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Regulators’ Solidarity to Be Tested

The IOSCO recently reached “an agreed set of high-level global standards [that] outline the basis of an effective and robust securities regulatory system.” If only everything that ails the financial industry and its regulatory structure could be resolved so decisively.

The second week of June, as the haggling began in Washington over the final version of financial legislation that President Obama wants on his desk by July 4, securities regulators from around the world commandeered a stage of their own: the International Organization of Securities Commissions (IOSCO) annual conference in Montreal.

The contrast was stark. As the U.S. Congress’ reform efforts entered their final, conference-committee stage with contentious issues still be to resolved, the 114 regulatory agencies represented in IOSCO were speaking virtually as one. “We have risen to the challenge [of the financial crisis] and accomplished a significant reform of the basis for global securities regulation,” proclaimed Jane Diplock, chairman of the IOSCO executive committee and of the New Zealand Securities Commission.

IOSCO finished its week of meetings June 10 by adding eight points to its “Objectives and Principles of Securities Regulation,” described as “an agreed set of high-level global standards [that] outline the basis of an effective and robust securities regulatory system.” The new principles, bringing the total to 38, cover such areas as hedge funds and credit rating agencies. Two principles address systemic risk: “a clear message that markets matter for the identification and management of systemic risk,” Diplock declared with an air of triumph. She considered it an historic turn of events that market regulation will now stand with prudential regulation, the traditional form of systemic-risk oversight, as “virtuous twins” safeguarding financial stability.

If only everything that ails the financial industry and its regulatory structure could be addressed and resolved so decisively. The odds are obviously against replicating — let alone implementing — IOSCO’s principled unity across the board in financial services, and in all countries. At least it’s a start, and IOSCO skillfully seized the part of the agenda it is capable of controlling.

Because there is so much more to the international challenge of harnessing and reforming an industry that had lost its moorings, the big picture could look quite different by the end of June. The G-20 summit meeting will have concluded in Toronto. President Obama and other world leaders will have assessed the progress toward their mandate of last September to move in a coordinated fashion toward a more resilient, less systemically risky financial industry framework under the aegis of the Basel, Switzerland-based Financial Stability Board.

IOSCO, which has two seats on the FSB alongside the core G-20 representatives, the International Monetary Fund and others, is, by charter, a standards-setting body that promotes consistency and cooperation among its member bodies. They include securities-focused market regulators such as the U.S. Securities and Exchange Commission, and agencies like the U.K.’s Financial Services Authority and Japan’s Financial Services Agency that supervise both banking and investment activities — which explains why many of the public discussions in Montreal veered into the broader territory that U.S. lawmakers were concerned with.

For example, former Federal Reserve Board chairman Paul Volcker devoted much of a nearly hour-long talk and Q&A session to the Washington battles, including the one over his eponymous rule that would bar regulated and insured banks from trading for their own accounts. Volcker was optimistic that restriction and others on over-the-counter derivatives would be enacted by July 4 and would serve as a model to the rest of the world — a reversal of perceptions that the U.S. is a laggard. If he is right, then Obama will stand tall at the Toronto summit. But then there will still be the matter of pulling the rest of the world down the same path: The G-20 has set a November goal to have its broad vision adopted.

IOSCO won praise from Volcker and, carrying a message from the G-20 finance ministers and central bankers meeting a few days earlier in Busan, Korea, Bank of Canada governor Mark Carney. “IOSCO is an important contributor to the G-20 process,” said Carney. “We share a common purpose. Reducing systemic risk is at the heart of the IOSCO principles. Your ongoing efforts to enhance investor production and market integrity will also serve to build a more resilient financial system.”

But Volcker and Carney also had stern messages for the banking sector. Volcker expressed impatience with those who say tighter regulations will put them at a competitive advantage. He said he was hopeful that regulators around the world will adopt a united front, not allowing banks protected by deposit insurance and central bank liquidity facilities to engage in risky trading activities.

Carney dismissed “apprehensions” about the potentially negative economic impact of higher capital requirements. He said institutions will have time to adjust to the reforms, however radical or substantial, and “measures to increase the capital held against trading books will encourage redeployment of capital from trading towards conventional lending.”

From Consensus to Implementation

This view of enlightened policy guidance at the highest, global level, underscored by IOSCO’s accomplishments, is sure to clash with on-the-ground political realities in the sovereign nations where legislators ultimately hold sway over the regulators and how they regulate. There is no telling at this still-developing stage of the G-20 process how or if its principles and mandates will translate into day-to-day supervisory reality.

Independent observers of the international coordination efforts are skeptical. Moody’s Investors Service analysts Alessandra Mongiardino, vice president and senior credit officer, and Alain Laurin, senior vice president, wrote in the company’s June 14 Weekly Credit Outlook that the Busan finance ministers gathering “point[ed] to a flagging consensus among member countries about the content of the financial regulatory reform package and the pace at which it should be implemented.” The resulting reforms are “likely to be less stringent and implemented at a slower pace than originally proposed,” the analysts said, also suggesting that “it is going to be far more challenging to implement a tighter capital and liquidity framework once the crisis becomes a distant memory and other priorities emerge.”

Any loss of momentum won’t sit well with the G-20 heads of state, assuming they stick to the guns they brandished at the Pittsburgh summit nine months ago. In Toronto, on their “core reform agenda” addressing capital, resolution and market infrastructure policies, “G-20 leaders can be expected to harden that resolve,” said the Bank of Canada’s Carney.

In practice, though, that just might mean depending on the kind of standard-setting that IOSCO exemplifies and letting the chips fall where they may.

“Rules cannot all be the same, but there can be common principles, using tools that can differ from one country to another,” Masamichi Kono, vice commissioner for international affairs at Japan’s FSA, said at the IOSCO meeting. Realistically speaking, that is the only way to achieve true international coordination. You cannot say one size fits all.”

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