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30 Group of Thirty FINANCIAL REFORM A Framework for Financial Stability Embargoed for release at 11:00am EST on January 15, 2009
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Page 1: G30 reformreport

30 Group of Thirty

Financial ReFoRm A Framework for Financial Stability

embargoed for release at 11:00am eST on January 15, 2009

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About the Authors

The views expressed in this paper are those of the Working Group on Financial Reform and do not necessarily represent the views of all of

the individual members of the Group of Thirty.

ISBN I-56708-146-0Copies of this report are available for $49 from:

The Group of Thirty1726 M Street, N.W., Suite 200

Washington, D.C. 20036Tel: (202) 331-2472 Fax: (202) 785-9423www.group30.org email:[email protected]

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Financial ReFoRm A Framework for Financial Stability

30 Group of Thirty

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Table oF conTenTs

Acronyms and Abbreviations ..............................................................................................5

Foreword ............................................................................................................................7

Acknowledgements .............................................................................................................9

Financial Reform Working Group .....................................................................................11

Introduction ......................................................................................................................13

Part 1 – An Overview of a Program for Reform ................................................................15 GuidingPrinciplesforFinancialReform....................................................................17

1. ThePublicSectorRoleinSafeguardingFinancialStability..................................172. FairandEffectiveCompetition............................................................................183. OfficialOversightandCrisisResponse................................................................184. InternationalConsistencyandCoordination.......................................................185. GovernanceandRiskManagement.....................................................................19

CoreRecommendations.............................................................................................21

Part 2 – Redefining the Boundaries of Prudential Regulation ............................................231. PrudentialRegulationandSupervisionofBankingOrganizations.......................27 Recommendation1:............................................................................................282. ConsolidatedSupervisionofNon-BankFinancialInstitutions............................29 Recommendation2:...........................................................................................293. MoneyMarketMutualFundsandSupervision...................................................29 Recommendation3:............................................................................................294. OversightofPrivatePoolsofCapital...................................................................30 Recommendation4:............................................................................................305. Government-SponsoredEnterprises.....................................................................31 Recommendation5:............................................................................................31

Part 3 – The Structure of Prudential Regulation and International Coordination ..............336. RegulatoryStructure..........................................................................................34 Recommendation6:............................................................................................357. RoleoftheCentralBank.....................................................................................35 Recommendation7:............................................................................................368. InternationalCoordination..................................................................................37 Recommendation8:............................................................................................37

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Part 4 – Improving Standards for Governance, Risk Management, Capital, and Liquidity .........................................................................39

9. RegulatoryStandardsforGovernanceandRiskManagement.............................40 Recommendation9:............................................................................................4110.RegulatoryCapitalStandards.............................................................................42 Recommendation10:..........................................................................................4311.StandardsforLiquidityRiskManagement..........................................................43 Recommendation11:..........................................................................................4412.FairValueAccounting.........................................................................................44 Recommendation12:..........................................................................................46

Part 5 – Improving Transparency and Incentives, and Strengthening the Financial Infrastructure ..................................................................47

13.RestoringConfidenceinSecuritizedCreditMarkets............................................48 Recommendation13:..........................................................................................4914.RatingAgencyReforms.......................................................................................50 Recommendation14:..........................................................................................5115.OversightofCreditDefaultSwaps(CDS) andOver-the-Counter(OTC)Markets................................................................52 Recommendation15:..........................................................................................5316.AResolutionMechanismforFinancialInstitutions.............................................53 Recommendation16:..........................................................................................5417.ImprovingTransparencyofStructuredProductMarkets.....................................55 Recommendation17:..........................................................................................5518.SharingMarketActivityandValuationInformation............................................56 Recommendation18:..........................................................................................56

Part 6 – Concluding Comment ..........................................................................................57

Appendix ..........................................................................................................................59

Members of the Group of Thirty .......................................................................................69

Publications of the Group of Thirty since 1990 .................................................................73

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acRonyms and abbReviaTions

CCP Centralcounterparty[clearing]

CDO Collateralizeddebtobligation

CDS Creditdefaultswap

CLO Collateralizedloanobligation

CRMPG CounterpartyRiskManagementPolicyGroup

FDIC FederalDepositInsuranceCorporation

FVA Fairvalueaccounting

GSE Government-SponsoredEnterprise

NAV Netassetvalue

NRSROs NationallyRecognizedSecuritiesRatingsOrganizations

OTC Over-the-counter

SEC SecuritiesandExchangeCommission

SIV StructuredInvestmentVehicle

TARP TroubledAssetReliefProgram

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FoRewoRd

InJuly2008,theGroupofThirty(G30)launchedaprojectonfinancialreformunderthe

leadershipofaSteeringCommitteechairedbyPaulA.Volcker,withTommasoPadoa-

SchioppaandArminioFragaNetoasitsViceChairmen.Theyweresupportedbyother

G30memberswhoparticipatedinaninformalworkinggroup.Allmembers(apartfrom

thosewithcurrentandprospectivenationalofficialresponsibilities)havehadtheopportu-

nitytoreviewanddiscusspreliminarydrafts.

TheReportistheresponsibilityoftheSteeringCommitteeandreflectsbroadareasof

agreementamongtheparticipatingG30members,whoparticipatedintheirindividualca-

pacities.TheReportdoesnotreflecttheofficialviewsofthoseinpolicymakingpositionsor

inleadershiprolesintheprivatesector.Wheretherearesubstantialdifferencesinemphasis

andsubstance,theyarenotedinthetext.

TheG30undertookthisprojectastheglobalfinancialcrisisentereditssecondyear.

Theanalysishasbeeninformedbytheextremeeventslaterin2008,whichrockedthevery

foundationoftheestablishedfinancialsystemandwhichledtounprecedentedandmassive

governmentinterventionbothintheUnitedStatesandinmanyothercountriestocontaina

spreadingfinancialpanic.

TheReportdoesnotaddresstheneedfortheseorpossiblefurtheremergencyactions.

Difficultquestionsofweaningmarketsandfinancialinstitutionsfromofficiallifesupport

aresuretoarise.Whiletheanalysisandrecommendationsdealinsomeinstanceswiththe

needforlegislation,regulation,andsupervision,theReportisnotdirectedtowardques-

tionsabouttheappropriatefocusandnatureofnationaladministrativearrangements.

Theseare,inanyevent,influencedbytheparticularconstitutional,legal,andadministra-

tivetraditionsofindividualnationsandregionalarrangements.

TheReport,rather,focusesonhowthefinancialsystemmightreasonablybeorganized

oncethepresentcrisishaspassed,tobetterassureareasonabledegreeofstability.Policy-

makers,centralbankers,andfinancialregulatorswillnecessarilyremainfocusedondealing

withimmediatethreatstotheeffectivefunctioningofmarkets.However,intakingwhat

areineffectemergencymeasures,aconsensusonthedesirableandlastingelementsofa

reformedsystemcanbeuseful,andevennecessary,tospeedrestorationofconfidencein

sturdy,competitive,andefficientfinancialarrangementsservingbothnationalandinter-

nationalmarkets.TheReport,benefittingfromtheexperienceandbroadperspectiveof

G30members,isintendedtohelpinformtheneededdebateamongpolicymakersandthe

internationalfinancialcommunityontheseissues.TheReportaddresses:

a. Thepolicyissuesrelatedtoredefiningthescopeandboundariesofprudential

regulation;

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b.Reformingthestructureofprudentialregulation,includingtheroleofcentralbanks,

theimplicationsfortheworkingsof“lender-of-last-resort”facilitiesandotherele-

mentsoftheofficial“safetynet,”andtheneedforgreaterinternationalcoordination;

c. Improvinggovernance,riskmanagement,regulatorypolicies,andaccountingprac-

ticesandstandards;and

d.Improvementsintransparencyandfinancialinfrastructurearrangements.

Twofinalnotesareinorder.

First,thisReportisintendedtobeusefultopolicymakersinallthecountrieswhose

financialsystemshavebeendisruptedinthiscrisis.Forthisreason,mostrecommendations

areframedintermsthatshouldpermitconsiderationindifferentcountriesinafashionthat

takesaccountofparticularfeaturesoftheirnationalsystems.However,sincethiscrisishas

beenrootedindevelopmentswithintheUnitedStates,andgiventheparticularimportance

ofreformstotheU.S.financialsystemintermsofitssizeandglobalimpact,severalofthe

issuesandrecommendationshaveadirectU.S.focus.

Second,thefocusofthisReportisonthesafetyandsoundnessaspectsoffinancial

regulation.Therearemanyotherimportantaspectsoffinancialregulationthataretouched

uponhereonlytotheextentthattheybearonfinancialstability,includingcompetition

policies,customerandinvestorprotection,marketpracticesoversight,andfinancialfraud

andcrimeprevention.Also,totheextentdistinctionsaredrawnbetweenregulationand

supervision,theformerencompassesthesettingofpolicies,principles,rules,andstandards,

whilethelatterencompassesthejudgmentalapplicationofthosepoliciesandstandardsto

particularinstitutions.

Thekeyissueposedbythepresentcrisisiscrystalclear:Howcanwerestorestrong,

competitive,innovativefinancialmarketstosupportglobaleconomicgrowthwithoutonce

againriskingabreakdowninmarketfunctioningsosevereastoputtheworldeconomies

atrisk?

Thesearchforviableanswerstothatquestionneedstobegin.

PaulA.Volcker

Chairman of the Trustees

The Group of Thirty

JacobA.Frenkel

Chairman

The Group of Thirty

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Acknowledgements

On behalf of the entire Group of Thirty (G30), I would like to express appreciation to

those whose time, talent, and energy have driven this project to successful fruition.

In particular, we acknowledge the leadership of the Steering Committee, chaired by Paul

Volcker and Vice Chairmen Arminio Fraga Neto and Tommaso Padoa-Schioppa. Their

collective understanding of the nature of the financial crisis and insights as to the necessary

reforms are invaluable.

Special recognition must also go to those members of the G30 who actively participated

in the working group project deliberations and discussions.

Crafting a thoughtful report that addresses many difficult supervisory, regulatory,

market, and other matters requires considerable knowledge of the issues and an ability to

synthesize the views of numerous individuals. We particularly appreciate the work of Ste-

phen Thieke, who served as principal draftsman of the report, who brought extraordinary

experience and accomplishment to that role and to our deliberations.

We would also like to thank a number of experts who advised the Steering Group and

participated in our deliberations. In particular, thanks go to Mark Walker, Alan Beller, and

Mayree Clark. Several institutions provided valuable in-kind support to the project including:

Cleary Gottlieb Steen and Hamilton LLP, Promontory Financial Group, and RiskMetrics.

Thanks also to the editor, Diane Stamm, and the designers, Sarah McPhie and Katie

Burgess, for their dedicated efforts and flexibility when working on this project.

Finally, the coordination of this project and the many aspects of report production had

their logistical center at the offices of the Group of Thirty. This project could not have been

completed without the efforts of Executive Director Stuart Mackintosh, Sviatlana Francis,

and Nicole Firment of the Group of Thirty.

Jacob A. Frenkel

Chairman

The Group of Thirty

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11

Financial ReFoRm woRking gRoup

Steering Committee

Chairman

Paul A. Volcker

ChairmanoftheTrustees,TheGroupofThirty

FormerChairman,BoardofGovernorsoftheFederalReserveSystem

Vice Chairman

Arminio Fraga Neto

FoundingPartner,GaveaInvestimentos

FormerGovernor,BancodoBrasil

Vice Chairman

Tommaso Padoa-Schioppa

FormerMinisterofEconomyandFinance,Italy

FormerChairman,InternationalAccountingStandardsCommittee

FormerMemberoftheExecutiveBoard,EuropeanCentralBank

FormerChairman,CONSOB,Italy

Project Director

Stephen Thieke,RiskMetrics

Wethankthefollowingmembers,whoparticipatedintheprojectintheirindividualcapaci-

ties.Theviewsexpresseddonotnecessarilyreflectthoseoftheinstitutionswithwhichthey

areaffiliated.

Jacob A. Frenkel

Chairman,GroupofThirty

Vice-Chairman,AmericanInternational

Group

FormerGovernor,BankofIsrael

Geoffrey L. Bell

ExecutiveSecretary,GroupofThirty

President,GeoffreyBell&Company

E. Gerald Corrigan

ManagingDirector,GoldmanSachs

Group,Inc.

FormerPresident,FederalReserve

BankofNewYork

Andrew D. Crockett

President,JPMorganChaseInternational

FormerGeneralManager,Bankfor

InternationalSettlements

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12

Richard Debs

AdvisoryDirector,MorganStanley

FormerPresident,MorganStanley

International

FormerCOO,FederalReserveBank

ofNewYork

Jacques de Larosière

Counseiller,BNPParibas

FormerPresident,EuropeanBank

forReconstructionandDevelopment

FormerManagingDirector,International

MonetaryFund

FormerGovernor,BanquedeFrance

Gerd Häusler

MemberoftheBoardofDirectorsand

SeniorAdvisor,RHJInternational

FormerCounsellorandDirector,

InternationalMonetaryFund

FormerManagingDirector,DresdnerBank

John G. Heimann

SeniorAdvisor,FinancialStabilityInstitute

FormerU.S.ComptrolleroftheCurrency

William R. Rhodes

SeniorViceChairman,Citigroup

Chairman,President,andCEO,

CiticorpandCitibank

Ernest Stern

PartnerandSeniorAdvisor,

TheRohatynGroup

FormerManagingDirector,

JPMorganChase

FormerManagingDirector,WorldBank

David Walker

SeniorAdvisor,MorganStanley

International

FormerExecutiveDirector,Bank

ofEngland

FormerChairman,Securitiesand

InvestmentsBoard,U.K.

experts

AlanBeller,ClearyGottliebSteen&Hamilton,LLP

MayreeClark,AetosCapital

MarkWalker,ClearyGottliebSteen&Hamilton,LLP

StuartP.M.Mackintosh,TheGroupofThirty

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1�

inTRoducTion

Marketeconomiesrequirerobustandcompetitivefinancialsystems,nationalandinterna-

tional,tointermediatebetweenthosewithfinancialresourcesandthosewithproductive

andinnovativeusesforthoseresources.Thatintermediationnecessarilyposesrisks—risk

withrespecttobridgingmaturitypreferencesofsaversandborrowersandriskwithrespect

tocreditworthiness.Theprocess,tobeeffective,dependsonmutualtrust—trustbasedon

confidenceintheintegrityofinstitutionsandthecontinuityofmarkets.Thatconfidence,

takenforgrantedinwell-functioningfinancialsystems,hasbeenlostinthepresentcrisis,in

substantialpartduetoitsrecentcomplexityandopacity.

Thecostsandeconomicimplicationsofthepresentcrisiscannotbefullyknownatthis

point,butweknowtheyaresevere,whethermeasuredintrillionsofdollars,inthelength

anddepthoftheworldwiderecession,orinthesimplehumantermsofunemploymentand

shatteredpersonalfinances.Wealsoknowthatthereisaneedforcomprehensivereform

thataddressesthemajorinstitutional,market,regulatory,policy,andinfrastructureweak-

nessesthathavebeenexposed.

Theseincludeweakcreditappraisalandunderwritingstandards;extremeandsometimes

unrealizedcreditconcentrations;misjudgedmaturitymismatches;wildlyexcessiveuseof

leverageonandoffbalancesheets,oftenimbeddedinlittle-understoodfinancialproducts;

andunwarrantedandunsustainableconfidenceinuninterruptedmarketliquidity.Gapsin

regulatoryoversight,accounting,andriskmanagementpracticesthatexaggeratedcycles,a

flawedsystemofcreditratings,andweaknessingovernancealsoneedattention.

Tosomedegree,thesefactorshavebeenevidentinother,lessdamagingperiodsoffinan-

cialcrises.Twouniquefeatureshaveworkedtogethertohelpaccountfortheextentofthe

currentmarketbreakdown.Highlyaggressiveandunbalancedcompensationpracticeshave

stronglyencouragedrisktakingoverprudence.Atthesametime,highlyengineeredfinan-

cialinstruments,intheircomplexity,obscuredtheriskanduncertaintiesinherentinthose

instruments,givingrisetofalseconfidenceandheavyuseofleveragetoenhanceprofits,as

assetpricesrose.Asthoseassetpricesbegandeclining,therisksbecameapparent,trig-

geringsalesofassets.Adownwardspiralofdeleveraginghasunderminedthestabilityof

eventhelargestfinancialinstitutionsatthecoreofthesystem,contributingtoaneconomic

contractionofglobalproportions.Authoritiesinmostcountrieshavebeenstretchedtoand

evenbeyondthelimitsoftheircapacitytorestoreliquidityandcontaintheinstability.

ThisReportisorganizedasfollows.Part1laysoutanoverviewofaprogramofreform,

theGroupofThirtyguidingprinciples,andcorerecommendations.Part2throughPart5

layoutthereasoningbehindandcontentof18specificpolicyrecommendations.Specifical-

ly,Part2reviewsthepolicyissuesrelatedtoredefiningtheboundariesofprudentialregula-

tion;Part3reviewsissuesrelatedtothestrengtheningofprudentialregulation,including

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1�

theroleofcentralbanks,andinternationalcoordination;Part4addressesmattersrelated

toimprovinggovernance,riskmanagement,regulatorypolicies,andaccountingpolicies;

Part5concernsneededimprovementsintransparencyandfinancialinfrastructure,includ-

ingarrangementsforclearingandsettlingover-the-countertransactions;Part6provides

aconcludingcomment;andafulllistoftherecommendationsprovidedthroughoutthe

ReportcanbefoundintheAppendix.

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paRT 1 An Overview of a Program for Reform

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Financial ReFoRm A Framework for Financial Stability16

Recentmarket-drivenforces,combinedwiththeofficialresponses,havesetinmotion

strongpressuresforconsolidationwithinfinancialsystemsandwholesalechangesinthe

structureofsuchsystems.Thepotentialforundueconcentration,unfaircompetition,and

increasingconflictsofinterestwillrequireattention.Massiveextensionsofthescaleand

reachofgovernmentsafetynetsprotectingthefinancialsystemraisepracticalquestionsof

fairandpredictableofficialintervention,includingissuesarisingfromresultinggovernment

ownershipinterest,and,morefundamentally,questionsastotheappropriateboundaries

andexpectationsofsuchinterventionsbybothfinancialinstitutionsandtheircustomers.

Theclearimplicationisthatatleasttheverylargeandcomplexbankingorganizationsthat

nowaccountforsomuchoftheextensionsofcreditandcarrythemajorresponsibilityfor

maintainingthefinancialinfrastructurewillneedtobeheldtomorerigorousstandardsof

prudentialregulationandsupervision,withnewconstraintsonthetypeandscopeoftheir

risk-takingactivities.Confidenceincapitalmarketswillalsohavetoberestored,withmore

transparentandunderstandablemarketsandproducts.

Atthesametime,whiletherecanbelittledoubtabouttheneedformoreeffectiveof-

ficialoversight,caremustbetakennottoextendthereachofregulationstoofarortoo

deeply.Thenewfinancialsystemmustnotbecomesoentangledinrestrictionsthatitcan-

notflexiblyandefficientlysupporttheprocessoffinancialintermediationsoessentialto

economicprogress.

Areformprogramthatreflectsasensiblebalancebetweentheseconsiderationsshould

helpbringabout:

4Asystemwithclearerboundariesbetweenthoseinstitutionsandfinancialactivities

thatrequiresubstantialformalprudentialregulationforreasonsoffinancialstability

andthosethatdonot.

4Asystemwithstrongerregulatoryincentivesforholdinglarge(systemicallysignifi-

cant)institutionstothehigheststandardsofgovernanceandriskmanagement.

4Asysteminwhichthereismorescopeforusingregulatorypoliciestomitigateinher-

enttendenciestowarddestabilizingexcessesinrisktakingandriskaversion.

4Asystemwithamorerobustfailureresolutionregime,havingthepracticalcapacityto

permitorderlyclosingsoflargefinancialinstitutionsandtheadministrationofsafety

netresourcesinamannerthatreinforcesdisciplineonmanagers,shareholders,and

sophisticatedcreditors.

4Asysteminwhichthoseresponsibleforprudentialregulationandsupervisionhave

ahighdegreeofpoliticalandmarketindependence,andtheresourcesnecessaryto

supervisegiantinstitutionsandtokeepabreastofmarketinnovations.

4Asysteminwhichcentralbankresponsibilitiesforpromotingfinancialstabilityare

supportedbyadequateauthorityandcapacity.

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Financial ReFoRm A Framework for Financial Stability 1�

4Asysteminwhichtherearestrongerincentivestoachievehigherlevelsofrisktrans-

parencyasregardsfinancialproducts,markets,andinstitutions.

4Asysteminwhichthereisahigherdegreeofinternationalconsistencyandcoordina-

tionasregardsregulatory,supervisory,andaccountingpoliciesandcrisisresolution

practices.

guiDing PrinCiPleS for finanCial reformTheoverallobjectiveoftheneededreformofthefinancialsystemmustbetoencourage

diverse,competitive,predominantlyprivatelyownedandmanagedinstitutionsandmar-

kets,abletoefficientlyandflexiblymeettheneedsofglobal,national,andlocalbusinesses,

governments,andindividuals.Thatbroadobjective,whetherachievedthroughthespon-

taneousforcesreleasedbythecurrentcrisisorbyconsideredpublicpolicy—mostlikelyby

acombinationofthetwo—mustalsoencompassassurancethatinstabilityinfreefinancial

marketsnotagainreachthepointofunderminingthefunctioningofnationalorinterna-

tionaleconomies.

Inrebuildingwhatisnowabrokensystemtomeetthoseneeds,certainguidingprin-

ciplesareparticularlyrelevant.Therecommendationssetoutinthisreportareresponsive

totheseprinciples.

1. the Public Sector role in Safeguarding financial Stability

Theinherentvolatilityoffreeandopenfinancialmarkets,andthedangerthatvolatility

mayoccasionallyreachcrisisproportionsthreateningeconomicstability,needstoberecog-

nizedinthedesignofthefinancialsystem.Theprimaryaimofprudentialregulationshould

betomaintainthehealthofthesystemandcontainsystemicriskby:

a. Subjectingthelargestandmostcomplexbankingorganizationsjudgedtobesystemi-

callyimportanttothehighestinternationalstandardsforongoingcloseregulation

andsupervision.

b.Requiringnon-bankfinancialinstitutionsthatarealsojudgedpotentiallytobeof

systemicimportancetobesubjecttosomeformofformalprudentialregulationand

supervisiontoassureappropriatestandardsforcapital,liquidity,andriskmanage-

ment.

c. Assuringcriticalelementsoftheinfrastructuresupportingthefinancialsystem,includ-

ingclearingandsettlementsystemsandrelatedlegalframeworks,aremadesufficient-

lyrobusttopermittheorderlyclosingoflarge,complexfinancialinstitutions.

d.Avoidingaccounting,regulatory,orotherpracticesthatmayinadvertentlyreinforce

recurrenttendenciestowardexcessiveexuberanceorriskaversion.

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Financial ReFoRm A Framework for Financial Stability1�

2. fair and effective Competition

Toenhancefairandeffectivecompetition,regulatorypoliciesandapproachesshould,

insofarasfeasible,treatfinancialservicescommontodifferentinstitutionsuniformlyby

seeking:

a.Abalancebetweenthebenefitsofopenandfreecompetitionandthepotentialfor

unfaircompetitionarisingfromexplicitandimplicitgovernmentprotection,excessive

concentrationoffinancialresources,orextensiveconflictsofinterest.

b.Abalancebetweentheprotectionimplicitinaccesstocentralbankliquiditysupport

forsystemicallyimportantinstitutionsandrestrictionsonrisk-proneactivitiesor

thosethatpresentunmanageableconflictsofinterest.

3. official oversight and Crisis response

Whiletheprecisearrangementsmaydifferamongcountries,officialoversightandcrisisre-

sponserequirebuildingastrong,professionallymanagedstructureofpublicagencies,with

substantialinsulationfromparticularpoliticalorprivateinterestsbyassuring:

a. Centralbanks,giventheirtraditionalroleandconcernsforfinancialstability,their

financialresources,theirresponsibilitiesas“lender-of-last-resort,”andtheirtypically

professionalmanagementandhighdegreeofindependencewithingovernments,have

animportantroleinregulatoryrulesandoversight;

b.Inthoserareandexceptionalinstancesofcrisiswhenbudgetaryresourcesarere-

quiredorgovernmentalfundsareplacedatrisk,theresponsibilitylieswiththeap-

propriategovernmentalauthoritiestoauthorizesuchexpendituresandtoaffirmand

supportcentralbankdecisions.

c. Basiccrisisresolutionproceduresandresourcesshouldbeavailabletoofficialagencies

todealwithinstancesofinstitutionalfailuresosevereastopotentiallyimpairsystem

functioning.

4. international Consistency and Coordination

Effectiveapplicationoftheseprinciplesrequiresasubstantialdegreeofinternationalconsis-

tencyinapproachandcoordinationbymeansof:

a. Reviewingandreinforcingexistingeffortstoachievecommoncapital,accounting,

andreportingstandards.

b.Achievingaclearunderstandingofanappropriateresponsetofailuresornearfailures

ofinternationallyactiveandsystemicallyimportantfinancialinstitutions.

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Financial ReFoRm A Framework for Financial Stability 1�

5. governance and risk management

Theneedforhighstandardsofinstitutionalgovernanceandriskmanagementmustbe

recognized,withemphasison:

a. Engagedandknowledgeableindependentboardsofdirectorsfocusedonlong-run

performance;

b.Acorporatecultureofgovernancethatdemandswell-balancedcompensationpolicies

andpracticesandfostersincentivesfordisciplinedriskmanagement,includingstrong

andindependentriskmanagementstaffs;

c. Regulatoryandsupervisorypoliciesthatreinforcethosepracticesandincentives.

Box 1 Key Characteristics of “Systemically Significant” institutions

Key characteristics of potentially “systemically significant” institutions are:

1. Size. The notional balance sheet is a frequently used measure, but it is not in itself sufficient. More refined measures would take into account a combination of on- and off-balance-sheet items, with appropriate risk weightings. These metrics should then be viewed relative to the size of a country’s financial markets, banking system, and economy, with some individual institutions or national banking systems posing potential for problems that exceed a home country govern-ment’s support capacity.

2. leverage. The scale of leverage being employed and the speed of potential liability contraction is a second important characteristic. Large size alone is not a sufficient determinant of potential systemic risk, if that size is supported by a combination of permanent equity and a structure of liabilities consistent with asset characteristics. It is the interaction of relatively illiquid risky assets and large amounts of short-term funding that creates the greatest potential for disruptive failures.

3. Scale of interconnectedness. This refers to the degree to which one financial firm’s potential failure will have immediate and sizeable knock-on effects on a large number of other significant financial institutions. In this regard, perhaps the two best systemic risk metrics are: the scale (size) and scope (range of markets) of over-the-counter (OTC) derivative market contracts; and the largest gross and net collateral counterparty risk exposures to particular firms. The lack of transparency in these markets—as contrasted with exchange-based clearinghouse arrange-ments—has made judging systemically significant degrees of interconnectedness particularly difficult.

4. the Systemic Significance of infrastructure Services. Certain types of infrastructure-like services provided by financial institutions to other such institutions are of systemic importance. These include highly specialized custody, clearing, settlement, and payment services, and many of the services provided by prime brokers. The nature of these services is such that they inevitably re-quire large credit linkages between service providers and users, and changes in service relation-ships are operationally complex and time-consuming.

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Financial ReFoRm A Framework for Financial Stability20

Throughouttheseprinciples,aconsistentthemeistheimportanceofcontainingsystemic

riskandmaintainingcloseoversightof“systemicallyimportant”financialinstitutions.

Ifthefinancialindustryandmarketsaretooperate,asfaraspossible,accordingtothe

principlesofcompetitivemarkets,thenexitsoffirmsthatareunprofitableandineffective

mustbeaccepted.Regulationandsupervisioncannotandshouldnotpursueanobjective

ofzerofailuresevenamongthelargestplayers.Theprimaryaimofprudentialregulationis

tomaintainthehealthofthesystemasawholeandcontainsystemicrisk.Theappropriate

standardsforjudgingregulatoryeffectivenessarelimitingthepotentialforwildlydisrup-

tiveinstitutionalfailures,managingtheprocessoffailureswhentheyoccurinawaythat

reinforcesdisciplineonseniormanagementandshareholders,andcontainingthemarket

falloutfromsuchfailures.

Therearegeneralcharacteristicsthattogetherdefineafinancialinstitutionas“poten-

tiallysystemicallysignificant.”Thesearesize,leverage,scaleofinterconnectedness,andthe

degreetowhichthecompanyprovidesinfrastructureservicescriticaltothemarkets.These

characteristicsaredescribedmorefullyinBox1.

Inpractice,itissomecombinationofthesecharacteristicsthatmakeforapotential“sys-

temicallyimportant”financialinstitution.Whilethesecriteriacanbedefinedinadvancein

generalterms,itwouldnotbesensibleorprudentforregulatorstodefinethemwithstatisti-

calprecisionorinflexibly.Rather,acountry’sprudentialregulator—incooperationwithits

centralbankinthosecountrieswheretheserolesareseparate—shouldhavesufficientau-

thoritytosetandmodifycriteriausedtomakethesedeterminations.Theendresultshould

beabasisforidentifyingfirmsthatarelikelytorequirepotentialregulatoryinterventionto

managetheprocessoffailureandhencealsorequiremorepreventativeoversight.

Thecommonexpression“toobigtofail”isbothmisleadingandtoofaciletoreflectthe

realityofofficialsupportfor“failing”institutions.Inperhapsthemosttypicalscenario,

theinstitutionisinfactpermittedtofail,inthesensethatpracticallyallequityinvestments

arelost.Depositorsandoftenotherunsophisticatedcreditorsareprotected,buttheinstitu-

tionlosesitsidentitybyliquidation,merger,oreffectivepublicownership.Insomerecent

instances,supporthasbeenprovidedinawaythatnotonlyhasprotectedalltypesofcredi-

tors,buthasalsoletstockholdersretainsomeequityinterestwithahopeofrecovery,thus

moreaccuratelyfittingthedescriptionof“toobigtofail.”

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Financial ReFoRm A Framework for Financial Stability 21

four Core reCommenDationSThereformproposalsdescribedinthebodyofthisreportconsistofanextensivesetof

interrelatedchangesinpolicies,practices,andmarketstandards.Thesearebestviewedin

thecontextofthefollowingfourbroadlystatedcorerecommendations,whichprovidea

frameworkfortheoverallprogramofreform:

I. Gaps and weaknesses in the coverage of prudential regulation and supervision must

be eliminated.Allsystemicallysignificantfinancialinstitutions,regardlessoftype,

mustbesubjecttoanappropriatedegreeofprudentialoversight.(Recommendations

1through5.)

II. The quality and effectiveness of prudential regulation and supervision must be

improved. Thiswillrequirebetter-resourcedprudentialregulatorsandcentralbanks

operatingwithinstructuresthataffordmuchhigherlevelsofnationalandinterna-

tionalpolicycoordination.(Recommendations6through8.)

III. Institutional policies and standards must be strengthened, with particular emphasis

on standards for governance, risk management, capital, and liquidity.Regulatory

policiesandaccountingstandardsmustalsoguardagainstprocyclicaleffectsandbe

consistentwithmaintainingprudentbusinesspractices(Recommendations9through

12.)

IV. Financial markets and products must be made more transparent, with better-aligned

risk and prudential incentives. The infrastructure supporting such markets must be

made much more robust and resistant to potential failures of even large financial

institutions.(Recommendations13through18.)

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paRT 2 Redefining the Boundaries of Prudential Regulation

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Financial ReFoRm A Framework for Financial Stability2�

Core reCommenDation igaps and weaknesses in the coverage of prudential regulation and supervision must be eliminated. Allsystemicallysignificantfinancialinstitutions,regardlessoftype,

mustbesubjecttoanappropriatedegreeofprudentialoversight.

Financialinstitutionsandthesysteminwhichtheyoperatedevelopinresponsetoanongo-

ingdynamictensionamongcompetitivemarketforces,innovationsthatalterthoseforces,

andlawsandregulationsthatconstrainchoices,influenceinnovations,andthenrespondto

subsequentmarketdevelopment.Whiletheincreaseddegreeofinternationalintegrationof

financialmarketshasworkedtobringaboutadegreeofconvergenceinkeycharacteristics

ofnationalfinancialsystems,thereremainanumberofsignificantdifferencesinthefinan-

cialinstitutionsstructuresacrosstheeconomicallymost-developedandemergingcountries

andinthenatureofofficialresponsetofailuresandmarketdisruptions.

Intimesoffinancialcrisis,suchaswearenowexperiencing,thesedifferencescanhave

animportantbearingonhowacrisisunfoldsandwhattypeofpolicyresponsesarere-

quired.Significantly,actionstakenbyoneormoreEuropeancountriestoprotectdeposi-

torsrapidlyinfluencedflowsoffundsinothernationaljurisdictionswithdifferentbanking

systemsandregulatoryauthorities.Becauseofanumberofdistinguishinginstitutional

characteristics,thecurrentcrisishasraisedanunusuallylargenumberofquestionswithin

theUnitedStatesastohowbesttodefinetheboundariesforprudentialregulationand

supervision.

TheU.S.financialsystemislarge,complex,andmultifaceted,withcharacteristicsdistin-

guishingitfromsystemsinothermajorcountries.Thesecharacteristics,whichhaveledto

particularchallengesinrespondingtothecurrentcrisis,are:(a)therelativesizeandimpor-

tanceofcapitalmarkets;(b)therelativesizeandimportance(untilrecently)ofstand-alone

investmentsbanks;(c)theregionalandlocalnatureofmuchofthedepositbankingsystem;

(d)thenatureoftheregulationoftheinsurancesector;(e)thesizeoffederalgovernmentdi-

rectandsponsoredinvolvementinmarket-basedcreditintermediation;and(f)thecomplex-

ityofthestructureofU.S.regulationandsupervision.(Thesecharacteristicsaredescribed

inmoredetailinBox2).

Inseveralimportantrespects,itwasproblemsatfirmsthatwereunderregulatedor

unregulatedthatbecameaflashpointforthespreadofthesubprimemortgagecrisis.At

thestartof2008,therewereeightverylargenon-bankU.S.financialfirmsthatshouldhave

beenregardedassystemicallysignificant;fiveinvestmentbanks,theworld’slargestinsur-

ancecompany,andtwoGovernment-SponsoredEnterprises(GSEs).Allofthesefirmshave

beenradicallytransformed.

TherewasalsoarunonU.S.moneymarketmutualfunds,leadingtoarushedprogram

oftemporaryfederalinsurance,backedbyanunprecedenteduseoftheresourcesofthe

Treasury’sExchangeStabilizationFund.Aseriesofcentralbankprogramshaveprovided

sizeabledirectsupporttothecommercialpaperfundingmarkets.Finally,withthecre-

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Financial ReFoRm A Framework for Financial Stability 2�

Box 2 the u.S. financial System

The following describes six particular characteristics of the U.S. financial system that distinguish it from other systems.

1. the relative size and importance of capital-market-based credit intermediation channels. This in-cludes the markets for corporate debt (investment-grade and high-yield bonds and commercial paper); the markets for asset-based credit (housing, auto loans, credit cards, and many other receivables, and markets for structured credit products); the size and importance of the over-the-counter (OTC) derivatives markets; and the money market mutual funds market channel for in-termediating liquid assets and meeting liquidity needs. In the markets for housing finance, there are the additional elements of networks of mortgage brokers and originators that operate largely, if not entirely, outside the boundaries of the regulated banking system. To be sure, all these market channels require banking system backup and support, but as alternative channels to the banking system, they are very large and relatively more significant than in most other countries.

2. the (until very recently) size and relative importance of stand-alone investment banks, as distinct from commercial banks, in the market-based credit intermediation process. This is tied closely to de-velopments in point 1 above and also to the forced separation of these two parts of the industry for most of the 20th century. As the commercial bank and investment bank sectors effectively merged into direct competition—and as traditional institutional asset managers were limited in their capacity to adapt to the emergence of derivative markets and various other tools for lever-age—private pools of capital (that is, private equity funds and hedge funds) have grown to a scale and position of relative importance that is unmatched in any other large country financial system, with the possible exception of the U.K.

3. the local and regional nature of the deposit-based banking system in the united States. Until recent-ly, only one of the five largest U.S. banks operated with a nationwide deposit-taking franchise. Moreover, while limited, arrangements still exist under which non-bank financial and non-finan-cial corporations can control government-insured savings banks and state-chartered industrial banks, while being subject to minimal or even no consolidated regulation and supervision.

4. the absence of national-level regulation of the insurance segment of the u.S. financial system. This framework of state, rather than national, laws and regulations has limited the degree and ef-fectiveness of oversight of the capital market activities of large, complex affiliates of regulated insurance companies.

5. the size of direct and sponsored federal government involvement in market-based housing finance channels. This has been large, if not widely understood, reflecting the size of and political sup-port for residential mortgage financing. The combined size of the balance sheets plus off-bal-ance-sheet guarantees of the Government Sponsored Enterprises (including Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System), and the size of full faith and credit entities such as the Federal Housing Administration and the Government National Mortgage Association, represents a significant direct and indirect claim on the public sector relative to the size of the U.S. marketplace.

ationofalargefundauthorizedbyCongress,theTroubledAssetReliefProgram(TARP),

expandedprogramsofFederalDepositInsuranceCorporation(FDIC)debtguarantees,and

extensivecentralbankassetmarketsupportprograms,publicsectorfinancialsupportis

beingprovidedtothecapitalstructureofinstitutionsandacrossabroadrangeofmarkets.

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Financial ReFoRm A Framework for Financial Stability26

Inresponsetothesecrisis-driveneventsandregulatoryinterventions,theUnitedStates

ismovingrapidlytoafinancialsysteminwhichasmallnumberofexceptionallylarge

bankholdingcompaniesareatthecoreofthesystem.Thesefirmsare,andpresumably

willcontinuetobe,characterizedbyascaleandcomplexitythatmarketparticipantsand

Administrationswillregardasbothtoobigandtoointerconnectedtobeallowedtodefault

oncreditorobligationsordisappear.Indeed,potentialfailurewouldbelikelytorequire

extensivegovernmentinterventionandgovernmentassistance,withfewifanydomestic

institutionscapableofacquiringthemintheirentirety.

Thesecoreinstitutionsaregainingevenlargerdominantpositionsintermsofcreditand

capitalmarketactivities,large-scalecorporatebanking,nationwidedeposittaking,and

manyothersegmentsofthecorporateandretailfinancialbusiness.Ifpermittedbylawand

regulation,thesefirmswilllikelybecomeintegratedacrossbusinesslinesandgeographies,

willmaintainapresenceasoperatorsofprivatepoolsofcapital,willdominatethecoreof

theOTCderivativemarkets,andwillstepintoanyvoidcreatedbythetruncationofthe

GSEsintermsofvariousformsofhousingfinance.

Thesedevelopmentsarewidelyviewedasportendingafurtherroundofextensivecon-

solidationintheU.S.bankingsystem.Howfastandfarthatproceedswilldependnotonly

oneconomicandmarketdevelopments,butalsoonhowgovernmentprogramsdeliberately

orotherwiseencouragemergersandonhowstatutorylimitsondepositconcentrationand

certainfunctionsareadministeredormodified.

Plainly,thesedevelopmentsposepublicpolicyissues,includingquestionsofexcessive

concentration,competitivefairness,moralhazard,andconflictsofinterest,whicharenot

new.Inthepast,theyhavebeendealtwithinapiecemealandpoorlycoordinatedfashion.

Therushofrecenteventsandthescaleofstructuralchangesthathavebeensetinmotion

addtoboththecomplexityandurgencyofdevelopingmoreappropriatepolicies.

Insum,marketforcesandcrisis-drivenactionshavemovedtheUnitedStatesperhapsbe-

yondapointofnoreturn,towardafinancialsystemwithamuchgreaterconcentrationof

financialresourcesandinfluenceinasmallnumberofextremelylargeandcomplexbanking

organizations.Inothermajorcountries,concentrationinarelativelyfewinstitutionshas

beenmorecommon.However,thechangesforcedbythisfinancialcrisis,towardfurther

consolidationinnationalbankingsystemsandrenewedimportanceofthebankingsector

relativetonon-bankfinancialandcapitalmarketsectors,areofadifferentmagnitude.

Theeventsof2008underscoretheimportanceofredefiningtheboundariesoftheofficial

“safetynet”andofprudentialregulation,strengtheningtheeffectivenessandstreamlining

thestructureoffinancialregulation,andreassessingtheroleofcentralbanksandtheeffec-

tivenessofthetoolsavailabletothem.

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Financial ReFoRm A Framework for Financial Stability 2�

1. Prudential regulation and Supervision of Banking organizations

Nomatterhowrobustfailuremanagementmechanismsare,marketsarelikelytopresume

thatthelargestregulatedfinancialinstitutionswill,tosomeextent,beprotectedagainstthe

fullforceofmarketdisciplinewiththepotentialconsequenceofencouragingexcessiverisk

taking—theessenceofmoralhazard.Tocompensateforthis,andtokeeptheprobabilityof

potentialfailureofsuchinstitutionstoacceptablylowlevels,existingregulatorystandards

andsupervisoryapproacheswillneedtobeupgraded.Thenecessarycorollaryisincreased

emphasisonthequalityandlevelofregulatoryandsupervisoryresources.

RecentexperienceintheUnitedStatesandelsewherehasdemonstratedinstancesin

whichunanticipatedandunsustainablylargelossesinproprietarytrading,heavyexposure

tostructuredcreditproductsandcreditdefaultswaps,andsponsorshipofhedgefundshave

placedatrisktheviabilityoftheentireenterpriseanditsabilitytomeetsitsresponsibilities

toitsclients,counterparties,andinvestors.

Theseactivities,andthe“originate-to-distribute”model,whichfacilitatedsellingandre-

sellinghighlyengineeredpackagesofconsolidatedloans,areforthemostpartofrelatively

recentorigin.Inessence,theseactivitiesallstepawayfromthegeneralconceptofrelation-

shipbanking,restingonindividualcustomerservice,towardamoreimpersonalcapital

marketstransaction-orientedfinancialsystem.Whatisatissueistheextenttowhichthese

approachescansensiblybecombinedinasingleinstitution,andparticularlyinthosehighly

protectedbankinginstitutionsatthecoreofthefinancialsystem.

Almostinevitably,thecomplexityofmuchproprietarycapitalmarketactivity,andthe

perceivedneedforconfidentialityofsuchactivities,limitstransparencyforinvestorsand

creditorsalike.Inconcept,therisksinvolvedmightbereducedbylimitingleverageandat-

tachinghighcapitalstandardsandexceptionallyclosesupervision.

SomemembersoftheG30feelsuchanapproachcouldbesufficienttodealwiththese

risks.Inpractice,anyapproachmustrecognizethattheextentofsuchrisks,potential

volatility,andtheconflictsofinterestswillbedifficulttomeasureandcontrol.Experience

demonstratesthatunderstress,capitalandcreditresourceswillbedivertedtocoverlosses,

weakeningprotectionofclientinterests.Complexandunavoidableconflictsofinterest

amongclientsandinvestorscanbeacute.Moreover,totheextentthattheseproprietary

activitiesarecarriedoutbyfirmssupervisedbygovernmentandprotectedfromthefull

forceofpotentialfailure,thereisastrongelementofunfaircompetitionwith“free-stand-

ing”institutions.Inthelastanalysis,thereisamoreintangibleaspecthighlightedbyrecent

experience.Isitreallypossible,withallthecomplexities,risks,andpotentialconflicts,that

eventhemostdedicatedboardofdirectorsandtopmanagementcanunderstandandmain-

taincontroloversuchadiverseandcomplexmixofactivities?

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Financial ReFoRm A Framework for Financial Stability2�

Thesequestionsarerelatedtotheissueofwhetherprudentialregulationandsupervision

shouldfollowfunctionalorconsolidatedlines:shouldprimarysupervisionoftradingand

securitiesactivities,hedgefunds,investmentmanagement,andotherelementsofalarge

bankingorganizationbetheresponsibilityofsecurityormarketauthoritiestofacilitate

competitiveequality,orshouldasingleregulatortakeresponsibilityforprudentialsupervi-

sionofanentirediversifiedbankingorganizationorotherinstitutionsofsystemicimpor-

tance?Iftheconsolidationofoversighttakesplaceinaninstitutionapartfromthecentral

bank,the“lastresort”funderfortroubledinstitutions,whatprinciplescanbeestablished

toencourageappropriaterelationshipsamongthevariousagenciesandwiththetreasuryor

financeministrythatcarrybroadgovernmentalresponsibilities?

Settingoutareasonableanddesirableapproachtowardtheseorganizationalandregu-

latorychallengesliesattheheartoffashioningthenewfinancialsystem.Thefollowing

recommendationssuggestsuchanapproach.

recommendation 1:

a. Inallcountries,theactivitiesofgovernment-insured,deposit-takinginstitutions

shouldbesubjecttoprudentialregulationandsupervisionbyasingleregulator(that

is,consolidatedsupervision).Thelargestandmostcomplexbankingorganizations

shouldbesubjecttoparticularlycloseregulationandsupervision,meetinghighand

commoninternationalstandards.

b.Large,systemicallyimportantbankinginstitutionsshouldberestrictedinundertak-

ingproprietaryactivitiesthatpresentparticularlyhighrisksandseriousconflictsof

interest.Sponsorshipandmanagementofcommingledprivatepoolsofcapital(that

is,hedgeandprivateequityfundsinwhichthebankinginstitutionsowncapitalis

commingledwithclientfunds)shouldordinarilybeprohibitedandlargeproprietary

tradingshouldbelimitedbystrictcapitalandliquidityrequirements.Participation

inpackagingandsaleofcollectivedebtinstrumentsshouldrequiretheretentionofa

meaningfulpartofthecreditrisk.

c. Ingeneral,government-insureddeposit-takinginstitutionsshouldnotbeownedand

controlledbyunregulatednon-financialorganizations,andstrictlimitsshouldbe

imposedondealingsamongsuchbankinginstitutionsandpartialnon-bankowners.

d.Toguardagainstexcessiveconcentrationinnationalbankingsystems,withimplica-

tionsforeffectiveofficialoversight,managementcontrol,andeffectivecompetition,

nationwidelimitsondepositconcentrationshouldbeconsideredatalevelappropriate

toindividualcountries.

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Financial ReFoRm A Framework for Financial Stability 2�

2. Consolidated Supervision of non-Bank financial institutions

Recentexperienceindealingwithtroubledbutsystemicallysignificantnon-bankfinancial

institutionsinsomecountriespointstotheneedforconsolidatedregulationandsupervi-

sionofsuchinstitutions.

recommendation 2:

a. Forthosecountrieslackingsucharrangements,aframeworkfornational-levelcon-

solidatedprudentialregulationandsupervisionoverlargeinternationallyactiveinsur-

ancecompaniesshouldbeestablished.

b.Anappropriateprudentialregulatorshouldbedesignatedforthoselargeinvestment

banksandbroker-dealersthatarenotorganizedasbankholdingcompanies.

3. money market mutual funds and Supervision

Thewidespreadrunonmoneymarketmutualfundshasunderscoredthedangersofinstitu-

tionswithnocapital,nosupervision,andnosafetynetoperatingaslargepoolsofmaturity

transformationandliquidityrisk.Thesehavebeencompoundedbyprovisionoftransaction

accountservices,withwithdrawalsondemandatpar,mimickingtheservicesofregulated

commercialbanks.Aregulatorydistinctionshouldbedrawnbetweenthoseservicesthat

aremostappropriatelyhousedinregulatedandsupervisedbanks,particularlytherightto

withdrawfundsondemandatpar,andthosethatcanreasonablybeprovidedbymutual

fundsfocusedonshort-termfixed-ratecreditinstruments.

recommendation 3:

a. Moneymarketmutualfundswishingtocontinuetoofferbank-likeservices,such

astransactionaccountservices,withdrawalsondemandatpar,andassurancesof

maintainingastablenetassetvalue(NAV)atpar,shouldberequiredtoreorganize

asspecial-purposebanks,withappropriateprudentialregulationandsupervision,

governmentinsurance,andaccesstocentralbanklender-of-last-resortfacilities.

b.Thoseinstitutionsremainingasmoneymarketmutualfundsshouldonlyofferacon-

servativeinvestmentoptionwithmodestupsidepotentialatrelativelylowrisk.The

vehiclesshouldbeclearlydifferentiatedfromfederallyinsuredinstrumentsofferedby

banks,suchasmoneymarketdepositfunds,withnoexplicitorimplicitassurancesto

investorsthatfundscanbewithdrawnondemandatastableNAV.Moneymarketmu-

tualfundsshouldnotbepermittedtouseamortizedcostpricing,withtheimplication

thattheycarryafluctuatingNAVratherthanonethatispeggedatUS$1.00pershare.

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Financial ReFoRm A Framework for Financial Stability�0

4. oversight of Private Pools of Capital

Theissueoftheappropriateprudentialregulatorytreatmentofprivatepoolsofcapi-

tal—morespecifically,hedgefunds—hasbeenconsideredbypolicymakersnumeroustimes

sincethecollapseofLongTermCapitalManagementin1998.Thegenerallyprevailing

viewhasbeentocontinuetorelyonacombinationof:(a)enhancedmarketdiscipline,(b)

indirectoversightviaclosescrutinyoftheregulatedintermediariestheyuseforfinancing

andoperatingservices,and(c)moralsuasiontoencouragethespreadofimprovedrisk

managementandcompliancepractices.Insomejurisdictions,suchastheU.K.,thishas

beensupplementedbyformalregulatoryoversightofthelocalmanagers—butnotthefunds

themselves—andmoreformalarrangementstodevelopbestpracticesstandards,which

havebeenencouragedbyitsrecentlycreatedHedgeFundsStandardsBoard.

Takentogether,thesemeasureshavehadsomedegreeofsuccess,intermsofbringing

aboutimprovementsinhedgefundriskmanagementandfundingpractices,andimproved

counterpartyriskmanagementpractices.Nonetheless,volatilityhasbeengreaterthan

anticipated,withinstancesofstronglyadverseconsequencesforsponsoringinstitutions,

includingsomeofsystemicimportance.

Thequestion,goingforward,iswhetherexperiencewarrantsacontinuationofthe

largelyunregulatedstatusofhedgefunds,andifnot,theextentofsuchregulation.Several

indicationspointtowardlimitedandflexibleofficialregulation.Theneedforgreatertrans-

parencysupportstheintroductionofformalauthoritytoregisterandtrackthosefunds,

intermsofsize,useofleverage,riskstyles,andotherimportantvariables.Thisauthority

shouldbeassociatedwiththejurisdictionsinwhichthefundmanagersconductamajor-

ityoftheirbusiness.Second,effortstoachievecontinuousimprovementinmarketand

counterpartydisciplinewouldbeenhancedbyformalregulatoryauthorityrelativetothe

fundsandmanagers.Third,theincreasedemphasisonfinancialstabilityinthemandates

ofprudentialregulatorsandcentralbankspointstotheneedforgreater,moresystemic

accesstoinformationcrucialtounderstandingthepotentialforgrowingriskimbalancesin

thesystem.Finally,therecanbenoassurances—especiallyifthissectorcontinuestogrow

inrelativeimportance—thatthelargest,mostcomplexfundsmightnotbecomeafuture

sourceofsignificantsystemicrisk.

Whilelesspressing,similarconsiderationsmayberelevantforlargeprivateequityfunds

operatingonthebasisofsubstantialborrowing.Incontrast,venturecapitalfunds,dealing

bytheirnaturewithsmallcompaniesandprovidingessentialcapitalandmanagerialsup-

portforentrepreneurialinnovation,needtobefreeofinhibitingoversight.

recommendation 4:

a.Managersofprivatepoolsofcapitalthatemploysubstantialborrowedfundsshould

berequiredtoregisterwithanappropriatenationalprudentialregulator.Thereshould

besomeminimumsizeandventurecapitalexemptionsfromsuchregistrationrequire-

ment.

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Financial ReFoRm A Framework for Financial Stability �1

b.Theprudentialregulatorofsuchmanagersshouldhaveauthoritytorequireperiodic

regulatoryreportsandpublicdisclosuresofappropriateinformationregardingthe

size,investmentstyle,borrowing,andperformanceofthefundsundermanagement.

Sinceintroductionofevenamodestsystemofregistrationandregulationcancreate

afalseimpressionoflowerinvestmentrisk,disclosure,andsuitabilitystandardswill

havetobereevaluated.

c.Forfundsaboveasizejudgedtobepotentiallysystemicallysignificant,theprudential

regulatorshouldhaveauthoritytoestablishappropriatestandardsforcapital,liquid-

ity,andriskmanagement.

d.Forthesepurposes,thejurisdictionoftheappropriateprudentialregulatorshouldbe

basedontheprimarybusinesslocationofthemanagerofsuchfunds,regardlessof

thelegaldomicileofthefundsthemselves.Giventheglobalnatureofthemarketsin

whichsuchmanagersandfundsoperate,itisimperativethataregulatoryframework

beappliedonaninternationallyconsistentbasis.

5. government-Sponsored enterprises

ThehybridbusinessmodelofthehousingfinanceGovernment-SponsoredEnterprises

(GSEs),inwhichtheyarebothprofit-seekingprivatecompaniesandagentsofgovernment

policy,hasbeenshowntobeunworkableovertimeandparticularlyinthemidstofcrises.

Thesenseofanimplicitgovernmentbackingfacilitatedadegreeofleverageandrisktaking

thatprovedunsustainable.Thespecializedregulatoryoversightwasbothinadequateand

toosusceptibletopoliticalpressure.Thiswascompoundedbymisalignedincentivesin

bankcapitalrulesforbankstotakeonoversizedexposurestotheseGSEs.Thecompetition

fromprivatemarketfirmsfurtherinducedtheGSEstoexpandintohigherrisk-takingac-

tivitiesandlowerunderwritingstandardsintheinterestsofmaintainingadominantmarket

position.Then,inthefaceofthefallofhousingmarketprices,theGSEshadlostthecapac-

itytoprovidestrongsupportforthemortgagemarket,whichwastheirpublicmandate.In

theend,thegovernmenthadnochoicebuttointervenedirectly.

Twoimportantfinancialpolicylessonsare:(a)thecrucialimportanceofclearlysepa-

ratinggovernmentfinancialsupportfromprivateprofitseeking;and(b)theneedforany

chosenlevelofgovernmentsupporttobeexplicitandproperlyaccountedfor.Theselessons

arerelevantforotherindustriesandothercountries.

recommendation 5:

a.FortheUnitedStates,thepolicyresolutionoftheappropriateroleofGSEsinmort-

gagefinanceshouldbebasedonaclearseparationofthefunctionsofprivatesector

mortgagefinanceriskintermediationfromgovernmentsectorguaranteesorinsurance

ofmortgagecreditrisk.

b.Governmentalentitiesprovidingsupportforthemortgagemarketbymeansofmarket

purchasesshouldhaveexplicitstatutorybackingandfinancialsupport.Hybridsof

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Financial ReFoRm A Framework for Financial Stability�2

privateownershipwithgovernmentsponsorshipshouldbeavoided.Intime,existing

GSEmortgagepurchasingandportfolioactivitiesshouldbespunofftoprivatesector

entities,withthegovernment,ifitdesires,maintainingacapacitytointerveneinthe

marketthroughawhollyownedpublicinstitution.

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paRT � The Structure of Prudential Regulation and International Coordination

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Financial ReFoRm A Framework for Financial Stability��

Core reCommenDation iithe quality and effectiveness of prudential regulation and supervision must be improved. Thiswillrequirebetter-resourcedprudentialregulatorsandcentralbanks

operatingwithinstructuresthataffordmuchhigherlevelsofnationalandinternational

policycoordination.

Box 3 the Structure of financial Supervision

The four approaches to the structure of financial supervision can be described as follows.

1. the institutional approach: In which a firm’s legal status (for example, a bank, broker-dealer, or insurance company) determines which regulator is tasked with overseeing its activity from both a safety and soundness and a business conduct perspective (for instance, as in China, Hong Kong, and Mexico).

2. the functional approach: In which supervisory oversight is determined by the business that is be-ing transacted by the entity, without regard to its legal status. Each type of business may have its own functional regulator (for instance, as in France and Italy).

(In practice, as the institutional approach has progressively become outmoded, supervisors using this structure have moved toward a functional approach, so the line between the two has become blurred.)

3. the integrated approach: In which a single, universal regulator conducts both safety and soundness oversight and conduct-of-business regulation for all the sectors of financial services business (for instance, as in Germany, Japan, and the United Kingdom).

4. the twin-peaks approach: A form of regulation by objective in which there is a separation of regula-tory functions between two regulators: one that performs the safety and soundness supervision function and the other that focuses on conduct-of-business regulation (for instance, as in Austra-lia and the Netherlands).

6. regulatory Structure

TherecentG30report,The Structure of Financial Supervision,presentsinsomedetailthe

characteristicsoffourdifferentapproachestotheorganizationoffinancialregulationand

supervision.Thefourapproachesare:institutional,functional,integrated,andtwinpeaks.

ThesedifferentapproachesaredescribedindetailinBox3.

Theconceptualprosandconsofeachapproacharesetoutintheearlierreportandwill

notberepeatedhere.Thedirectionofchangeisclear—thatis,tosomevariantofeither

thetwin-peaks(regulationbyobjective)orintegratedapproach.Eitherapproach,anda

numberofvariantsonthem,iscompatiblewiththelarge,bank-centeredstructuresthatare

emergingwithinmostcountries.

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Financial ReFoRm A Framework for Financial Stability ��

Toasignificantextent,thechoiceofwhichregulatorystructuralmodeltoemployhasto

reflectabalancingofcountry-specificpreferences,withappropriateweighttoitsfounding

politicalprinciplessuchas,intheUnitedStates,theprinciplesofchecksandbalances,and

amixofFederalandStateauthority.Thereis,therefore,nosinglecorrectanswertothe

questionofwhatistheoptimalstructurefororganizingfinancialregulationandsupervi-

sion.Thereis,however,anemergingconsensusaroundanumberofkeypoints,including:

(a)theneedtosubstantiallysimplifyandconsolidateoverlycomplexstructures;(b)theem-

phasisonclarifyingandstressingguidingprinciplesofregulationratherthanarules-based

approachtoregulation;(c)theimportanceformuchgreaterlevelsofinternationalcoopera-

tionandcoordinationonsuchmattersasaccountingstandards,listingstandards,licenses

tooperateasregulatedfirms,supervisoryoversightmechanisms,and,mostimportant,

prudentialcapitalandliquiditystandards;(d)theimportanceofregulatoryarrangements

havingtheflexibilitytoadapttonewtypesofinstitutions,instruments,andmarkets;and

(e)theneedtoensurethepoliticalandmarketindependenceofnationalregulatoryauthori-

ties.Finally,thereisagrowingappreciationoftheimportanceofensuringthatcentral

bankresponsibilityforpromotingfinancialstabilityissupportedbyadequateauthorityand

capacity.

Regardlessofhowregulatoryagenciesarereorganized,prudentialsupervisorshavea

commonneedtobetterensurethatfinancialinstitutionsadequatelyprepareforandre-

spondtoperiodsoffinancialstress.Thatrolerequiresarenewedemphasisonthecomplex

natureofjudgmentsaboutthestabilityoflargebankingorganizations.Thecaliber,quality,

andintegrityofpeoplerequiredtomeetthesechallengespointstotheneedformoresub-

stantialeffortstoattract,develop,andretainindividualsfullycapableofengagingsenior

privatesectorcounterparts.

recommendation 6:

a.Countriesshouldreevaluatetheirregulatorystructureswithaviewtoeliminating

unnecessaryoverlapsandgapsincoverageandcomplexity,removingthepotentialfor

regulatoryarbitrage,andimprovingregulatorycoordination.

b.Inallcases,countriesshouldexplicitlyreaffirmtheinsulationofnationalregulatory

authoritiesfrompoliticalandmarketpressuresandreassesstheneedsforimproving

thequalityandadequacyofresourcesavailabletosuchauthorities.

7. role of the Central Bank

Acentralpolicyissueinregulatoryreorganizationishowtostriketherightbalancebe-

tweentheroleofthecentralbankandthatofothernationalregulators.Nationalgovern-

mentsmustdecidepreciselywheretostrikethatbalance.Whatisimportantistodosoin

afashionthatproperlyenablesthecentralbanktofulfillitsmainpolicymissions.Beyond

thecentralmissionofmonetarypolicy,centralbanksnormallyhavearoleinmanagingand

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Financial ReFoRm A Framework for Financial Stability�6

supportingpaymentssystems,inprovidingliquiditytobanksintimesofstress,andmore

broadlyinmaintainingfinancialstability.

Recenteventsprovideimpetusforrecognizingafinancialstabilityroleforcentralbanks.

Thatcarrieswithitaneedforadequateauthorityandthetoolstocarryoutthismission.

Broaderauthoritytocollectinformationhelpfultounderstandingpotentialthreatsto

stabilityisbutoneelementofthis.Anotherishowbesttocombatthedevelopmentof

financialexcessesbeforetheybuildintofull-fledgedcrises.Morecountercyclicalregulatory

andsupervisorypoliciesareonesuchtool.Considerationofassetmarketdevelopmentsin

settingmonetarypolicieshasbeenacontroversialbutimportantdebate.

Totheextentthatexcessiveuseofleverageisarecurringsignificantcontributionto

potentialfinancialinstability,centralbanksmayconsiderthevalueofemployingcounter-

cyclicaltoolsthatworkdirectlytoavoidexcesses.Someformofbroad-basedcollateral

requirementsormargin-settingauthority,includingauthoritytosetminimuminitialand

maintenancemarginrequirementsacrossabroadrangeoffinancialassetmarketsandin-

strumentsinwhichleverageistypicallyemployed,isapossibility.Aswithanyformalrule-

makingauthority,overtime,marketpracticesandinnovationswilldeveloptoexploitgaps

andweaknesses.Anyrulethatforcesmarketparticipantstoholdmorecollateralthanthey

wouldvoluntarilycreatessomecosts.These,however,arenotreasonstoabandonconsider-

ationofexpandingthetoolsavailabletotemperextremefinancialexcessesthatpotentially

createfargreatercosts.

Animportantelementofpost-crisisreformistoconsiderwhichcrisismanagement

actionsandinnovationsdevelopedbycentralbanksshouldusefullyremainpartofpoli-

cymakers’toolkitsandwhichshouldbestrictlylimitedoreliminatedentirely.Thepoint

isthatbroadlyextendingthesafetynetmayactuallyencouragerisktakingtothepointof

facilitatingfutureexcessesandcarrycentralbanksintoareasmoreappropriatelyreserved

forpoliticalauthorities.

recommendation 7:

a. Wherenotalreadythecase,centralbanksshouldacceptaroleinpromotingand

maintainingfinancialstability.Theexpectationshouldbethatconcernsforfinancial

stabilityarerelevantnotjustintimesoffinancialcrisis,butalsointimesofrapid

creditexpansionandincreaseduseofleveragethatmayleadtocrises.

b.Incountrieswherethecentralbankisnottheprudentialregulator,thecentralbank

shouldhave:(i)astrongroleonthegoverningbodyoftheprudentialandmarkets

regulator(s);(ii)aformalreviewrolewithrespecttoproposedchangesinkeypruden-

tialpolicies,especiallycapitalandliquiditypoliciesandmarginarrangements;and(iii)

asupervisoryroleinregardtothelargestsystemicallysignificantfirms,andcritical

paymentandclearingsystems.

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c. Asharpdistinctionshouldbemaintainedbetweenthoseregulatedbankingorganiza-

tionswithnormalaccesstocentralbankliquidityfacilitiesandothertypesoffinancial

institutionswhoseaccess,ifany,shouldbelimitedtoextremeemergencysituationsof

criticalsystemicimportance.

d.Centralbankemergencylendingauthorityforhighlyunusualandexigentcircum-

stancesshouldbepreserved,butshouldinclude,bylaworpractice,supportbyap-

propriatepoliticalauthoritiesfortheuseofsuchauthorityinextendingsuchcreditto

non-bankinstitutions.

e. Centralbankliquiditysupportoperationsshouldbelimitedtoformsthatdonot

entaillendingagainstortheoutrightpurchaseofhigh-riskassets,orotherformsof

long-termdirectorindirectcapitalsupport.Inprinciple,thoseformsofsupportare

moreappropriatelyprovidedbydirectlyaccountablegovernmententities.Inpractice,

totheextentthecentralbankistheonlyentitywiththeresourcesandauthoritytoact

quicklytoprovidethisformofsystemicsupport,thereshouldbesubsequentapproval

ofanappropriategovernmentalentitywiththeconsequentrisktransfertothatentity.

8. international Coordination

Thereismuchthatcanbedonetoimproveinternationalregulatoryandsupervisorycoordi-

nation.Certainspecificandneededenhancementscanandshouldmoveforwardwithinthe

existingframeworkofinternationalcooperation.Themostpressingandcomplexofthose

enhancementsrelatetomakingcrisismanagementcoordinationmoreeffectiveandopera-

tionalbyagreedprotocols.Effectiveandtimelyinformationsharing,includinginformation

aboutlargeindividualinstitutionsoperatinginanumberofjurisdictions,isastart.Greater

clarityisrequiredastowhichjurisdictionoragencyhastheresponsibility,intermsofman-

agingthefailureprocess,andhowthecostsoffailureandtheburdensoffinancialsupport,

totheextentneeded,willbeshared.Inthecurrentmarketenvironment,someofthelargest

regulatedfinancialinstitutionshavegrowntoascalethatraisesquestionsastothecapac-

ityofsomehomecountryregulatorstomanageandsupportthefailureresolutionprocess.

Theseconcernswarrantearlyhigh-levelconsiderationwithininternationalpolicyforums.

recommendation 8:

a.Nationalregulatoryauthoritiesandfinanceministersarestronglyencouragedto

adaptandenhanceexistingmechanismsforinternationalregulatoryandsupervisory

coordination.Thefocusofneededenhancementsshouldbeto:(i)bettercoordinate

oversightofthelargestinternationalbankingorganizations,withmoretimelyand

openinformationsharing,andgreaterclarityonhomeandhostresponsibilities,in-

cludingincrisismanagement;(ii)movebeyondcoordinatedrulemakingandstandard

settingtotheidentificationandmodificationofmaterialnationaldifferencesinthe

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applicationandenforcementofsuchstandards;(iii)closeregulatorygapsandraise

standards,whereneeded,withrespecttooffshorebankingcenters;and(iv)develop

themeansforjointconsiderationofsystemicriskconcernsandthecyclicalityimplica-

tionsofregulatoryandsupervisorypolicies.Theappropriateagenciesshouldstrength-

entheiractionsinmembercountriestopromoteimplementationandenforcementof

internationalstandards.

b.Giventherecurringimportanceofexcessiveleverageasacontributingfactorto

financialdisruptions,andtheincreasinglycomplexwaysinwhichleveragecanbe

employedonandoffbalancesheets,prudentialregulatorsandcentralbanksshould

collaboratewithinternationalagenciesinanefforttodefineleverageandthencollect

andreportdataonthedegreeofleverageandmaturityandliquiditymismatchesin

variousnationalsystemsandmarkets.

c. Totheextentnewinternationalregulatoryorganizationsareultimatelyneeded,the

initialfocusshouldbeondevelopingmoreformalregionalmechanisms,suchasinthe

EuropeanUnion,butwithcontinuedattentivenesstotheglobaldimensionofmost

significantfinancialmarkets.

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Core reCommenDation iiiinstitutional policies and standards must be strengthened, with particular emphasis on standards for governance, risk management, capital, and liquidity. Regulatorypoliciesandaccountingstandardsmustalsoguardagainstprocyclicaleffects

andbeconsistentwithmaintainingprudentbusinesspractices.

Inamarket-basedfinancialsystem,manystakeholdersareinvolved:shareholders,manag-

ersandotheremployees,clients,regulators,andthepublicatlarge.Foreachstakeholder,

costsandbenefitsandrisksandrewardsshould—asfaraspossible—bebalanced.Apre-

requisiteforthisisthatincentivesshouldbeconsistentwiththeprinciplethatrisksshould

bebornebythosewhotakethem.Themorethisconditionissatisfied—andoneroleof

publicpolicyistohelpbringthisabout—themoretheriskofsystemicinstabilityisre-

duced.Asecondprerequisiteisthatrisksmustbeastransparentaspossibletotherelevant

stakeholdersinfinancialinstitutions.Themoreopaquearetherisksbeingtaken,themore

difficultitisforstakeholderstoascertainifthereisreasonablebalancebetweenrisksand

expectedrewards.

Inlookingbackatthearrayofproblemsencounteredduringthisfinancialcrisis,there

arenumerousexamplesofmisalignedincentives,ofincentivesthatcontributetoinstabil-

ityandcyclicalityinfinancialmarkets,andofshortcomingsinthetransparencyofrisks,in

firms,inmarkets,andinstructuredproducts.

Thefirststeptowardimprovingincentivesandtransparencymustbetakenatthelevel

ofprivatesectorfirmscentraltofinancialriskintermediation.Furtherstepscanbetakenby

regulatorsandbyaccountingstandardsetters.

9. regulatory Standards for governance and risk management

Tobeeffectiveandsustainable,improvementsingovernanceandriskmanagementmust

bedrivenbyleadershipinprivatesectorfirmsincorporatedintoabusinessculturethat

promotesdisciplineandafocusonlong-runperformance.Directionforthatmuststart

atthetop,withboardsofdirectorsthatareengagedanduptothetaskofoverseeingthe

complexitiesofmodernfinancialriskmanagement.Complexitiescannotbeanexcusefor

poorlypreparedandinformedboards.Inthefirstinstance,seniormanagementhasrespon-

sibilityforprovidingboardswithtimelyinformation,and,ifnecessary,thetrainingneces-

sarytouseit.Inturn,boardsmustbepopulatedwithsufficientexpertisetoabsorbsuch

informationandactonit,ifneedbewiththebenefitofindependentoutsideadvice.Ifthese

criteriacannotbemet,theargumentforreducingthesizeandcomplexityoftheseorganiza-

tionsbecomesrelevant.

Intermsofspecificimprovementsinfirmriskmanagementpractices,leadingfirmsinthe

financialindustryhaveinrecentyearstogetherassessedtheircapacityandwillingnessto

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cooperateintakingcorrectivestepstoforestallcrises.Itislessclearhowdiligentfirmsand

regulatorshavebeeninfollowinguponimplementationofrecommendedimprovements.

Itisquiteclearthatwhathadbeenrecommendedbeforethismostsevereofcriseswasnot

sufficienttopreventtheerosionofdisciplineatmanyleadingfirms.Thissuggeststheneed

foramoresystematicandforcefulfollow-uponimplementationofbestpractices,bysenior

management,byboards,andbyregulators.

Finally,thiscrisishasdrivenhometheimportanceofaligningcompensationpractices

withtheincentivesandcontrolsinafirm’sriskmanagementprogram.Seniormanagement

andboardsneedtoensureaconsistencyinthatrespect,aligningpaywithlong-runshare-

holderinterestratherthanshort-termreturnsthatcannotbesustainedandentailgreater

risk.Regulatorsneedtosatisfythemselvesonthisscoreandfactormisalignedincentives

intotheiroveralljudgmentsregardingthequalityofthefirm’sriskmanagementcapabilities.

recommendation 9:

Regulatorystandardsforgovernanceandriskmanagementshouldberaised,withparticu-

laremphasison:

a. Strengtheningboardsofdirectorswithgreaterengagementofindependentmembers

havingfinancialindustryandriskmanagementexpertise;

b.Coordinatingboardoversightofcompensationandriskmanagementpolicies,with

theaimofbalancingrisktakingwithprudenceandthelong-runinterestsofand

returnstoshareholders;

c. Ensuringsystematicboard-levelreviewsandexercisesaimedatestablishingthemost

importantparametersforsettingthefirm’srisktoleranceandevaluatingitsriskpro-

filerelativetothoseparameters;

d.Ensuringtheriskmanagementandauditingfunctionsarefullyindependentand

adequatelyresourcedareasofthefirm.Theriskmanagementfunctionshouldreport

directlytothechiefexecutiveofficerratherthanthroughtheheadofanotherfunc-

tionalarea;

e. Conductingperiodicreviewsofafirm’spotentialvulnerabilitytoriskarisingfrom

creditconcentrations,excessivematuritymismatches,excessiveleverage,orunduereli-

anceonassetmarketliquidity;

f. Ensuringthatalllargefirmshavethecapacitytocontinuouslymonitor,withinamat-

terofhours,theirlargestcounterpartycreditexposuresonanenterprisewidebasis

andtomakethatinformationavailable,asappropriate,toitsseniormanagement,its

board,anditsprudentialregulatorandcentralbank;

g. Ensuringindustrywideacceptanceofandactiononthemanyspecificriskmanage-

mentpracticeimprovementscontainedinthereportsoftheCounterpartyRiskMan-

agementPolicyGroup(CRMPG)andtheInstituteofInternationalFinance.

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10. regulatory Capital Standards

Thebusinessofbankingisinherentlycyclical.Movementsinassetprices,collateralvalues,

assetquality,capitalmarkettransactionvolumes,andmarketliquidityallreflecteconomic

fluctuationswithconsequencesforearningsgrowthandcapitalgeneration.Regulatorypoli-

ciesandpracticescannotrepealbusinesscycles.Theycan,however,beassessedinterms

oftheimpacttheyhaveinamplifyinginstitutionalbehaviorduringthecycle.Inseekingto

temperregulatorysourcesofprocyclicality,theobjectiveshouldbetoreinforcetheprimary

aimofprudentialregulation—tomaintainthehealthofthesystemandcontainsystemic

risk.

Thereareseveralaspectsofprudentialregulatorypoliciesinwhichprocyclicalfeatures

areevident:capitalstandards,liquiditypolicies,andreservingpractices.Thesearediscussed

inthissection.Extensiveregulatorypolicyimprovementeffortsarealreadyunderway,

undertheleadershipoftheFinancialStabilityForumandtheBaselCommitteeonBanking

Supervision.

Prudentialsupervisorshaveacriticalroletoplayinensuringthatthelargestbanking

organizationsadequatelyprepareforandrespondtotheupsanddownsofcycles.Well-de-

signedandsensiblyexecutedsupervisoryprogramswillbeanessentialelementofeffective

regulatoryreformeffortstodampenprocyclicality.Astartingpointforavoidingexcessive

riskistosupporteffortsofsupervisorstoreportonandpushbackagainsterosioninrisk

standardsanddisciplineduringperiodsofeconomicexpansionandconfidence.

Inthissamevein,whenrisksarematerializingandextremepressuresmounting,itis

evenmorechallengingforsupervisorsnottooverreacttotheuseofcapital,reserve,and

liquiditybuffersthatshouldhavebeenbuiltupforuseinjustsuchcircumstances.Allthis

furtherunderscorestheimportanceoftheseagencieshavinghigh-qualityresourceswiththe

independencetocarryoutthiscomplextask.

Aparticularlydisturbingaspectofthecurrentcrisisisthespeedwithwhichlargeregu-

latedfinancialinstitutionsmovedfrombeingrepresentedaswellcapitalizedwithstrong

liquiditypositionstorequiringgovernmentinterventionsandsizeablefinancingsupportto

avoidbankruptcy.Tobesure,financialpanicscanproduceconditionsthatareunmanage-

ableforevenverystrongfinancialinstitutions,astheyallrequiremarketconfidenceto

functionproperly.Butitisalsotruethatexistinginternationalcapitalstandardshavelost

credibilitywithmarketparticipants.Itiscriticallyimportantthatmarketcredibilitybe

reestablished.

Theprincipleoftyingcapitalstandardstoestimatedriskisappropriateonlyifriskesti-

mationtechniquesaresoundandexperiencehasrevealedimportantlimitationsthatneedto

beaddressed.Considerationshouldbegiventoimprovedmethodstoidentifyandaccount

forhiddencreditconcentrations,undulyoptimisticassumptionsaboutmarketliquidity

risk,socalled“pipeline”riskinoriginate-to-distributebusinessmodels,andnoncontractual

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exposures,suchasthosearisingfromsponsorshipofoff-balance-sheetvehiclesandvarious

typesofinvestmentfunds.

Evenimprovedtechniquesforestimatingriskwillhaveinherentlimitations.Recognizing

thoselimitations,capitalstandardscanbemademorepracticalandlessprocyclical,byex-

pressingthemintermsofwideoperatingranges,ratherthanasminimumpointestimates.

Suchanapproachshouldencourageabuildupofcapitalduringexpansionperiods,dis-

couragingaggressivesharebuybackanddividendpolicieswhilepermittingsomereductions

intimesofstress.Regulatorswillneedtoencouragebankstointernalizethisdisciplineby

requiringcapitalmanagementpoliciestobetiedtocarefulanalysisofwhatstressscenarios

implyaboutcapitalneeds.

recommendation 10:

a. Internationalregulatorycapitalstandardsshouldbeenhancedtoaddresstendencies

towardprocyclicality.Benchmarksforbeingwellcapitalizedshouldberaised,given

thedemonstrablelimitationsofeventhemostadvancedtoolsforestimatingfirmwide

risk.

b.Thesebenchmarksshouldbeexpressedasabroadrangewithinwhichcapitalratios

shouldbemanaged,withtheexpectationthat,aspartofsupervisoryguidance,firms

willoperateintheupperendofsucharangeinperiodswhenmarketsareexuberant

andtendenciesforunderestimatingandunderpricingriskaregreat.

c. Theexistinginternationaldefinitionsofcapitalshouldbereevaluated,lookingtoward

closealignmentonnationaldefinitions.

d.Capitalandriskdisclosurestandardsshouldbereevaluatedtoprovideahigherdegree

oftransparencyofafirm’sriskappetite,itsestimatedneedsforandallocationofeco-

nomiccapital,anditsvaluationpractices.

11. Standards for liquidity risk management

Twointerrelatedsetsofliquiditystrainshavecharacterizedthecurrentfinancialcrisis.

Oneistheevaporationofactivemarketsforassetsapartfromgovernmentsecuritieswith

theconsequencethatpricediscoveryinmanymarketsbecameunreliable.Theotheris

strainsonfunding,asreflectedinthedislocationsintheinterbankfundingmarketsand

thevirtualshutdownoftermdebtfundingmarketsforevenhighlyratedfinancialinstitu-

tions.Theextentofthesestrainssuggeststhatenhancedrisk-basedcapitalstandardsareby

themselvesnotasufficientbasisforensuringfinancialstability.Standardsarealsoneeded

forliquidityrisk.

Stronger,moresystematicmeasuresneedtobetakenthatbuildontheframeworkused

forcapitalstandards.Afirststepinthisregardwastakeninearly2008withtheBasel

Committee’sPrinciplesforSoundLiquidityRiskManagement.

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recommendation 11:

a. Base-levelliquiditystandardsshouldincorporatenormsformaintainingasizable

diversifiedmixoflong-termfundingandanavailablecushionofhighlyliquidunen-

cumberedassets.Oncesuchstandardsaredeveloped,considerationshouldbegivento

whatisthepreferredmixofseniorandsubordinateddebtinbankcapitalstructures.

b.Supervisoryguidanceforliquiditystandardsshouldbebasedonamorerefinedanaly-

sisofafirm’scapacitytomaintainampleliquidityunderstressconditions,including

evaluationofthequalityandeffectivenessofitsliquiditymanagementpoliciesand

contingencyfundingplan.

c. Liquiditydisclosurestandards,buildingonthesuggestedpracticesintheBaselCom-

mitteePrinciples,shouldcomplementthesuggestedimproveddisclosurepracticesfor

capitalandriskprofileinformation.

12. fair Value accounting

Thecurrentfinancialcrisishastriggeredanintenseandoftenfrustratingdebateconcerning

theissuesraisedbystrictapplicationoffairvalueaccounting(FVA)rulestothefinancial

statementsofregulatedfinancialinstitutions.Indistressed,illiquid,virtuallynonfunction-

ingmarketssuchashavebeenwitnessed,thelimitationsandunintendedconsequences

ofFVAruleshavebecomeapparent,seeminglycontributingtouncertaintiesanddistress.

Somerecentinterpretativeguidanceregardingtoo-rigidapplicationoftheseruleshasbeen

viewedashelpful.Butapplicationofthatguidancehasbeenunevenacrossinstitutionsand

nationalregimesandhascausedfurtherdivergence,ratherthanconvergence,betweenU.S.

andInternationalAccountingStandards,withoutresolvingthecoreissues.

Apartfromthecurrentdifficultiesindeterminingmarketprices,thereisanunderlying

tensionbetweenthebusinesspurposesservedbyregulatedfinancialinstitutions—particu-

larlythoseinwhichthebasicfunctionistointermediatecreditandliquidityriskbyfunding

illiquidloansbymeansofdemandorshort-termdeposits—andtheinterestsofinvestors

andcreditorstohavethebestpossiblecurrentinformationontheimmediatemarketvalue

ofassetsandliabilities.Thattensionhasalsobeenreflectedhistoricallyindifferentap-

proachesfavoredbyprudentialandsecurityregulators.

Thedirectionuntilrecentlyhasbeentoseektoresolvethattensionbyforcingasmuch

oftheaccountingandvaluationofallassetsandliabilitiesaspossibleintoanaccounting

modeldesignedanddevelopedtoaddressmarketvaluesofliquidtradeableinstruments.

Theextenttowhichthisrepresentsa“forcedfit”hasbecomeveryapparentinthecurrent

crisis.Onedramaticresulthasbeentheabilityofdistressedinstitutionstoincreasetheir

reportedearningsbymarkingtomarketofcertainoftheirownliabilitiesasthecreditrisk

ontheirdebthasincreased.Anotherproblemisvaluationsonilliquidassetsthatsometimes

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havelimitedrelationshiptoexpecteddiscountedcashflows.

Thewayforwardisnottoabandonappropriateconsiderationoffairvalueprinciples

buttoseekabetterprinciples-basedbalancebetweenthelegitimateneedsofinvestorsfor

usefulcurrentfinancialinformationandthebusinessmodeloftheregulatedfinancialinsti-

tutions.

Astartingpointistorecognizetherelevanceforsoundinternalriskmanagementof

trackingthebestavailableinformationonthechangesinvalueofafinancialfirm’sassets

andliabilities.Marketpricingvalidated,ifpossible,byindependentappraisalisoneimpor-

tantrequirement.Butitisnotnecessarilytheonlyoneforevaluatingriskandprofitability

intheabsenceofmarketliquidityandwhentheintrinsicvalueofcontinuingcustomer

relationshipisarelevantconsideration.

Anotherpracticalconsiderationistheresponsibilityofprudentialregulatorsandsuper-

visorstothemselvesmonitor,evaluate,anddisciplinevaluationpractices.Theirconcerns

mustbetojudgethenatureandextentoftherisksinvolvedandtoconsidertheadequacy

ofreserveprovisionstoabsorbpotentiallosses,mattersthatcannotbefullyencompassed

inmarkingtomarketinallcircumstances.

Insum,theaccountingprinciplesandapproachesapplicabletoregulatedfinancialinsti-

tutionswhoseprimarypurposeistointermediatecreditandliquidityriskneedstobebetter

alignedwiththefirm’sbusinessmodel.Apuremark-to-marketaccountingmodelisgener-

allypreferredfortradingactivitiesandmostelementsofmarketrisk.Variationsonthecur-

rentintent-basedaccountingmodelapplicabletobankingorganizationsareabetterplace

tostartforthesetypesofintermediaries.Morerealisticguidelinesforaddressingvaluation

issuesforilliquidinvestmentsinthesetypesofportfolios—includingguidanceonhowto

treatintent-basedchangesandmovementsintheseinstrumentsbetweenaccounts—isalsoa

betterstartingpointforfirmswiththisbusinessmodel. Rigorinthestandardsforalterna-

tivemethodsofvaluation(includingimpairments)andforevaluatingintent(andabilityto

carrythatintentthrough)isessentialtoserveinvestorneeds.

Moregenerally,therecanandshouldbeanimprovedlevelofdisclosureandtranspar-

encyaroundregulatedfirms’riskprofiles,riskreporting,andvaluationpractices.Themore

flexibilityregulatedfirmsandtheirregulatorshavetoapplyappropriatereasonablevalua-

tionpracticestoriskportfolios,thegreateristheburdenonthemtoprovidefull,fair,and

timelydisclosuresofinformationrelatedtotheirvaluationpractices.

Finally,safetyandsoundnessconsiderationsrequirethatregulatedfirmsmaintainfull

andadequatereservesforspecificexpectedcreditlossesoverthelifeofcreditexposures,

andgeneralvaluationreservestodealwithcyclicalandliquidityrisksinrelevantpartsof

theirportfolios,includingderivativeportfolios.Tensionsinthisregardbetweenaccounting

rulesandsafeandsoundbankingpracticesshouldberesolvedinawaythatpromotessafe-

tyandsoundness,withfullandcompletetransparencyanddisclosureofresultingreserves.

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recommendation 12:

a. Fairvalueaccountingprinciplesandstandardsshouldbereevaluatedwithaviewto

developingmorerealisticguidelinesfordealingwithless-liquidinstrumentsanddis-

tressedmarkets.

b.Thetensionbetweenthebusinesspurposeservedbyregulatedfinancialinstitutions

thatintermediatecreditandliquidityriskandtheinterestsofinvestorsandcreditors

shouldberesolvedbydevelopmentofprinciples-basedstandardsthatbetterreflectthe

businessmodeloftheseinstitutions,applyappropriaterigortovaluationandevalu-

ationofintent,andrequireimproveddisclosureandtransparency.Thesestandards

shouldalsobereviewedby,andcoordinatedwith,prudentialregulatorstoensure

applicationinafashionconsistentwithsafeandsoundoperationofsuchinstitutions.

c. Accountingprinciplesshouldalsobemademoreflexibleinregardtotheprudential

needforregulatedinstitutionstomaintainadequatecredit-lossreservessufficientto

coverexpectedlossesacrosstheirportfoliosoverthelifeofassetsinthoseportfolios.

Thereshouldbefulltransparencyofthemannerinwhichreservesaredeterminedand

allocated.

d.AsemphasizedinthethirdreportoftheCRMPG,underanyandallstandardsof

accountingandunderanyandallmarketconditions,individualfinancialinstitutions

mustensurethatwhollyadequateresources,insulatedbyfail-safeindependentdeci-

sion-makingauthority,areatthecenterofthevaluationandpriceverificationprocess.

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Core reCommenDation iV financial markets and products must be made more transparent, with better-aligned risk and prudential incentives. the infrastructure supporting such markets must be made much more robust and resistant to potential failures of even large financial institutions.

13. restoring Confidence in Securitized Credit markets

Priortothecurrentcrisis,ameaningfulportionofthecreditextensionprocesshadmi-

gratedawayfromtraditionalloanoriginationandretentionbyindividualbanksorother

financialinstitutionsthathavedirectknowledgeofandrelationshipswithborrowers,to

onewherefinancialinstitutionshavereliedoneachothertooriginateloansthatarethen

parceledoutandsharedamongabroadgroupofotherwiseunrelatedentities.Onecon-

sequencehasbeenthatthelossofconfidenceexperiencedduringthiscrisishasextended

beyondspecificinstitutionstoincludealossofconfidenceinentiresectorsoftheworld’s

capitalmarkets.

Prominentinthisregardhasbeenthecompletedryingupofnewdebtissuanceinvirtu-

allyallsegmentsoftheasset-backedsecuritiesmarkets.Thishasextendedwellbeyondthe

marketsforcomplexstructuredcollateralizeddebtobligations(CDOs)andcollateralized

loanobligations(CLOs)toincludeso-calledplainvanillaasset-backedreceivablestransac-

tions.

Theprimaryfactorscontributingtothislossofconfidencehavebeentheexcessive

complexityoftheseinstrumentsandthelackoftransparencythathascharacterizedthese

markets.Anadditionalcontributingfactorhasbeenflawsexposedintheworkingsofthe

“originate-to-distribute”businessmodelfollowedinthecapitalmarketunitsofvirtually

alllargebankingorganizations.Thoseflawsinclude:(a)anerosionincreditunderwrit-

ingstandards,basedonatransactionratherthanarelationshipandretentionapproachto

creditrisk;(b)concentrationsofpipelinecreditrisk,basedonoverlyoptimisticassumptions

regardingmarketliquidityandredistributioncapabilities;and(c)retentionofwhatturned

outtobebadlystructuredandgrosslyoverratedtranchesofstructuredproducts,inorder

todrivenewdealflow.Theextenttowhichtheoriginate-to-distributemodelwillsurvive

thepresentcrisisisinquestion.Whatisclearisthatitshouldnotcontinueasamajorele-

mentinfinancewithoutaconcertedefforttoremedytheflawedapproaches.Someofthe

flawscanbeaddressedinthestrengtheningofregulatorycapitalandliquiditystandards.

Othersneedtobeaddressedaspartofbroadereffortstoreduceriskandrestoreinvestor

confidenceinthesemarkets.

Theplanned2010implementationofnewinternationalaccountingstandardsforcon-

solidationofvarioustypesofoff-balance-sheetvehiclesmayimpactsecuritizationmarkets.

Manyofthosevehicles—particularlyso-calledStructuredInvestmentVehicles(SIVs)—were

createdinparttogetaroundexistingaccountingrulesandregulatorycapitalstandards.

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Oncethesetypesofvehiclesareforcedbackontobalancesheetsandbackintoregulatory

capitalcalculations,theymaybephasedoutofexistence,suggestingtheyservednosustain-

ableeconomicpurposeotherthanleveragedarbitrageofthoserules.

Incontrasttotheabove,off-balance-sheettrustvehiclesthatareusedtosupportthe

issuanceoftraditionalasset-backedsecuritizationsmustbevieweddifferently.Account-

ingstandardsettersshouldgivefurtherconsiderationtotheusefulnessofthesetypesof

truststructuresbeingtreatedfullyason-balance-sheetitemsandwhatthismightimplyfor

thefuturefunctioningofmarketsforthesetypesofasset-backedsecurities.Afulldiscussion

ofhowpendingaccountingchangesarelikelytoimpactthereportingandbalancesheet

treatmentofthesetypesofentitiesisbeyondthescopeofthisreport.(Ausefulreviewis

providedonpages38–52oftheCRMPGIIIreport.)Totheextentthesevehiclesalsoland

backonfinancialinstitutionbalancesheets,thereneedstobeearlyresolutionoftheimpact

thismayhaveontheusefulnessofleverageratiosasaregulatorycapitalmetric,andthe

potentialunevenuseofthatmetricacrossdifferentnationalregulatoryregimes.

Sincemostofthesecuritizedcapitalmarketshavebecomeinternationalinscope,efforts

toreopenthemusingnewprinciplesfortransparency,riskunderwriting,andaccounting

arebestapproachedonacoordinatedbasis,particularlybetweenauthoritiesintheUnited

KingdomandtheUnitedStates,wheremostofthisactivityhasbeencentered.

recommendation 13:

a. MarketSupervision:Extensiveinnovationinthecapitalmarketsandtherapidgrowth

ofsecuritizationmakeitimperativethatsecuritizedandotherstructuredproductand

derivativesmarketsbeheldtoregulatory,disclosure,andtransparencystandardsat

leastcomparabletothosethathavehistoricallybeenappliedtothepublicsecurities

markets.Thismayrequirethatabroaderrangeofmarketsbemonitored,thatthere

beadequatetransparencyastotransactionvolumesandholdingsacrossallproducts,

andthatbothcreditandleverageelementsofeachproductbethoroughlyunderstood

andmonitored.

b.CreditUnderwritingStandards:Thehealthyredevelopmentofsecuritizedcreditmar-

ketsrequiresarestorationofmarketconfidenceintheadequacyandsustainabilityof

creditunderwritingstandards.Tohelpachievethis,regulatorsshouldrequireregu-

latedfinancialinstitutionstoretainameaningfulportionofthecreditrisktheyare

packagingintosecuritizedandotherstructuredcreditproducts.

c. Off-Balance-SheetVehicles:Pendingaccountingrulechangesfortheconsolidation

ofmanytypesofoff-balance-sheetvehiclesrepresentapositiveandneededimprove-

ment.Itisimportant,beforetheyarefullyimplemented,thatcarefulconsiderationbe

giventohowtheserulesarelikelytoimpacteffortstorestoretheviabilityofsecuri-

tizedcreditmarkets.

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14. rating agency reforms

Numerousissuesandquestionshavebeenraisedaboutproblemsarisingfromthepre-cri-

sisoperationsoftheNationallyRecognizedSecuritiesRatingsOrganizations(NRSROs),

particularlyfocusingontheratingsattachedtocomplexsecuritizedinstruments.Theyin-

cludepotentialconflictsinherentintheissuerpaybusinessmodels;limitsonratingagency

accountability;theusefulnessofratingsthatonlyratecreditdefaultprobabilities,tothe

exclusionofmanyotherimportantriskfactors;andexcessiveregulatoryandinvestorreli-

anceonNRSROratings.Issueshavealsobeenraisedabouttheneedformorecompetition

andforbetterregulation.

Inmanyfinancialinstitutionsthenumberandqualityofpersonneldevotedtocredit

analysishasfailedtokeeppacewiththeincreasedcomplexityofindividualsecuritiesand

portfoliosofcreditinstruments.Overtime,afocusonprofitabilitywithinfinancialinstitu-

tionshasledmanyinvestorsandintermediariesto“outsource”thescreeningofcredits,and

inmanycases,theentirecreditevaluationfunction,tothetraditionalratingsagencies.

RegulatorybodieshavealsoreliedoncreditratingsfromNRSROsasanimportantinput

inassessingtheadequacyofnetcapital.Infact,creditratingshavebecome“hardwired”

inavastspectrumofrules,regulations,andinvestmentguidelinesaffectingcapitalrequire-

ments,disclosurerequirements,portfolioconstruction,andahostofotheractivitiesunder-

takenbybanks,broker-dealers,corporations,andotherissuers,pensionfunds,insurance

companies,professionalmoneymanagers,andotherinvestors.

Unfortunately,however,theeconomicmodelthatsupportstheratingagenciesisdriven

notbytheseusersbutbyissuerswhoselectandpayfortheratings.Therearenodirect

economicconsequencesforpoorcreditresearchoraratingthatfailstopredictanevent

ofdefault,becausethepayer,theissuer,isnotharmedineitherevent.Manyissuersare

believedtohave“shopped”amongthetraditionalprovidersforhigherratings,lendinga

perversenegativeconsequencetoregulatoryattemptstoincreasecompetition.

Inaddition,theratingagenciesarenotheldlegallyaccountableforthequalityoftheir

work.Sincethereisnocontractualrelationshipbetweenthosewhorelyonratings(inves-

tors)andtheprovidersofratings,thereisnolegalrecourse.Theagencieshave,todate,

escapedaccountabilityforthequalityoftheirratingsinthecourts.IntheUnitedStatesthey

havesuccessfullyarguedthattheirratings/opinionsaresubjecttoprotectionundertheFirst

Amendment.

Amodelwherebycreditresearchandsummaryratingsarepaidforbyinvestorsrather

thanissuershasbeenusedattimesinthepastandwouldbesuperiortothecurrentmodel.

Somesubscriptionmodelsforcreditresearchandsummaryratingshavebeguntoemerge.

However,thecurrentmodelsmakeitdifficultforproviderstobepaidbasedonvalue

added,bothbecausetheyhavetocompetewiththe“free”ratingsprovidedbythetradi-

tionalissuers,andbecauseitisdifficultforthemtodiscoverandmonitorhowextensively

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Financial ReFoRm A Framework for Financial Stability �1

theirintellectualpropertyisbeingdeployed.Considerationoughttobegiventoalternative

approaches.

Whiletherehasbeensubstantialinnovationinthedevelopmentofstructuredproducts

ratedbythetraditionalagencies,therehasbeenlittleinnovationinthemeasurementtech-

niquesincorporatedintheratingsthemselves,includingriskmeasuresrelatedtoliquidity,

volatility,spreadrisk,andotherriskfactorsrelevanttomarketvaluations.

Althoughmanypracticechangeshavebeenannouncedand/orproposedbythe

NRSROs,theEuropeanCommission,andtheSecuritiesandExchangeCommission(SEC),

itisnotclearthatthesechangesgofarenoughtoaddresstheunderlyingincentiveprob-

lems.Thethree-partrecommendationsetoutbelowisintendedtoaddressmoredirectlythe

needtoimprovethealignmentofincentivesforthethreepartiestotheratingprocess—the

issuer,theinvestor,andtheratingserviceprovider.

recommendation 14:

RegulatorypolicieswithregardtoNRSROsandtheuseofratingsshouldberevised,pref-

erablyonaninternationallycoordinatedbasis,toachievethefollowing:

a. Usersofriskratings,mostimportantlyregulatedusers,shouldbeencouragedtore-

storeoracquirethecapacityforindependentevaluationsoftheriskofcreditproducts

inwhichtheyareinvesting.

b.RiskratingsissuedbytheNRSROsshouldbemademorerobust,toreflecttherisk

ofpotentialvaluationlossesarisingnotjustfromdefaultprobabilitiesandlossin

theeventofdefault,butalsofromthefullrangeofpotentialriskfactors(including

liquidityandpricevolatility).

c. Regulatorsshouldencouragethedevelopmentofpaymentmodelsthatimprovethe

alignmentofincentivesamongtheprovidersofriskratingsandtheirclientsandusers,

andpermituserstoholdNRSROsaccountableforthequalityoftheirworkproduct.

infrastructure Developments

Theeventsof2008haveunderscoredtheimportanceofastronginfrastructureforthe

financialsystem—onethatkeepspacewiththeinnovationsandnewmarketsthatarepart

ofmodernfinance.AsFederalReserveBoardChairmanBenBernankehaspointedout,

thereareboth“hardware”elements(thatis,systemsforexecution,clearingandsettle-

ment,andsoforth)and“software”elements(thatis,statutory,regulatory,andcontractual

frameworks)totheinfrastructure.Significantweaknesseshavebeenexposedinboththese

aspectsofthesystem’sinfrastructure.

Thefinalthreerecommendationsthatfollowcoverthreeareasforinfrastructureim-

provement:OTCmarketchanges,legalresolutionmechanismsforfinancialinstitutions,

andinfrastructureinsupportoftransparencyinthemarketsforstructuredproducts.

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15. oversight of Credit Default Swaps (CDS) and over-the-Counter (otC) markets

ThiscrisishasexposedseriousshortcomingsintheinfrastructureinsupportoftheOTC

derivativesmarkets.Whilesomeofthoseshortcomingsmaybeviewedasconductof

businessormarketintegrityissues,severalproblemshavereachedascalethathasraised

systemicdisruptionissues.Theseproblemsincludetradeconfirmationbacklogs,lackof

transparencyontransactionreportingandpricing,contractcloseoutprocedures,valuation

practicesandcollateraldisputes,anddirectandindirectcounterpartycreditissues.Most

oftheseissueseitherdonotariseoraregenerallywellmanagedwithintheexchange-based

derivativemarkets.

Underpressurefromvariousregulatorybodies,theleadingfirmsinthesemarketshave

beenworkingcloselyonacomprehensiveprogramtoaddresstheseinfrastructureweak-

nesses.Prominentwithinthatprogramareeffortstoestablishacentralcounterpartyclear-

ing(CCP)arrangementforthecreditderivativesmarketandcoordinatedeffortstogreatly

Box 4 regulation of the otC Derivatives markets

The following five points outline the nature and scope of proposed regulation of the over-the-counter (OTC) derivatives markets.

1. The appropriate national regulator should have the authority to promulgate rules applicable to market participation to promote sound practices and mitigate systemic risk in relation to credit default swaps (CDSs) and other OTC derivatives, including rules regarding sound risk manage-ment practices, trade reporting and confirmation standards, appropriate counterparty collateral requirements, contract closeout practices, and other measures needed to achieve market trans-parency.

2. Persons subject to regulation would include: those engaged in making two-sided markets in CDS or other OTC derivatives or who are engaged in the business of providing credit protection through CDS and whose activities reach a systemically significant threshold (to be established by the regulator), nonintermediaries whose OTC derivatives portfolios reach a systematically signifi-cant threshold (to be established by the regulator), and an OTC derivatives clearinghouse.

3. A professional intermediary in OTC derivatives would be required to be already regulated as a bank or must register with the regulator as a professional intermediary.

4. The regulator should promulgate rules requiring the reporting of large positions in OTC deriva-tives and related large counterparty credit exposure by both intermediaries and nonintermediar-ies.

5. The regulator should promulgate rules with respect to multilateral clearing organizations that clear OTC derivatives transactions other than on a securities or futures exchange to ensure the financial integrity of such clearing organizations and to mitigate systemic risk, promote reliable clearance and settlement, sound risk management practices, and market transparency.

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reducethegrosssizeofoutstandingcontractsthroughbilateralcompressionarrangements.

Significantprogresshasbeenmadeonthesefronts.Furtherprogresstowardstandardiza-

tionanduseofCCPmechanismsshouldbeencouraged,ifneedbewith

regulatorycapitalrequirementsthatbearmoreheavilyoninstrumentsthatarenotcleared

throughaCCP.

Whiletheseeffortsmaywellresultinadequatesolutionstothemostpressingexisting

problems,thebroaderpolicyquestionsregardingtheappropriateregulatorystatusofthese

marketsremainopen.Formostofthepast30years,themarketsdevelopedinsomething

ofaregulatoryvacuum,beingregardedlegallyasneithersecuritiesnorfuturescontracts.

Innovationswerewidespreadandthemarketsgrewexplosively,suggestingthat,beyond

servingavaluablerisktransferfunction,alargespeculativeelementhasemerged.

Asthesemarketshavegrownincomplexityandsizetodwarftheverycashmarketsto

whichtheyarerelated,thescaleofinfrastructure,credit,valuation,andtransparencyprob-

lemshaveloomedlarge.Pressureoncentralbanksandotherregulatorstodealwiththese

problemshasgrown.

Ithaslongbeenrecognizedthattheverysameeconomicriskcanbetakenonortrans-

ferredbyacombinationofsecurities,futurescontracts,orOTCderivatives.Yet,depending

ontheinstrumentused,vastlydifferentrules,oversightarrangements,andinfrastructure

supportmechanismsapply.WhilethismayhavemadepublicpolicysensewhentheOTC

derivativesmarketswereintheirearlystagesofdevelopment,thejustificationnolonger

exists.Thetimehascometoharmonizestandardsandpracticesacrosstheseinstrument

markets.Thetimehasalsocometomovebeyondmoralsuasionandenlightenedmarket

self-interesttoensurethatmarketpracticesdevelopinatimely,healthy,andcomprehensive

fashion.ApossiblesystemofregulationshouldincludetheelementslistedinBox4.

recommendation 15:

a. Much-neededplannedimprovementstotheinfrastructuresupportingtheOTC

derivativesmarketsshouldbefurthersupportedbylegislationtoestablishaformal

systemofregulationandoversightofsuchmarkets.

b.Giventheglobalnatureofthemarket,itisessentialthattherebeaconsistentregula-

toryframeworkonaninternationalscale,andnationalregulatorsshouldshareinfor-

mationandenterintoappropriatecooperativearrangementswithauthoritiesofother

countriesresponsibleforoverseeingactivities.

16. a resolution mechanism for financial institutions

Marketdisciplineworksbestinasysteminwhichfailurescanhappenwithoutbeinga

sourceofmajordisruptionandcontagion.Thatcanonlyhappenwithlarge,complexfinan-

cialfirmsiftheinfrastructureandrelatedmarketmechanismsthathavetooperateinthe

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faceoffailuresarerobust,transparent,andpermittimelybutnotforcedactionsonthepart

ofcreditorsandothercounterpartiestoprotecttheirinterest.

IntheUnitedStates,existinglegalmechanismsformanagingbankfailures,whilenot

perfect,haveproventobeworkable.Theproblemshaveariseninthecontextofpotential

andactualfailuresoflargenon-bankfinancialinstitutions.Specifically,theinterventionto

preventthefailureofBearSterns,thebankruptcyfilingsofLehmanBrothers,andother

interventionsdemonstratethatthereisaneedtoestablishaneffectivefailureresolution

regimeforlargenon-bankfinancialinstitutions.Partofthatcanbeaddressedbyimprove-

mentstotheinfrastructureoftheOTCderivativesmarkets.Partofitcanalsobeaddressed

byclosingthegapsinconsolidatedprudentialoversightoflargeregulatednon-bank

financialinstitutions.Buttobefullyeffective,thelegalregimesthatoperateoncefailureis

triggeredshouldbemodified,withaviewtoplacingprimaryimportanceonthecapacity

oftheauthoritiestotakeactionstoprotectthehealthofthesystem.Arelatedconcernis

thegeneralframeworkforhandlingqualifiedfinancialcontractsintheUnitedStates,which

mustbereconsideredinlightofrecentevents.

Insomecountries,alegalframeworktoprovidefortheorderlyclosingofregulated

banksisnotyetfullyinplace,letaloneaframeworkforsystemicallysignificantnon-

bankfinancialinstitutions.Adesirableframeworkshouldprovidefor:(a)continuityof

operationsandserviceaccessfordepositorsandotherclients,(b)appropriatediscretion

forreceiversformanagingpaymentpriorities,(c)discretiontoimposecostappropriately

withinthecapitalstructureandonexecutivemanagementtoreducemoralhazard,and(d)

appropriatefinancialflexibilityfortheregulator/receivertoprovidefortimelytransferof

financialassetsandliabilitiesandpromptaccessofclientstoproperlysegregatedassetsand

accounts.

Afurthercomplicationthatmustbeconsidered—bothintheUnitedStatesandother

jurisdictions—relatestoapotentialfailureofalarge,leveragedhedgefundorgroupof

relatedfunds,wherethefundsinquestionaredomiciledinanoffshorecenter.Thebank-

ruptcyandgovernanceregimesofsuchcentersmaybeatoddswiththepublicinterestof

thecountriesinwhosemarketsthefundsactuallyoperateintermsofcontainingtheimpact

offailuresonthesystem.Oncesuchfundsandmanagersarebroughtunderaformalregu-

latorysystem,theappropriatenationalregulatorshouldrequireananalysisofthisissue

forthelargestfunds.Theregulatorshouldhavetheauthoritytorequirethemanagerofthe

fundsinquestiontomodifyexistinglegalarrangementstoprovideforanacceptablelegal

regimeforgovernanceandpotentialbankruptcyliquidations.

recommendation 16:

a. Incountrieswherethisisnotalreadythecase,alegalregimeshouldbeestablishedto

provideregulatorswithauthoritytorequireearlywarning,promptcorrectiveactions,

andorderlyclosingsofregulatedbankingorganizations,andothersystemically

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Financial ReFoRm A Framework for Financial Stability ��

significantregulatedfinancialinstitutions.IntheUnitedStates,legislationshould

establishaprocessformanagingtheresolutionoffailednon-depositoryfinancial

institutions(includingnon-bankaffiliateswithinabankholdingcompanystructure)

comparabletotheprocessfordepositoryinstitutions.

b.Theregimefornon-depositoryfinancialinstitutionsshouldapplyonlytothosefew

organizationswhosefailuremightreasonablybeconsideredtoposeathreattothe

financialsystemandthereforesubjecttoofficialregulation.

c. Aregulatorybodyhavingpowerscomparabletothoseavailablefortheresolution

ofbankinginstitutionsshouldbeempoweredtoactasareceiverorconservatorof

afailednon-depositoryorganizationandtoplacetheorganizationinliquidationor

takeactiontorestoreittoasoundandsolventcondition.

d.Thespecialtreatmentaccordedtovariousformsoffinancialcontractsundercurrent

U.S.lawshouldbeexaminedinlightofrecentexperience,withaviewtowardresolv-

ingclaimsunderthesecontractsinamannerleastdisruptivetothefinancialsystem.

17. improving transparency of Structured Product markets

Disclosurestandardsinasset-backedandotherstructuredfixed-incomemarketsneedto

bereexaminedandenhanced.Publicinterestinensuringadequatedisclosuretotheinves-

torsintheprivateorwholesalemarketsforasset-backedandotherstructuredfixed-income

productsshouldberecognizedbyregulators.Atpresent,informationthatislikelytobe

significantisnotgenerallyavailable,andthisneedstobeaddressed.

Onceappropriatenewdisclosurestandardshavebeenagreed,thisinformationshould

beprovidedinamannerthatiscomparableandfacilitatesanalysisovertimeandacross

transactions.Satisfyingthisobjectivewillrequirethatinformationbepresentedinamore

consistentandstructuredformatthaniscurrentlythecase.Atpresent,financialinforma-

tionforcorporateissuersisprovidedinasubstantiallystructuredmannerunderthecontent

andpresentationrequirementofgenerallyacceptedaccountingprinciples.However,there

arenoanalogouscontentandpresentationrequirementsforasset-backedandotherstruc-

turedproducts.

recommendation 17:

a. Thedisclosureanddisseminationregimeforasset-backedandotherstructuredfixed-

incomefinancialproducts(includingsecuritiesandotherfinancialproducts)inthe

publicandprivatemarketsshouldbeenhanced.

b.Theappropriatenationalregulatorshould,inconjunctionwithinvestors,determine

whatinformationismaterialtoinvestorsintheseproductsandshouldconsideren-

hancingexistingrulesoradoptnewrulesthatensuredisclosureofthatinformation,

forbothasset-backedandsyntheticstructuredproducts.

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Financial ReFoRm A Framework for Financial Stability�6

c. Theappropriatenationalregulatorshouldconditiontransactionsintheprivateand

wholesalemarketsonsatisfactionofappropriateinformationdisclosurestandards.

18. Sharing market activity and Valuation information

Publicpolicyconsiderationshavegenerallysupportedtheimportanceofcompetingchan-

nelsfortradingexecutioninfinancialmarketssubjecttosomebasicminimumpublic

marketstandards.Exchange-basedexecutionmechanisms,andbroadlycomparableelec-

tronicexecutionfacilities,aretypicallycharacterizedbyhighdegreesoftransparencyand

pricediscovery.Lesserstandardsapplyinvarioussegmentsoftheover-the-countermarkets,

insomecasestosuchadegreethatthemarketsarebetterdescribedasopaqueratherthan

transparent.

recommendation 18:

Effortstorestoreinvestorconfidenceintheworkingsofthesemarketssuggestaneedtore-

visitevaluationsofthecostsandbenefitsofinfrastructureinvestmentsthatwouldfacilitate

amuchhigherleveloftransparencyaroundactivitylevels,tradedprices,andrelatedvalua-

tions.Partofthecostsofsuchchangesistheimpactonfirm-specificconcernsregardingthe

privatenatureoftheirmarketactivity.Theseconcerns,anddirectinvestmentcosts,needto

beweighedagainstthepotentialbenefitsofhigherlevelsofmarkettransparency.

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paRT 6 Concluding Comment

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Intheyearahead,policymakerswillbefacedwithanextraordinarysetofchallenges.The

financialcrisishasyettofullyrunitscourse.Financialmarketsandinstitutionshaveyetto

reengageinahealthyprocessofriskintermediation.Realeconomiesaroundtheworldare

experiencingsharpcontraction,whichislikelytoleadtoadditionalcreditdefaults.Gov-

ernmentsandcentralbanksarestretchingtotheirlimitswithprogramstostabilizeboth

financialsystemsandrealeconomies.

Initiativestoaddresstheseimmediatechallengesmusttakeprecedenceovereventhe

mostpressingagendasforfinancialregulatoryreform.Moreover,untilthefullcostsofthe

currentcrisisareknown—includingthefinancialcostsfromitseconomicfallout—therewill

notbeclarityontheextentofneededreformsandasensibletimetableforimplementing

themandforrollingbackofgreatlyextendedsafetynets.

Theviewsandrecommendationssetforthhererepresentanassessment,atoneparticu-

larpointinthecrisis,astotheneededelementsofacomprehensivefinancialreformplan.

Thesesuggestionsfocusprimarilyonfinancialstabilityconsiderationsanddonotcoverin

anydetailotherpotentialneededchangesinbusinesspractice,inmarketoradministrative

structure,orincompetitionpolicies.

Thisreportshouldbereadincombinationwiththepriorextensiveprivatesectorand

publicsectorreformproposalsreferredtoinourreport.Policymakersshouldhavean

extensivesetofproposalsforframingtheissuesinvolvedintheneededcomprehensive

overhaulofthenationalandinternationalfinancialsystemsandsuggestingappropriatere-

form.ThesereformsarelikelytobemoreextensiveandimportantthananysincetheGreat

Depression.

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��

appendix

liSt of reCommenDationS

Core reCommenDation igaps and weaknesses in the coverage of prudential regulation and supervision must be eliminated. Allsystemicallysignificantfinancialinstitutions,regardlessoftype,

mustbesubjecttoanappropriatedegreeofprudentialoversight.

Prudential regulation and Supervision of Banking organizations

recommendation 1:

a. Inallcountries,theactivitiesofgovernment-insureddeposit-takinginstitutionsshould

besubjecttoprudentialregulationandsupervisionbyasingleregulator(thatis,con-

solidatedsupervision).Thelargestandmostcomplexbankingorganizationsshould

besubjecttoparticularlycloseregulationandsupervision,meetinghighandcommon

internationalstandards.

b.Large,systemicallyimportantbankinginstitutionsshouldberestrictedinundertak-

ingproprietaryactivitiesthatpresentparticularlyhighrisksandseriousconflictsof

interest.Sponsorshipandmanagementofcommingledprivatepoolsofcapital(that

is,hedgeandprivateequityfundsinwhichthebankinginstitutionsowncapitalis

commingledwithclientfunds)shouldordinarilybeprohibitedandlargeproprietary

tradingshouldbelimitedbystrictcapitalandliquidityrequirements.Participation

inpackagingandsaleofcollectivedebtinstrumentsshouldrequiretheretentionofa

meaningfulpartofthecreditrisk.

c. Ingeneral,government-insureddeposit-takinginstitutionsshouldnotbeownedand

controlledbyunregulatednon-financialorganizations,andstrictlimitsshouldbe

imposedondealingsamongsuchbankinginstitutionsandpartialnon-bankowners.

d.Toguardagainstexcessiveconcentrationinnationalbankingsystems,withimplica-

tionsforeffectiveofficialoversight,managementcontrol,andeffectivecompetition,

nationwidelimitsondepositconcentrationshouldbeconsideredatalevelappropri-

atetoindividualcountries.

Consolidated Supervision of non-Bank financial institutions

recommendation 2:

a. Forthosecountrieslackingsucharrangements,aframeworkfornational-levelcon-

solidatedprudentialregulationandsupervisionoverlargeinternationallyactiveinsur-

ancecompaniesshouldbeestablished.

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Financial ReFoRm A Framework for Financial Stability60

b.Anappropriateprudentialregulatorshouldbedesignatedforthoselargeinvestment

banksandbroker-dealersthatarenotorganizedasbankholdingcompanies.

money market mutual funds and Supervision

recommendation 3:

a. Moneymarketmutualfundswishingtocontinuetoofferbank-likeservices,such

astransactionaccountservices,withdrawalsondemandatpar,andassurancesof

maintainingastablenetassetvalue(NAV)atparshouldberequiredtoreorganizeas

special-purposebanks,withappropriateprudentialregulationandsupervision,gov-

ernmentinsurance,andaccesstocentralbanklender-of-last-resortfacilities.

b.Thoseinstitutionsremainingasmoneymarketmutualfundsshouldonlyofferacon-

servativeinvestmentoptionwithmodestupsidepotentialatrelativelylowrisk.The

vehiclesshouldbeclearlydifferentiatedfromfederallyinsuredinstrumentsofferedby

banks,suchasmoneymarketdepositfunds,withnoexplicitorimplicitassurancesto

investorsthatfundscanbewithdrawnondemandatastableNAV.Moneymarketmu-

tualfundsshouldnotbepermittedtouseamortizedcostpricing,withtheimplication

thattheycarryafluctuatingNAVratherthanonethatispeggedatUS$1.00pershare.

oversight of Private Pools of Capital

recommendation 4:

a. Managersofprivatepoolsofcapitalthatemploysubstantialborrowedfundsshould

berequiredtoregisterwithanappropriatenationalprudentialregulator.There

shouldbesomeminimumsizeandventurecapitalexemptionsfromsuchregistration

requirement.

b.Theprudentialregulatorofsuchmanagersshouldhaveauthoritytorequireperiodic

regulatoryreportsandpublicdisclosuresofappropriateinformationregardingthe

size,investmentstyle,borrowing,andperformanceofthefundsundermanagement.

Sinceintroductionofevenamodestsystemofregistrationandregulationcancreate

afalseimpressionoflowerinvestmentrisk,disclosure,andsuitabilitystandardswill

havetobereevaluated.

c.Forfundsaboveasizejudgedtobepotentiallysystemicallysignificant,theprudential

regulatorshouldhaveauthoritytoestablishappropriatestandardsforcapital,liquid-

ity,andriskmanagement.

d.Forthesepurposes,thejurisdictionoftheappropriateprudentialregulatorshouldbe

basedontheprimarybusinesslocationofthemanagerofsuchfunds,regardlessof

thelegaldomicileofthefundsthemselves.Giventheglobalnatureofthemarketsin

whichsuchmanagersandfundsoperate,itisimperativethataregulatoryframework

beappliedonaninternationallyconsistentbasis.

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Financial ReFoRm A Framework for Financial Stability 61

government-Sponsored enterprises (gSes)

recommendation 5:

a.FortheUnitedStates,thepolicyresolutionoftheappropriateroleofGSEsinmort-

gagefinanceshouldbebasedonaclearseparationofthefunctionsofprivatesector

mortgagefinanceriskintermediationfromgovernmentsectorguaranteesorinsurance

ofmortgagecreditrisk.

b.Governmentalentitiesprovidingsupportforthemortgagemarketbymeansofmarket

purchasesshouldhaveexplicitstatutorybackingandfinancialsupport.Hybridsof

privateownershipwithgovernmentsponsorshipshouldbeavoided.Intime,existing

GSEmortgagepurchasingandportfolioactivitiesshouldbespunofftoprivatesector

entities,withthegovernment,ifitdesires,maintainingacapacitytointerveneinthe

marketthroughawhollyownedpublicinstitution.

Core reCommenDation iithe quality and effectiveness of prudential regulation and supervision must be improved. Thiswillrequirebetter-resourcedprudentialregulatorsandcentralbanks

operatingwithinstructuresthataffordmuchhigherlevelsofnationalandinternational

policycoordination.

regulatory Structure

recommendation 6:

a.Countriesshouldreevaluatetheirregulatorystructureswithaviewtoeliminatingun-

necessaryoverlapsandgapsincoverageandcomplexity,removingthepotentialfor

regulatoryarbitrage,andimprovingregulatorycoordination.

b.Inallcases,countriesshouldexplicitlyreaffirmtheinsulationofnationalregulatory

authoritiesfrompoliticalandmarketpressuresandreassesstheneedforimproving

thequalityandadequacyofresourcesavailabletosuchauthorities.

role of the Central Bank

recommendation 7:

a. Wherenotalreadythecase,centralbanksshouldacceptaroleinpromotingand

maintainingfinancialstability.Theexpectationshouldbethatconcernsforfinancial

stabilityarerelevantnotjustintimesoffinancialcrisis,butalsointimesofrapid

creditexpansionandincreaseduseofleveragethatmayleadtocrises.

b.Incountrieswherethecentralbankisnottheprudentialregulator,thecentralbank

shouldhave:(i)astrongroleonthegoverningbodyoftheprudentialandmarkets

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Financial ReFoRm A Framework for Financial Stability62

regulator(s);(ii)aformalreviewrolewithrespecttoproposedchangesinkeypruden-

tialpolicies,especiallycapitalandliquiditypoliciesandmarginarrangements;and(iii)

asupervisoryroleinregardtothelargestsystemicallysignificantfirms,andcritical

paymentandclearingsystems.

c. Asharpdistinctionshouldbemaintainedbetweenthoseregulatedbankingorganiza-

tionswithnormalaccesstocentralbankliquidityfacilitiesandothertypesoffinancial

institutionswhoseaccess,ifany,shouldbelimitedtoextremeemergencysituationsof

criticalsystemicimportance.

d.Centralbankemergencylendingauthorityforhighlyunusualandexigentcircum-

stancesshouldbepreserved,butshouldinclude,bylaworpractice,supportbyap-

propriatepoliticalauthoritiesfortheuseofsuchauthorityinextendingsuchcreditto

non-bankinstitutions.

e. Centralbankliquiditysupportoperationsshouldbelimitedtoformsthatdonot

entaillendingagainstortheoutrightpurchaseofhigh-riskassets,orotherformsof

long-termdirectorindirectcapitalsupport.Inprinciple,thoseformsofsupportare

moreappropriatelyprovidedbydirectlyaccountablegovernmententities.Inpractice,

totheextentthecentralbankistheonlyentitywiththeresourcesandauthoritytoact

quicklytoprovidethisformofsystemicsupport,thereshouldbesubsequentapproval

ofanappropriategovernmentalentitywiththeconsequentrisktransfertothatentity.

international Coordination

recommendation 8:

a. Nationalregulatoryauthoritiesandfinanceministersarestronglyencouragedto

adaptandenhanceexistingmechanismsforinternationalregulatoryandsupervisory

coordination.Thefocusofneededenhancementsshouldbeto:(i)bettercoordinate

oversightofthelargestinternationalbankingorganizations,withmoretimelyand

openinformationsharing,andgreaterclarityonhomeandhostresponsibilities,in-

cludingincrisismanagement;(ii)movebeyondcoordinatedrulemakingandstandard

settingtotheidentificationandmodificationofmaterialnationaldifferencesinthe

applicationandenforcementofsuchstandards;(iii)closeregulatorygapsandraise

standards,whereneeded,withrespecttooffshorebankingcenters;and(iv)develop

themeansforjointconsiderationofsystemicriskconcernsandthecyclicalityimplica-

tionsofregulatoryandsupervisorypolicies.Theappropriateagenciesshouldstrength-

entheiractionsinmembercountriestopromoteimplementationandenforcementof

internationalstandards.

b.Giventherecurringimportanceofexcessiveleverageasacontributingfactorto

financialdisruptions,andtheincreasinglycomplexwaysinwhichleveragecanbe

employedonandoffbalancesheets,prudentialregulatorsandcentralbanksshould

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Financial ReFoRm A Framework for Financial Stability 6�

collaboratewithinternationalagenciesinanefforttodefineleverageandthencollect

andreportdataonthedegreeofleverageandmaturityandliquiditymismatchesin

variousnationalsystemsandmarkets.

c. Totheextentnewinternationalregulatoryorganizationsareultimatelyneeded,the

initialfocusshouldbeondevelopingmoreformalregionalmechanisms,suchasinthe

EuropeanUnion,butwithcontinuedattentivenesstotheglobaldimensionofmost

significantfinancialmarkets.

Core reCommenDation iiiinstitutional policies and standards must be strengthened, with particular emphasis on standards for governance, risk management, capital, and liquidity. Regulatorypoliciesandaccountingstandardsmustalsoguardagainstprocyclicaleffects

andbeconsistentwithmaintainingprudentbusinesspractices.

regulatory Standards for governance and risk management

recommendation 9:

Regulatorystandardsforgovernanceandriskmanagementshouldberaised,withparticu-

laremphasison:

a. Strengtheningboardsofdirectorswithgreaterengagementofindependentmembers

havingfinancialindustryandriskmanagementexpertise;

b.Coordinatingboardoversightofcompensationandriskmanagementpolicies,with

theaimofbalancingrisktakingwithprudenceandthelong-runinterestsofand

returnstoshareholders;

c. Ensuringsystematicboard-levelreviewsandexercisesaimedatestablishingthemost

importantparametersforsettingthefirm’srisktoleranceandevaluatingitsriskpro-

filerelativetothoseparameters;

d.Ensuringtheriskmanagementandauditingfunctionsarefullyindependentand

adequatelyresourcedareasofthefirm.Theriskmanagementfunctionshouldreport

directlytothechiefexecutiveofficerratherthanthroughtheheadofanotherfunc-

tionalarea;

e. Conductingperiodicreviewsofafirm’spotentialvulnerabilitytoriskarisingfrom

creditconcentrations,excessivematuritymismatches,excessiveleverage,orunduereli-

anceonassetmarketliquidity;

f. Ensuringthatalllargefirmshavethecapacitytocontinuouslymonitor,withinamat-

terofhours,theirlargestcounterpartycreditexposuresonanenterprisewidebasis

andtomakethatinformationavailable,asappropriate,toitsseniormanagement,its

board,anditsprudentialregulatorandcentralbank;

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Financial ReFoRm A Framework for Financial Stability6�

g. Ensuringindustrywideacceptanceofandactiononthemanyspecificriskmanage-

mentpracticeimprovementscontainedinthereportsoftheCounterpartyRiskMan-

agementPolicyGroup(CRMPG)andtheInstituteofInternationalFinance.

regulatory Capital Standards

recommendation 10:

a. Internationalregulatorycapitalstandardsshouldbeenhancedtoaddresstendencies

towardprocyclicality.Benchmarksforbeingwellcapitalizedshouldberaised,given

thedemonstrablelimitationsofeventhemostadvancedtoolsforestimatingfirmwide

risk.

b.Thesebenchmarksshouldbeexpressedasabroadrangewithinwhichcapitalratios

shouldbemanaged,withtheexpectationthat,aspartofsupervisoryguidance,firms

willoperateattheupperendofsucharangeinperiodswhenmarketsareexuberant

andtendenciesforunderestimatingandunderpricingriskaregreat.

c. Theexistinginternationaldefinitionsofcapitalshouldbereevaluated,lookingtoward

closealignmentonnationaldefinitions.

d.Capitalandriskdisclosurestandardsshouldbereevaluatedtoprovideahigherdegree

oftransparencyofafirm’sriskappetite,itsestimatedneedsforandallocationofeco-

nomiccapital,anditsvaluationpractices.

Standards for liquidity risk management

recommendation 11:

a. Base-levelliquiditystandardsshouldincorporatenormsformaintainingasizable

diversifiedmixoflong-termfundingandanavailablecushionofhighlyliquidunen-

cumberedassets.Oncesuchstandardsaredeveloped,considerationshouldbegivento

whatisthepreferredmixofseniorandsubordinateddebtinbankcapitalstructures.

b.Supervisoryguidanceforliquiditystandardsshouldbebasedonamorerefinedanaly-

sisofafirm’scapacitytomaintainampleliquidityunderstressconditions,including

evaluationofthequalityandeffectivenessofitsliquiditymanagementpoliciesand

contingencyfundingplan.

c. Liquiditydisclosurestandards,buildingonthesuggestedpracticesintheBaselCom-

mitteePrinciples,shouldcomplementthesuggestedimproveddisclosurepracticesfor

capitalandriskprofileinformation.

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Financial ReFoRm A Framework for Financial Stability 6�

fair Value accounting

recommendation 12:

a. Fairvalueaccountingprinciplesandstandardsshouldbereevaluatedwithaview

todevelopingmorerealisticguidelinesfordealingwithlessliquidinstrumentsand

distressedmarkets.

b.Thetensionbetweenthebusinesspurposeservedbyregulatedfinancialinstitutions

thatintermediatecreditandliquidityriskandtheinterestsofinvestorsandcreditors

shouldberesolvedbydevelopmentofprinciples-basedstandardsthatbetterreflectthe

businessmodeloftheseinstitutions,applyappropriaterigortovaluationandevalu-

ationofintent,andrequireimproveddisclosureandtransparency.Thesestandards

shouldalsobereviewedby,andcoordinatedwith,prudentialregulatorstoensure

applicationinafashionconsistentwithsafeandsoundoperationofsuchinstitutions.

c. Accountingprinciplesshouldalsobemademoreflexibleinregardtotheprudential

needforregulatedinstitutionstomaintainadequatecreditlossreservessufficientto

coverexpectedlossesacrosstheirportfoliosoverthelifeofassetsinthoseportfolios.

Thereshouldbefulltransparencyofthemannerinwhichreservesaredeterminedand

allocated.

d.AsemphasizedinthethirdreportoftheCRMPG,underanyandallstandardsof

accountingandunderanyandallmarketconditions,individualfinancialinstitutions

mustensurethatwhollyadequateresources,insulatedbyfail-safeindependentdeci-

sion-makingauthority,areatthecenterofthevaluationandpriceverificationprocess.

Core reCommenDation iV financial markets and products must be made more transparent, with better-aligned risk and prudential incentives. the infrastructure supporting such markets must be made much more robust and resistant to potential failures of even large financial institutions.

restoring Confidence in Securitized Credit markets

recommendation 13:

a. MarketSupervision:Extensiveinnovationinthecapitalmarketsandtherapidgrowth

ofsecuritizationmakeitimperativethatsecuritizedandotherstructuredproductand

derivativesmarketsbeheldtoregulatory,disclosure,andtransparencystandardsat

leastcomparabletothosethathavehistoricallybeenappliedtothepublicsecurities

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Financial ReFoRm A Framework for Financial Stability66

markets.Thismayrequirethatabroaderrangeofmarketsbemonitored,thatthere

beadequatetransparencyastotransactionvolumesandholdingsacrossallproducts,

andthatbothcreditandleverageelementsofeachproductbethoroughlyunderstood

andmonitored.

b.CreditUnderwritingStandards:Thehealthyredevelopmentofsecuritizedcreditmar-

ketsrequiresarestorationofmarketconfidenceintheadequacyandsustainabilityof

creditunderwritingstandards.Tohelpachievethis,regulatorsshouldrequireregu-

latedfinancialinstitutionstoretainameaningfulportionofthecreditrisktheyare

packagingintosecuritizedandotherstructuredcreditproducts.

c. Off-Balance-SheetVehicles:Pendingaccountingrulechangesfortheconsolidation

ofmanytypesofoff-balance-sheetvehiclesrepresentapositiveandneededimprove-

ment.Itisimportant,beforetheyarefullyimplemented,thatcarefulconsiderationbe

giventohowtheserulesarelikelytoimpacteffortstorestoretheviabilityofsecuri-

tizedcreditmarkets.

rating agency reforms

recommendation 14:

RegulatorypolicieswithregardtoNationallyRecognizedSecuritiesRatingOrganizations

(NRSROs)andtheuseofratingsshouldberevised,preferablyonaninternationallycoordi-

natedbasis,toachievethefollowing:

a. Usersofriskratings,mostimportantlyregulatedusers,shouldbeencouragedtore-

storeoracquirethecapacityforindependentevaluationsoftheriskofcreditproducts

inwhichtheyareinvesting.

b.RiskratingsissuedbytheNRSROsshouldbemademorerobust,toreflecttherisk

ofpotentialvaluationlossesarisingnotjustfromdefaultprobabilitiesandlossinthe

eventofdefault,butalsofromthefullrangeofpotentialriskfactors(includingliquid-

ityandpricevolatility).

c. Regulatorsshouldencouragethedevelopmentofpaymentmodelsthatimprovethe

alignmentofincentivesamongtheprovidersofriskratingsandtheirclientsandusers,

andpermituserstoholdNRSROsaccountableforthequalityoftheirworkproduct.

the oversight of Credit Default Swaps (CDS) and over-the-Counter (otC) markets

recommendation 15:

a. Much-neededplannedimprovementstotheinfrastructuresupportingtheOTCderiva-

tivesmarketsshouldbefurthersupportedbylegislationtoestablishaformalsystem

ofregulationandoversightofsuchmarkets.

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Financial ReFoRm A Framework for Financial Stability 6�

b.Giventheglobalnatureofthemarket,itisessentialthattherebeaconsistentregula-

toryframeworkonaninternationalscale,andnationalregulatorsshouldshareinfor-

mationandenterintoappropriatecooperativearrangementswithauthoritiesofother

countriesresponsibleforoverseeingactivities.

a resolution mechanism for financial institutions

recommendation 16:

a. Incountrieswherethisisnotalreadythecase,alegalregimeshouldbeestablishedto

provideregulatorswithauthoritytorequireearlywarning,promptcorrectiveactions,

andorderlyclosingsofregulatedbankingorganizations,andothersystemicallysignif-

icantregulatedfinancialinstitutions.IntheUnitedStates,legislationshouldestablish

aprocessformanagingtheresolutionoffailednon-depositoryfinancialinstitutions

(includingnon-bankaffiliateswithinabankholdingcompanystructure)comparable

totheprocessfordepositoryinstitutions.

b.Theregimefornon-depositoryfinancialinstitutionsshouldapplyonlytothosefew

organizationswhosefailuremightreasonablybeconsideredtoposeathreattothe

financialsystemandthereforesubjecttoofficialregulation.

c. Aregulatorybodyhavingpowerscomparabletothoseavailablefortheresolution

ofbankinginstitutionsshouldbeempoweredtoactasareceiverorconservatorof

afailednon-depositoryorganizationandtoplacetheorganizationinliquidationor

takeactiontorestoreittoasoundandsolventcondition.

d.Thespecialtreatmentaccordedtovariousformsoffinancialcontractsundercurrent

U.S.lawshouldbeexaminedinlightofrecentexperience,withaviewtowardresolv-

ingclaimsunderthesecontractsinamannerleastdisruptivetothefinancialsystem.

improving transparency of Structured Product markets

recommendation 17:

a. Thedisclosureanddisseminationregimeforasset-backedandotherstructuredfixed-

incomefinancialproducts(includingsecuritiesandotherfinancialproducts)inthe

publicandprivatemarketsshouldbeenhanced.

b.Theappropriatenationalregulatorshould,inconjunctionwithinvestors,determine

whatinformationismaterialtoinvestorsintheseproductsandshouldconsideren-

hancingexistingrulesoradoptnewrulesthatensuredisclosureofthatinformation,

forbothasset-backedandsyntheticstructuredproducts.

c. Theappropriatenationalregulatorshouldconditiontransactionsintheprivateand

wholesalemarketsonsatisfactionofappropriateinformationdisclosurestandards.

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Financial ReFoRm A Framework for Financial Stability6�

Sharing market activity and Valuation information

recommendation 18:

Effortstorestoreinvestorconfidenceintheworkingsofthesemarketssuggestaneedtore-

visitevaluationsofthecostsandbenefitsofinfrastructureinvestmentsthatwouldfacilitate

amuchhigherleveloftransparencyaroundactivitylevels,tradedprices,andrelatedvalua-

tions.Partofthecostsofsuchchangesistheimpactonfirm-specificconcernsregardingthe

privatenatureoftheirmarketactivity.Theseconcerns,anddirectinvestmentcosts,needto

beweighedagainstthepotentialbenefitsofhigherlevelsofmarkettransparency.

Page 71: G30 reformreport

6�

membeRs oF The gRoup oF ThiRTy

Paul A. VolckerChairmanoftheBoardofTrustees,GroupofThirtyFormerChairman,BoardofGovernorsoftheFederalReserveSystem

Jacob A. FrenkelChairman,GroupofThirtyViceChairman,AmericanInternationalGroupFormerGovernor,BankofIsrael

Geoffrey L. BellExecutiveSecretary,GroupofThirtyPresident,GeoffreyBell&Company,Inc.

Montek S. Ahluwalia DeputyChairman,PlanningCommissionofIndiaFormerDirector,IndependentEvaluationOffice,InternationalMonetaryFund

Abdulatif Al-HamadChairman,ArabFundforEconomicandSocialDevelopmentFormerMinisterofFinanceandMinisterofPlanning,Kuwait

Leszek BalcerowiczChairmanoftheBoard,BruegelProfessor,WarsawSchoolofEconomicsFormerPresident,NationalBankofPolandFormerDeputyPrimeMinisterandMinisterofFinance,Poland

Jaime CaruanaFinancialCounsellor,InternationalMonetaryFundFormerGovernor,BancodeEspañaFormerChairman,BaselCommitteeonBankingSupervision

Domingo CavalloChairmanandCEO,DFCAssociates,LLCFormerMinisterofEconomy,Argentina

E. Gerald CorriganManagingDirector,GoldmanSachsGroup,Inc.FormerPresident,FederalReserveBankofNewYork

Andrew D. CrockettPresident,JPMorganChaseInternationalFormerGeneralManager,BankforInternationalSettlements

Guillermo de la Dehesa RomeroDirectorandMemberoftheExecutiveCommittee,GrupoSantanderFormerDeputyManagingDirector,BancodeEspañaFormerSecretaryofState,MinistryofEconomyandFinance,Spain

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�0

Mario Draghi Governor,Bancad’ItaliaChairman,FinancialStabilityForumMemberoftheGoverningandGeneralCouncils,EuropeanCentralBankFormerViceChairmanandManagingDirector,GoldmanSachsInternational

Martin Feldstein ProfessorofEconomics,HarvardUniversityPresidentEmeritus,NationalBureauofEconomicResearchFormerChairman,CouncilofEconomicAdvisers

Roger W. Ferguson, Jr.ChiefExecutive,TIAA-CREFFormerChairman,SwissReAmericaHoldingCorporationFormerViceChairman,BoardofGovernorsoftheFederalReserveSystem

Stanley FischerGovernor,BankofIsraelFormerFirstManagingDirector,InternationalMonetaryFund

Arminio Fraga NetoPartner,GaveaInvestimentosFormerGovernor,BancodoBrasil

Timothy F. GeithnerPresidentandChiefExecutiveOfficer,FederalReserveBankofNewYorkFormerU.S.UndersecretaryofTreasuryforInternationalAffairs

Gerd HäuslerMemberoftheBoardofDirectorsandSeniorAdvisor,RHJInternationalFormerCounsellorandDirector,InternationalCapitalMarketsDepartment, InternationalMonetaryFundFormerManagingDirector,DresdnerBank

Philipp Hildebrand ViceChairmanoftheGoverningBoard,SwissNationalBankFormerPartner,MooreCapitalManagement

Mervyn King Governor,BankofEnglandFormerProfessorofEconomics,LondonSchoolofEconomics

Paul KrugmanProfessorofEconomics,WoodrowWilsonSchool,PrincetonUniversityFormerMember,CouncilofEconomicAdvisors

Guillermo Ortiz MartinezGovernor,BancodeMexicoFormerSecretaryofFinanceandPublicCredit,Mexico

Tommaso Padoa-SchioppaFormerMinisterofEconomyandFinance,ItalyFormerChairman,InternationalAccountingStandardsCommitteeFormerMemberoftheExecutiveBoard,EuropeanCentralBankFormerChairman,CONSOB

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�1

Kenneth Rogoff ThomasD.CabotProfessorofPublicPolicyandEconomics,HarvardUniversityFormerChiefEconomistandDirectorofResearch,IMF

Tharman Shanmugaratnam MinisterofFinance,SingaporeFormerManagingDirector,MonetaryAuthorityofSingapore

Lawrence Summers CharlesW.EliotUniversityProfessor,HarvardUniversityFormerPresident,HarvardUniversityFormerU.S.SecretaryoftheTreasury

Jean-Claude TrichetPresident,EuropeanCentralBankFormerGovernor,BanquedeFrance

David WalkerSeniorAdvisor,MorganStanleyInternational,Inc.FormerChairman,MorganStanleyInternational,Inc.FormerChairman,SecuritiesandInvestmentsBoard,UK

Zhou Xiaochuan Governor,People’sBankofChinaFormerPresident,ChinaConstructionBankFormerAsst.MinisterofForeignTrade

Yutaka YamaguchiFormerDeputyGovernor,BankofJapanFormerChairman,EuroCurrencyStandingCommission

Ernesto ZedilloDirector,YaleCenterfortheStudyofGlobalization,YaleUniversityFormerPresidentofMexico

Senior memBerS

William McDonoughViceChairmanandSpecialAdvisortotheChairman,MerrillLynchFormerChairman,PublicCompanyAccountingOversightBoardFormerPresident,FederalReserveBankofNewYork

William R. RhodesSeniorViceChairman,CitigroupChairman,PresidentandCEO,CiticorpandCitibank

Ernest SternPartnerandSeniorAdvisor,TheRohatynGroupFormerManagingDirector,JPMorganChaseFormerManagingDirector,WorldBank

Marina v N. WhitmanProfessorofBusinessAdministration&PublicPolicy,UniversityofMichiganFormerMember,CouncilofEconomicAdvisors

Page 74: G30 reformreport

�2

emerituS memBerS

Lord Richardson of Duntisbourne, KGHonoraryChairman,GroupofThirtyFormerGovernor,BankofEngland

Richard A. DebsAdvisoryDirector,MorganStanleyFormerPresident,MorganStanleyInternationalFormerCOO,FederalReserveBankofNewYork

Gerhard FelsFormerDirector,InstitutderdeutschenWirtschaft

Wilfried GuthFormerSpokesmenoftheBoardofManagingDirectors,DeutscheBankAG

Toyoo Gyohten President,InstituteforInternationalMonetaryAffairsFormerChairman,BankofTokyo

John G. HeimannSeniorAdvisor,FinancialStabilityInstituteFormerUSComptrolleroftheCurrency

Erik HoffmeyerFormerChairman,DanmarksNationalbank

Peter B. KenenSeniorFellowinInternationalEconomics,CouncilonForeignRelationsFormerWalkerProfessorofEconomics&InternationalFinance, DepartmentofEconomics,PrincetonUniversity

Jacques de LarosièreConseiller,BNPParibasFormerPresident,EuropeanBankforReconstructionandDevelopmentFormerManagingDirector,InternationalMonetaryFundFormerGovernor,BanquedeFrance

Shijuro OgataFormerDeputyGovernor,BankofJapanFormerDeputyGovernor,JapanDevelopmentBank

Sylvia OstryDistinguishedResearchFellowMunkCentreforInternationalStudies,TorontoFormerAmbassadorforTradeNegotiations,CanadaFormerHead,OECDEconomicsandStatisticsDepartment

Page 75: G30 reformreport

��

publicaTions oF The gRoup oF ThiRTy since 1��0

SPeCial rePortSTheStructureofFinancialSupervision:ApproachesandChallengesinaGlobalMarketplace G30 Financial Regulatory Systems Working Group. 2008

Global Clearing and Settlement: Final Monitoring Report Global Monitoring Committee. 2006

Reinsurance and International Financial Markets Reinsurance Study Group. 2006

Enhancing Public Confidence in Financial Reporting Steering & Working Committees on Accounting. 2004

Global Clearing and Settlement: A Plan of Action Steering & Working Committees of Global Clearing & Settlements Study. 2003

Derivatives: Practices and Principles: Follow-up Surveys of Industry Practice Global Derivatives Study Group. 1994

Derivatives: Practices and Principles, Appendix III: Survey of Industry Practice Global Derivatives Study Group. 1994

Derivatives: Practices and Principles, Appendix II: Legal Enforceability: Survey of Nine Jurisdictions Global Derivatives Study Group. 1993

Derivatives:PracticesandPrinciples,AppendixI:WorkingPapers Global Derivatives Study Group. 1993

Derivatives: Practices and Principles Global Derivatives Study Group. 1993

Clearance and Settlement Systems: Status Reports, Autumn 1992 Various Authors. 1992

Clearance and Settlement Systems: Status Reports, Year-End 1990 Various Authors. 1991

Conference on Clearance and Settlement Systems; London, March 1990: Speeches Various Authors. 1990

ClearanceandSettlementSystems:StatusReports,Spring1990 Various Authors. 1990

rePortSSharingtheGainsfromTrade:RevivingtheDohaRound Study Group Report. 2004

KeyIssuesinSovereignDebtRestructuring Study Group Report. 2002

ReducingtheRisksofInternationalInsolvency A Compendium of Work in Progress. 2000

Collapse:TheVenezuelanBankingCrisisof‘94 Ruth de Krivoy. 2000

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TheEvolvingCorporation:GlobalImperativesandNationalResponses Study Group Report. 1999

InternationalInsolvenciesintheFinancialSector Study Group Report. 1998

GlobalInstitutions,NationalSupervisionandSystemicRisk Study Group on Supervision and Regulation. 1997

LatinAmericanCapitalFlows:LivingwithVolatility Latin American Capital Flows Study Group. 1994

DefiningtheRolesofAccountants,BankersandRegulatorsintheUnitedStates Study Group on Accountants, Bankers and Regulators. 1994

EMU After Maastricht Peter B. Kenen. 1992

Sea Changes in Latin America Pedro Aspe, Andres Bianchi and Domingo Cavallo, with discussion by S.T. Beza and William Rhodes. 1992

The Summit Process and Collective Security: Future Responsibility Sharing The Summit Reform Study Group. 1991

Financing Eastern Europe Richard A. Debs, Harvey Shapiro and Charles Taylor. 1991

The Risks Facing the World Economy The Risks Facing the World Economy Study Group. 1991

tHe William taYlor memorial leCtureSThe Credit Crisis: The Quest for Stability and Reform E. Gerald Corrigan. 2008

Lessons Learned from the 2008 Financial Crisis Eugene A. Ludwig. 2008

Two Cheers for Financial Stability Howard Davies. 2006

Implications of Basel II for Emerging Market Countries Stanley Fisher. 2003

Issues in Corporate Governance William J. McDonough. 2003

Post Crisis Asia: The Way Forward Lee Hsien Loong. 2001

Licensing Banks: Still Necessary? Tommaso Padoa-Schioppa. 2000

Banking Supervision and Financial Stability Andrew Crockett. 1998

Global Risk Management Ulrich Cartellieri and Alan Greenspan. 1996

The Financial Disruptions of the 1980s: A Central Banker Looks Back E. Gerald Corrigan. 1993

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oCCaSional PaPerS78.TheG30atThirty Peter B. Kenen. 2008

77.DistortingtheMicrotoEmbellishtheMacro:TheCaseofArgentina Domingo Cavallo, Joaquín Cottani. 2008

76. Credit Crunch: Where Do We Stand? Thomas A. Russo. 2008

75. Banking, Financial, and Regulatory Reform Liu Mingkang, Roger Ferguson, Guillermo Ortiz Martinez. 2007

74. The Achievements and Challenges of European Union Financial Integration and Its Implications for the United States Jacques de Larosiere. 2007

73. Nine Common Misconceptions About Competitiveness and Globalization Guillermo de la Dehesa. 2007

72. International Currencies and National Monetary Policies Barry Eichengreen. 2006

71. The International Role of the Dollar and Trade Balance Adjustment Linda Goldberg and Cédric Tille. 2006

70.TheCriticalMissionoftheEuropeanStabilityandGrowthPact Jacques de Larosiere. 2004

69.IsItPossibletoPreservetheEuropeanSocialModel? Guillermo de la Dehesa. 2004

68.ExternalTransparencyinTradePolicy Sylvia Ostry. 2004

67.AmericanCapitalismandGlobalConvergence Marina v. N. Whitman. 2003

66.Enronetal:MarketForcesinDisarray Jaime Caruana, Andrew Crockett, Douglas Flint, Trevor Harris, Tom Jones. 2002

65.VentureCapitalintheUnitedStatesandEurope Guillermo de la Dehesa. 2002

64.ExplainingtheEurotoaWashingtonAudience

Tommaso Padoa-Schioppa. 2001

63.ExchangeRateRegimes:SomeLessonsfromPostwarEurope Charles Wyplosz. 2000

62.DecisionmakingforEuropeanEconomicandMonetaryUnion Erik Hoffmeyer. 2000

61.ChartingaCoursefortheMultilateralTradingSystem: TheSeattleMinisterialMeetingandBeyond Ernest Preeg. 1999

60.ExchangeRateArrangementsfortheEmergingMarketEconomies Felipe Larraín and Andrés Velasco. 1999

59.G3ExchangeRateRelationships:ARecapoftheRecord andaReviewofProposalsforChange Richard Clarida. 1999

Page 78: G30 reformreport

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58.RealEstateBoomsandBankingBusts:AnInternationalPerspective Richard Herring and Susan Wachter. 1999

57.TheFutureofGlobalFinancialRegulation Sir Andrew Large. 1998

56.ReinforcingtheWTO Sylvia Ostry. 1998

55.Japan:TheRoadtoRecovery Akio Mikuni. 1998

54.FinancialServicesintheUruguayRoundandtheWTO Sydney J. Key. 1997

53.ANewRegimeforForeignDirectInvestment Sylvia Ostry. 1997

52.DerivativesandMonetaryPolicy Gerd Hausler. 1996

51.TheReformofWholesalePaymentSystemsandImpactonFinancialMarkets David Folkerts-Landau, Peter Garber, and Dirk Schoenmaker. 1996

50.EMUProspects Guillermo de la Dehesa and Peter B. Kenen. 1995

49.NewDimensionsofMarketAccess Sylvia Ostry. 1995

48.ThirtyYearsinCentralBanking Erik Hoffmeyer. 1994

47.Capital,AssetRiskandBankFailure Linda M. Hooks. 1994

46.InSearchofaLevelPlayingField:TheImplementation oftheBasleCapitalAccordinJapanandtheUnitedStates Hal S. Scott and Shinsaku Iwahara. 1994

45.TheImpactofTradeonOECDLaborMarkets Robert Z. Lawrence. 1994

44.GlobalDerivatives:PublicSectorResponses James A. Leach, William J. McDonough, David W. Mullins, Brian Quinn. 1993

43.TheTenCommandmentsofSystemicReform Vaclav Klaus. 1993

42.Tripolarism:RegionalandGlobalEconomicCooperation Tommaso Padoa-Schioppa. 1993

41.TheThreatofManagedTradetoTransformingEconomies Sylvia Ostry. 1993

40.TheNewTradeAgenda Geza Feketekuty. 1992

39.EMUandtheRegions Guillermo de la Dehesa and Paul Krugman. 1992

38.WhyNow?ChangeandTurmoilinU.S.Banking Lawrence J. White. 1992

37.AreForeign-ownedSubsidiariesGoodfortheUnitedStates? Raymond Vernon. 1992

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36.TheEconomicTransformationofEastGermany:SomePreliminaryLessons Gerhard Fels and Claus Schnabel. 1991

35.InternationalTradeinBankingServices:AConceptualFramework Sydney J. Key and Hal S. Scott. 1991

34.PrivatizationinEasternandCentralEurope Guillermo de la Dehesa. 1991

33.ForeignDirectInvestment:TheNeglectedTwinofTrade DeAnne Julius. 1991

32.InterdependenceofCapitalMarketsandPolicyImplications Stephen H. Axilrod. 1990

31.TwoViewsofGermanReunification Hans Tietmeyer and Wilfried Guth. 1990

30.EuropeintheNineties:ProblemsandAspirations Wilfried Guth. 1990

29.ImplicationsofIncreasingCorporateIndebtednessforMonetaryPolicy Benjamin M. Friedman. 1990

28.FinancialandMonetaryIntegrationinEurope:1990,1992andBeyond Tommaso Padoa-Schioppa. 1990

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30


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