions, credit rating agencies, and hedge funds were being subjected to greater scrutiny, while the transparency and oversight of securitization and credit default swap (CDS) markets were being improved.
· International cooperation was being reinforced. More than thirty colleges of supervisors have met for the major international financial institutions. The Financial Stability Board (FSB, previously the Financial Stability Forum – FSF) had been strengthened and expanded to include all G-20 countries.
· Market integrity had been strengthened. The G-20 had acted to improve adherence to international standards in the areas of prudential supervision, anti-money laundering and counter financing of terrorism, and tax information exchange.
PittsburghSummit
A fundamental objective of the Pittsburgh Summit was to build on these accomplishments and the work underway, and to identify and gain agreement on areas needing further attention. Accordingly, the G-20 Leaders focused on timetables for action in four key priority areas.
· Capital. The crisis demonstrated that capital and liquidity requirements were simply too low and that firms were not required to hold increased capital during good times to prepare for bad. Thus, G-20 Leaders agreed to develop rules to improve the quantity and quality of bank capital and to develop a non-risk based leverage ratio by end-2010. The Leaders' agreement recognizes that strengthening capital standards is at the core of the reform effort and it tracks closely with Secretary Geithner's views set forth in early September.
· Compensation. Compensation practices at some firms created a misalignment of incentives that amplified a culture of risk-taking. Building on the FSB's Principles for Sound Compensation Practices, G-20 Leaders endorsed implementation standards to help significant financial institutions and regulators better align compensation with long-term value and risk management. National supervisors will review firms' policies and structures and impose stricter measures on financial firms with unsound compensation practices.
· Over-the-counter (OTC) derivatives. The OTC derivatives markets, which were mainly used to disperse risk to those most able to bear it, also allowed hidden concentrations of risk to build up. G-20 Leaders agreed that all standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms and cleared through central counterparties by end-2012. Further, they affirmed that non-centrally cleared contracts should be subject to higher capital requirements.
· Cross-border banking resolution. G-20 Leaders agreed to establish crisis management groups for the major cross-border firms, to require major firms to produce contingency resolution plans, and to strengthen their domestic frameworks for resolution of financial firms. Further, it was agreed that prudential standards for the largest, most interconnected firms should be commensurate with the costs of their failure.
In addition, the Leaders called on international accounting bodies to redouble efforts to achieve a single set of high quality, global accounting standards and they also reaffirmed their commitment to deal with tax havens, money laundering, and terrorist finance as well as to adopt Basel II.
These are important achievements. But by no means can we be complacent. Not only must the international community act to make sure that all G-20 commitments are put in place at the international level, each G-20 country must now intensify its effort to help ensure that these commitments are implemented at the national level.
IV. U.S.-EU Cooperation
In advancing the G20's agenda for strengthening the international financial system, the United States and the European Union – as the world's two largest financial markets – will have critical roles to play in striking the right balance between promoting sound regulation and preserving market dynamism, while ensuring that their actions are firmly anchored in the global system. Indeed, I would go further and argue that the U.S. and the EU have a special responsibility to intensify cooperation and reaffirm our commitment to preserving the global nature of markets, while ensuring robust and consistent regulation.
On the whole, the US and EU have worked and are working successfully together. But in addition to agreeing upon high-level principles in the context of G20 Summits, the U.S. and EU will need to work together to promote consistent implementation of these principles because we know that quite often, the devil is in the details.
Nor is addressing such details a new role for us. For seven years, the U.S.-EU Financial Markets Regulatory Dialogue has worked through many critical issues, seeking to minimize inconsistencies and spillovers. The Dialogue worked through the third country effects of the Financial Conglomerates Directive, facilitated accommodations to Sarbanes-Oxley, resulted in a U.S. roadmap to accept public listings by EU firms using IFRS, and addressed European concerns related to de-registration from U.S. markets and U.S. concerns that the Markets in Financial Instruments Directive reflect the realities of global trading.
Looking forward, the U.S.-EU Financial Markets Regulatory Dialogues faces a large and complex agenda.
National regulators on the front lines, under the pressure of a crisis, will inevitably feel the pressure first and foremost to take care of the home market. None of us are immune. Further, no two systems will ever be identical. But there is much that can go wrong if we do not respect our differences while working to forge consistency around high quality standards and practices. In a world of mobile capital, no single jurisdiction can achieve its regulatory objectives in isolation. Hence, we cannot go our own ways, deviating significantly from international standards or practices, and exposing global markets to the risk of fragmentation. Nor should we seek to impose standards on one another if we are not identical. Rather, we should ensure that both sides converge around high quality regulatory and supervisory outcomes so that our firms can operate in each others' jurisdiction without encountering needless friction while ensuring that they are subject to rigorous oversight. Fortunately, given our collaboration in standard setting bodies, the Financial Stability Board, and other global fora, this should not be a tall order.
In this spirit, let me briefly mention a few of the key issues on which the US and EU must show leadership and increased pragmatism in their work.
· Credit rating agencies (CRAs) must be subjected to a more rigorous supervisory regime, consistent with the IOSCO Code of Conduct, but we cannot go so far as to prevent them from operating globally when they adhere to strengthened standards. Again, our focus must be on outcomes, not identical behavior. The EU has passed its CRA Directive, and we must now work together on the process for equivalence and endorsement so as to ensure the smooth functioning of global markets. We are looking forward to the collaboration between CESR and the SEC on this topic.
· For hedge funds, the US and EU agree on the broad strategy of registration and improved disclosure, consistent with the G20's work. This will enable us to minimize any threat to financial stability, while allowing funds to pursue global strategies on the basis of sound management practices. The EU's hedge fund proposal is a long way from being finalized. This gives us the opportunity to now work through and resolve the inevitable questions of equivalence and third country issues arising in the EU directive, as well as recognize that the business models of hedge funds and private equity are different. We have much work to do.
· We also must continue our collective work to achieve comprehensive reform of OTC derivatives markets. We must respect that global infrastructure is vital to the goal of maintaining efficient, well-integrated markets and payments systems.
· We need to work together to address trans-Atlantic concerns over the operation of globally active insurance firms and the oversight of auditing firms.
· And as our leaders re-committed to in Pittsburgh, we must keep the convergence work of the FASB and IASB on track towards the goal of a single set of high quality global accounting standards and continue the implementation of the Basel II capital accords, even as we also reform Basel II in ways recognized as important by G20 leaders.
· Finally, we will work together to develop a simple, non-risk based leverage ratio which the Leaders and the Basel Committee have endorsed as a supplement to the Basel II capital framework. Some have expressed concern this ratio is incompatible across countries given different accounting treatments. But as the accounting convergence process is completed, regulators can address these differences through regulatory definitions for the key items.
Conclusion
There is much afoot in efforts worldwide to strengthen the international financial system. Given this lengthy and complex agenda, I cannot emphasize enough the importance of preserving the strong international cooperation and convergence that have been the driving forces behind our swift and effective response to this global crisis. I can assure you that the proposed U.S. regulatory reform has international cooperation at its heart and we remain committed to working bilaterally with the EU and multilaterally through the G-20, FSB, and standard setting bodies to advance our shared agenda.