Published: July 1, 2009
Raising International Regulatory Standards and Cooperation in Troubled Times
Securities Industry Alert
In June, the U.S. Department of the Treasury and President Obama revealed a five-part report titled “Financial Regulatory Reform A New Foundation: Rebuilding Financial Supervision and Regulation” (FRR Report) recommending several regulatory proposals for the financial system. Although the FRR Report predominantly focused on domestic reform, there was a portion dedicated to improvements in international regulation. The FRR Report made proposals in three distinct areas of international concern:
1. strengthening the international capital framework;
2. enhancing supervision of internationally active financial firms and global markets; and
3. reforming crisis prevention and management authorities and procedures.
To strengthen the international capital framework, the FRR Report recommended the Basel Accord II (Basel II) be implemented. In 1988, the original Basel Accord was adopted to strengthen the banking system by initiating consistent bank regulatory capital requirements throughout the world and was subsequently amended by Basel II. The FRR Report encourages the widespread implementation of the Basel II recommendations. Further, the FRR Report recommends additional amendments to the Basel Accord, including, among other things:
• Improving the regulatory capital framework for trading book and securitization exposures by 2010;
• Implementing recommendations to mitigate pro-cyclicality by requiring banks to build capital buffers in favorable economic times;
• Issuing guidelines to harmonize the definition of capital by the end of 2009; and
• Developing a non-model-based measure of leverage.
The FRR Report also recommends enhanced supervision of internationally active financial firms and global markets. In particular, the Financial Stability Board (FSB) and other national authorities would be required to establish and maintain operational development of supervisory colleges under the FRR Report’s recommendations. Supervisory colleges are groups of advisors predominantly located in Europe that monitor and report on financial institutions. In fact, these supervisory colleges have already been established for 30 of the most significant global financial institutions, and the FRR Report encourages the establishment of additional groups of advisors as well as a careful review of their findings.
Similarly, the FRR Report seeks to improve the oversight of global financial markets. Specifically, the FRR Report recommends that the United States work with international partners to raise the standards for over-the-counter (OTC) derivatives markets and engage in a central clearing for all credit derivatives. The FRR Report further recommends the establishment of a peer review system to assess compliance and prevent money laundering and terrorist financing as well as police credit ratings agencies.
The FRR Report also proposes to strengthen international financial crises prevention procedures and related authorities. Particularly, it recommends that the International Monetary Fund, the FSB, World Bank and the Basel Committee on Banking Supervision develop an international framework for cross-border bank resolutions and information sharing. Additionally, the Obama Administration intends to encourage the FSB to continue cross-border crisis management planning.
Generally, the FRR Report identifies the dangers that may occur when various international jurisdictions have conflicting financial regulations, and, to avoid future international financial crises, it suggests that the United States intends to use its leadership role to encourage the global community to strengthen its supervision and regulation of financial markets.While the potential impact of the FRR Report’s domestic recommendations are easy to gauge, it is less clear to see how the FRR Report will affect the worldwide financial community.