Is the Financial Stability Board the regulator to rule them all?
By Susannah Hammond, Thomson Reuters’ regulatory intelligence team. The views expressed are her own
LONDON, May 9 (Thomson Reuters Accelus) – The Financial Stability Board, regulatory policy maker of choice for the G20, has started to show its teeth. From its roots as the supranational setter of standards, guidance, policies and principles in the wake of the financial crisis, the FSB has started to clarify how it will monitor compliance with its requirements as well as deal forcefully with breaches.
A progress report on one of its strands of work regarding promoting global adherence to regulatory and supervisory standards on international cooperation and information exchange highlights how the FSB uses the International Monetary Fund as its objective reviewer of compliance with international standards. Critically, it shows how the FSB has taken the first steps in setting out the implications for what are called non-cooperative jurisdictions.
The FSB has noted that a small number of jurisdictions prioritised for evaluation have not, as at the end of April 2011, cooperated satisfactorily with the its process for promoting adherence to regulatory and supervisory standards on international cooperation and information exchange. It would appear that in those jurisdictions the authorities have, for whatever reason, chosen not to speak to the FSB.
The FSB says it will continue to pursue dialogue and has tried a variety of channels in an attempt to get the jurisdictions concerned to engage with the process. The FSB goes on to state that: “other measures may be implemented to apply additional pressure”. However, it does not say what those measures might be or how the pressure will be applied. The FSB will publish a list of non-cooperative jurisdictions if positive measures are not seen to be making sufficient progress. The use of such name-and-shame lists is deemed to have been effective at incentivising improvements in other areas such as tax standards.
The implication for the FSB’s ability and intent to apply pressure as well as to name and shame increases the focus for jurisdictions, authorities and firms on its other streams of work.
In particular, it highlights the importance of the regulatory changes updated on in the report on the progress in the implementation of the G20 recommendations for strengthening financial stability submitted to G20 finance ministers and central bank governors in April. The areas and issues cover much of the same ground as consultations and recent regulatory changes coming out of the European Union and other jurisdictions. The key difference running throughout is one of timing. The FSB is developing its overarching, non-optional standards, whilst the rest of the world is consulting on, implementing and embedding actual policy and rule changes.
The FSB was established by the G20 as an upgrade to the Financial Stability Forum to address vulnerabilities and to develop and implement strong regulatory, supervisory and other policies in the interest of financial stability. An important element of the FSB’s approach is to ensure consistency of international approach on regulatory changes and where it deems necessary to apply pressure to bring non-cooperative jurisdictions into line. The next progress report on the implementation of the G20 recommendations is due to be submitted to the November 2011 G20 summit. In the interim there are a number of areas of further work including:
A public consultation in the second half of 2011 on the identification methodology for global systemically important institutions, the amounts and instruments needed for added loss absorbency and the likely implementation timetable.
A public consultation in the second half of 2011 on measures where the FSB will propose to improve resolution tools and regimes. The key issue is the concept of a so-called bail-in to give the authorities the power to impose losses on the uninsured creditors of a failing financial institution as part of a resolution process. The scope of any bail-in powers is a major debating point. If for instance a bail-in power were introduced into the UK’s special resolution regime for failing banks, the power would be subject to the same creditor safeguards that apply more generally within the SRR, including the safeguard that protects, covered bond holders for example. In addition, the UK believes that in the exercise of any bail-in powers secured creditors’ rights to collateral should not be over-ridden. For instance the claims of covered bond holders in relation to the asset pool of a covered bond, including under a guarantee forming part of the covered bond arrangement, should not be affected. The UK’s stance is that only a secured creditor’s residual unsecured claims after realisation of collateral or recoveries under a guarantee should be subject to bail-in.
The FSB’s October 2010 report on implementing over-the-counter derivatives markets reforms made a series of recommendations to assist authorities in implementing the commitments regarding standardization, central clearing, exchange or electronic platform trading and reporting of transactions to trade repositories by the end of 2012. The FSB has stated its concern that many jurisdictions may not meet the end of 2012 deadline and says jurisdictions need to take “substantial, concrete steps toward implementation immediately”.
The FSB is making extensive use of peer reviews. A country peer review of Australia is underway with regard to strengthening adherence to international supervisory and regulatory standards. Country peer reviews of Canada and Switzerland will be launched in the second half of 2011. Thematic peer reviews have been completed on residential mortgage underwriting and origination practices and risk disclosure practices both of which made a series of recommendations. The FSB will launch a thematic peer review on deposit insurance systems shortly.
A second thematic peer review currently is underway on compensation practices. The review will assess the progress made in implementing the FSB Principles for Sound Compensation as well as their Implementation Standards. It will also look directly at the approach taken by firms. In the UK, the Financial Services Authority is consulting on guidance on the remuneration code with comments due back by May 18, 2011.
When not using peer reviews the FSB uses the IMF to monitor the implementation of regulatory reform. In the wake of the financial crisis, the IMF has taken a direct interest in the changing approach to financial services regulatory policy and supervision. In the autumn of 2010, the IMF published a staff position note entitled “Shaping the New Financial System”. It concluded that policy reforms are moving in the right direction, but said there is much “urgent and challenging” reform still needed. The IMF has stated financial regulatory policies should aim to ensure:
— Financial intermediation that delivers products better geared to satisfy the needs of households and firms.
— A better governed and more transparent financial system in terms of corporate structures, instruments and markets.
— Institutions endowed with higher, better quality and globally consistent capital and liquidity buffers that weigh systemic risk appropriately and discourage pro-cyclical lending behaviour.
— Institutions, even systemically important ones that can be resolved in an effective and timely way and with minimum cost to the taxpayer.
— A financial system that is competitive and allows for ease of entry and exit.
— A better understanding and oversight of risks in the non-bank financial sector and greater transparency about the risks that institutions are taking and the protections they are receiving as a result. That will entail the extension of the regulatory perimeter to include all systemically important institutions, markets and instruments.
The IMF has also spoken of how tough the role of a financial services supervisor can be noting: “Supervisors are expected to stand out from the rest of society and not be affected by the collective myopia and consequent underestimation of risks associated with the good times. In this role, society and governments, too must support this approach and stand by their supervisors as they perform this unpopular role.”
The IMF does not act simply as the monitoring eyes of the FSB. It has an extensive financial services remit in its own right. In September 2010 it was agreed that the IMF would undertake, every five years, mandatory financial stability assessments for 25 jurisdictions with systemically important financial sectors.
An early glimpse of how this might look in practice for a jurisdiction is shown in the September 2010 Mission Concluding Statement for the UK. It commented directly on the proposals for a new regulatory architecture. The IMF stated that although the proposed new setup should facilitate the integration of micro- and macro-prudential oversight, the institutional changes alone are no guarantee for superior outcomes. The IMF is supportive of the change in direction of supervision in the UK and has said that it will be crucial to continue to enhance the more intrusive, judgement-based and strategic approach to supervision adopted since the crisis. In this context the IMF made four specific comments:
The proposed new Prudential Regulation Authority should have the power to supervise and, if necessary, give formal directions at the financial holding company level to enhance consolidated supervision.
The adoption of a prompt corrective action regime would further strengthen the supervisor’s capacity to address emerging risks at an early stage.
Prudential oversight should be supported by market discipline. A useful tool in this regard would be the regular public disclosure by the supervisor of non-confidential firm-level prudential returns.
The tightening of banking sector regulation might cause risks to migrate into less regulated parts of the financial system. A critical task for the Financial Policy Committee, therefore, will be to identify such risk migration and ensure a commensurate widening of the regulatory perimeter.
Given the status and role of the IMF, the UK would be hard pressed not to take (and indeed be seen to take) the comments into account in the development of the new financial services supervisory architecture.
The FSB has already established itself, under the aegis of the G20, as the supranational policy maker for financial services. The FSB is beginning to show how it intends to ensure that its policies, standards and principles are implemented on a consistent and coherent basis around the world. Similarly, the IMF has always been important given its role in lending to jurisdictions in economic distress but alongside the G20 and the FSB it is taking an active interest in the progress made not only with regulatory reform but also enhancements in supervisory practices.
Firms, their compliance officers and senior managers need to ensure that they are aware of all relevant statements made by both the FSB and the IMF and, in particular, to be aware of when any jurisdiction in which they undertake business is either the subject of a peer review or visited by the IMF under the FSAP. Other than responding to consultations the FSB make feel somewhat remote from firms and their ability to lobby to influence the shape of future regulation. Firms may therefore wish to discuss with their supervisory authorities and central banks how those bodies, many of which are members of the FSB, influence and shape the developing FSB approach to both policy making and increasingly ensuring consistent implementation.
(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete (http://accelus.thomsonreuters.com/solutions/regulatory-intelligence/compliance-complete/) provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges.)