G20 fires starting gun on global systemic risk regime

A declaration by the Group of 20 leading economies (G20) fleshed out plans for a global regime of systemic risk regulation, “covering regulated banks, shadow banks and private pools of capital to limit the build-up of systemic risk”.

A communiqué issued after the group’s London summit on April 2 said the plans would establish “much greater consistency and systemic co-operation between countries”.

At the centre of the proposals lay plans to increase the role of the Financial Stability Forum, which would be given greater powers and renamed the Financial Stability Board (FSB). Participating countries – comprising the FSB’s current members, plus Spain – will commit to maintaining financial stability, and enhancing the openness and transparency of the financial sector. They will also submit to regulatory peer reviews.

Alongside its current role, the FSB will also keep an eye regulatory policy, monitoring market developments and advising on international best practice. Among other responsibilities, it will undertake reviews of international standard setting bodies, manage contingency planning for cross-border crises, and collaborate with the International Monetary Fund on early warning exercises designed to prevent future crises.

Participating countries agreed to amend their regulatory systems to encompass all regulated banks, shadow banks and private pools of capital that might have an impact on systemic risk. This includes large hedge funds, which will be required to register and supply information to national regulators on questions such as the amount of leverage they employ. Any counterparties to trades with hedge funds will be required to have effective risk management, setting limits for single counterparty exposures and using mechanisms to monitor the leverage of the funds.

To prevent regulatory arbitrage, the FSB will draw up guidelines to help national authorities determine exactly what constitutes a systemically-important financial institution, market or instrument. “These guidelines should focus on what institutions do rather than their legal form,” the declaration said.

The FSB will also come up with mechanisms for co-operation between national supervisors overseeing cross-border hedge funds. And along with the Basel Committee on Banking Supervision and other international standard-setters, the FSB will develop “macro-prudential tools” to combat systemic risk – which will be the subject of a follow-up report to the G20 in the third quarter.

Where they have not been set up already, the G20 agreed that cross-border supervisory colleges for large financial firms should be convened, adding these should be urged to meet at least once a year by the institution’s home regulator.

The G20 said it wanted international financial organisations to move forward with efforts to mitigate pro-cyclicality – or reduce the propensity of banks to horde capital during downturns. However, alterations to minimum capital requirements should be deferred “until recovery is assured”, it said.

The declaration gave a nod to ongoing efforts to curtail the manufacturing of bad securitised assets by the Basel Committee. This might include requiring greater due diligence by arrangers or the mandatory retention of some exposures, it noted. Such a measure echoes the intention of the European Commission to modify the Capital Requirements Directive so that banks would have to retain at least 5% of any securitisation they originate.

It also said risk-based capital requirements should be supplemented by “a simple, transparent, non-risk based measure which is internationally comparable, takes into account off-balance sheet exposures and can help contain leverage in the banking system”. The Basel Committee is already looking into the idea of introducing a supplementary leverage ratio to the Basel II framework.

Remuneration was another topical issue addressed in the declaration. Principles on compensation at significant financial institutions, which have been drafted by the FSB’s predecessor, should be included in the scope of the Basel committee’s risk management guidance, the G-20 said. They require compensation arrangements, including bonuses, to properly reflect financial risk – by not offering short-term pecuniary rewards for excessive risk-taking in the long-term, for example. Firms would also be required to give more information to shareholders on their compensation policies.

On offshore tax havens, the G20 said it would take action against jurisdictions that failed to meet standards of tax transparency. “The era of banking secrecy is over,” the communiqué said. Such measures would range from merely requiring increased disclosure from financial firms and individuals doing business in these jurisdictions, through to “asking international institutions and regional development banks to review their investment policies” when dealing with tax havens.

The G20 called on standard-setters to improve financial accounting standards, including those for loan-loss provisions and off-balance sheet exposures. It also wants them to reduce the complexity of valuation requirements for financial instruments and make progress towards a consistent single set of global accounting standards. Such a goal was brought into question within hours of the declaration, with the US Financial Standards Accounting Board announcing amendments to fair-value accounting that allow banks significant leeway in calculating the value of assets and liabilities. In so doing, the gulf between FASB's approach and that of the International Accounting Standards Board grew much wider.

Regarding rating agencies, the declaration emphasised that a code of conduct created by the International Organisation of Securities Commissions should be enforced by its members. Meanwhile, the Basel Committee was urged to continue a review on the use of ratings in the Basel framework, to determine whether there were “any adverse incentives that need to be addressed”.

See also: Questions raised over possible systemic risk regulations
SEC official hopes G-20 will establish “broad parameters” for regulation
G20 calls for stronger IMF
New members will boost surveillance, FSF says
Bernanke calls for regulatory overhaul of financial system