Geneva Association_Global Supervision 2012

The Institutional Framework for Global Insurance Regulation and Supervision:The Changing Landscape

December 2012

The Geneva Association (The International Association

for the Study of Insurance Economics)The Geneva Association is the leading international insurance think tank for strategically important insurance and risk management issues.

The Geneva Association identifies fundamental trends and strategic issues where insurance plays a substantial role or which influence the insurance sector. Through the development of research programmes, regular publications and the organisation of international meetings, The Geneva Association serves as a catalyst for progress in the understanding of risk and insurance matters and acts as an information creator and disseminator. It is the leading voice of the largest insurance groups worldwide in the dialogue with international institutions. In parallel, it advancesin economic and cultural termsthe development and application of risk management and the understanding of uncertainty in the modern economy.

The Geneva Association membership comprises a statutory maximum of 90 Chief Executive Officers (CEOs) from the worlds top insurance and reinsurance companies. It organises international expert networks and manages discussion platforms for senior insurance executives and specialists as well as policy-makers, regulators and multilateral organisations. The Geneva Associations annual General Assembly is the most prestigious gathering of leading insurance CEOs worldwide.

Established in 1973, The Geneva Association, officially the International Association for the Study of Insurance Economics, has offices in Geneva and Basel, Switzerland and is a non-profit organisation funded by its members.

Chairman: Dr Nikolaus von Bomhard, Chairman of the Board of Management, Munich Re, Munich.

Vice Chairmen: Mr John Strangfeld, Chairman and CEO, Prudential Financial, Inc., Newark; Mr Kunio Ishihara, Chairman of the Board, Tokio Marine & Nichido Fire Insurance Co., Tokyo; Mr Michael Diekmann, Chairman of the Management Board, Allianz SE, Munich.

Members of the Board: Dr Carlo Acutis, Vice President, Vittoria Assicurazioni S.p.A., Turin; Dr Sergio Balbinot, Managing Director, Assicurazioni Generali S.p.A., Trieste; Mr Henri de Castries, Chairman of the Management Board and CEO, AXA Group, Paris; Mr Patrick de Larragoiti Lucas, President, Sul America Seguros, Rio de Janeiro; Mr Donald Guloien, President and CEO, Manulife Financial Corporation, Toronto; Prof. Denis Kessler, Chairman and CEO, SCOR, Paris; Mr Michel Lis, Group CEO, Swiss Re Group, Zurich; Mr Mike McGavick, CEO, XL Group plc, Hamilton; Mr Martin Senn, CEO, Zurich Financial Services, Zurich; Mr Esteban Tejera Montalvo, 1st Vice Chairman, MAPFRE, Madrid; Mr Tidjane Thiam, Group Chief Executive, Prudential plc, London; Dr Richard Ward, CEO, Lloyds, London; Dr Yan Wu, Chairman and President, The Peoples Insurance Company (Group) of China Ltd., Beijing.

Secretary General: Mr John H. Fitzpatrick, Basel/Geneva.

Vice Secretaries General: Prof. Jan Monkiewicz (Head of PROGRES and LiaisonEastern Europe), Warsaw; Mr Walter R. Stahel (Head of Risk Management), Geneva.

Heads of Programmes and Research Directors: Dr Etti Baranoff (Research Director for Insurance and Finance), Richmond, VA; Dr Christophe Courbage (Research Director and Head of Health and Ageing and Insurance Economics), Geneva; Mr Daniel Haefeli (Head of Insurance and Finance), Geneva; Mr Anthony Kennaway (Head of Communications), Geneva; Prof. Krzysztof Ostaszewski (Research Director for Life and Pensions), Normal, IL.

Special Officers: Mr Katsuo Matsushita (LiaisonJapan & East Asia), Yokohama; Mr Richard Murray (Head of Liability Regimes Project), New York; Mr Gordon Stewart, (LiaisonNorth America), New York; Dr Hans Peter Wrmli (Chairman of Chief Risk Officers Network), Zurich.

Chairman of the Scientific Advisory Council: Prof. Harold Skipper.

Former Presidents of The Geneva Association: Prof. Raymond Barre, Paris (1973-1976); Mr Fabio Padoa, Trieste (1976-1983); Mr Julius Neave, London (1983-1986); Prof. Dr Dr e.h. Reimer Schmidt, Aachen (1986-1990); Sir Brian Corby, London (1990-1993); Drs. Jan H. Holsboer, Amsterdam (1993-1999); Mr Walter Kielholz, Zurich (1999-2003); Mr Henri de Castries, Paris (2003-2008); Mr Martin J. Sullivan, New York (2008); Mr Jacques Aigrain, Zurich (2008-2009).

Former Secretaries General of The Geneva Association: Prof. Orio Giarini (1973-2000), Mr Patrick M. Liedtke (2000-2012).

The Institutional Framework for Global Insurance Regulation and Supervision:

The Changing Landscape

Patrick M. Liedtke and Jan Monkiewicz

December 2012

The Institutional Framework for Global Insurance Regulation and Supervision: The Changing Landscape The Geneva Association

Published by The Geneva Association (The International Association for the Study of Insurance Economics), Geneva

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iContents

Executive summary 1

1. Introduction 3

PART I: Understanding financial regulation and its wider context

2. Evolution of the global financial setting after World War II: from treaties to networks 93. Modern financial services regulation and the theory of transnational networks: an explanatory framework 13

PART II Analytical appreciation of developments under way at key institutions

4. G-20 - from crisis committee to global steering committee 195. The Financial Stability Board: a rebranded new global regulatory pillar 276. The International Monetary Fund: from monetary to financial system oversight 337. The Organisation for Economic Cooperation and Development: in search for the new mission 398. The Joint Forum disappearing regulatory body? 419. The International Association of Insurance Supervisors (IAIS): getting mature for the new challenges 4310. Conclusions and outlook for the future 49

AnnexesAnnex 1. Bank for International SettlementStatutes (of 20 January 1930; text as amended on 27 June 2005) 53Annex 2. Bank for International SettlementOrganigram 64Annex 3. Basel Committee on Banking SupervisionBank for International Settlement Organisation Chart 65Annex 4. Financial Stability BoardCharter 66Annex 5. International Monetary FundOrganisation Chart 73Annex 6. Convention on the Organisation for Economic Co-operation and Development 74Annex 7. International Association of Insurance SupervisorsBy-Laws (2010 Edition) 79

References and selected bibliography 89

List of acronyms 95

ii

The Institutional Framework for Global Insurance Regulation and Supervision: The Changing Landscape

AcknowledgementsThis report has been inspired by the discussions held by the authors with regulatory experts at

Geneva Association member companies, academics and insurance and financial services regulators at the large international institutions such as the IAIS, the FSB, the BIS, IOSCO, etc., which in many cases kindly offered their continuous intellectual support in the process of preparing this text. It is based on the work coordinated and carried out by the Research Programme on Regulation and Supervision (PROGRES) of The Geneva Association.

Marian Maecki, from the Warsaw Liaison Office of The Geneva Association, offered his special technical assistance and provided invaluable advice. We furthermore appreciate the input and comments received from Geneva Association Board Associates.

We also profited immensely from the exchange of ideas with other colleagues from the staff of The Geneva Association and thank them also for their support in preparing the final version of this report, in particular Susanne LeRoux for editing and Franoise Jaffr for copy-editing and layout.

1Executive summary

Summary

The recent financial crisis has undermined the widely held belief that the existing global regulatory and supervisory structures are sufficient to cope with the challenges of the dynamic financial systems in the 21st century and provide appropriate protection against possible market excesses and transborder contagion. Since 2008, the global community has therefore initiated a wave of actions, projects and policies to repair the elements of regulatory and supervisory structures held liable for the crisis outbreak and its dissemination. However, due to the very high dynamics of the adverse developments in motion, that repair was neither preceded by a systematic overhaul of the entire system nor a comprehensive institutional discussion. As a result there is the danger of curing only what is visible and not necessarily what is the most important. For the same reason, the risk of introducing more inconsistency into the system has substantially increased.

An essential part of the said repair relates to the global institutional arrangements which provide a framework within which regulatory and supervisory activities are carried out. Their role is by no means neutral to the final outcome of the whole process. On the contrary some solutions are more conducive than others to the accomplishment of desired goals, whereas others may even be counterproductive.

The aim of this report is to map out and review the changes that are taking place or are likely to take place in the global institutional framework for financial regulation and supervision and to discuss their likely consequences. Our focus is on insurance. However, it is self-evident that the existing framework is overwhelmingly a cross-sectoral one and touches all parts of the financial services sector, including banking, asset management and insurance plus other financial intermediaries. At the same time, it must be noted that financial regulation on the global level has been influenced by banking regulation and that discussions on how to develop a future global financial architecture are very much asymmetrically bank-oriented, which has a special impact on ongoing and future discussions for insurance.

The first major observation of this report is that the global institutional framework for insurance regulation will, in future, remain even more dependent on network bodies than treaty organisations. That means inter alia that the process of developing global standards will take place via the interaction of relevant national authorities. This also means that, in principle, the possible impact upon its content may be best accomplished not by discussion with the staff of networking associations who are largely performing organisational and coordinating tasks but rather by discussions with staff of the relevant national jurisdictions. The recent financial crisis substantially expanded the perimeter of relevant jurisdictions by upgrading the role of the G-20 in the context of the financial systems. Hence there are more partners in the game which will also generate a different global regulatory agenda.

2The Institutional Framework for Global Insurance Regulation and Supervision: The Changing Landscape

The second major observation of the report is that the insurance industry is going to remain in the shadow of the banking industry and will not be properly differentiated. Under the new situation, banking will receive even more attention and more powers due to the expanding role of the central banks in macroprudential supervision, a key tool to mitigate systemic risk. Thus central banks will increasingly be charged with responsibility for the supervision of the entire financial system including insurance.

The third major observation is about the growing role in the years to come of the International Association of Insurance Supervisors (IAIS) which in the aftermath of the financial crisis reinforced its position as the primary source of global insurance expertise and as a reliable partner of other relevant bodies in particular the Financial Stability Board (FSB) and the International Monetary Fund (IMF).

3As a result of globalisation, national financial markets are increasingly integrated internationally. These processes require rules, standards and institutions to protect individual national financial systems against the risk of external shocks and the global financial system against contagion effects resulting from the interaction of national financial systems. Additionally there is a need for facilitation of the cross-border business relationships of the market players based on the different regulatory arrangements. This has to take place in the multipolar and multilayer political set-up without endangering national sovereignty of the countries concerned.

The recent financial crisis has undermined the widely-held belief that the existing global regulatory and supervisory structures are adequate to cope with the challenges of dynamic financial systems and provide appropriate protection against possible market excesses. Since 2008, the global community has therefore initiated a wave of actions, projects and policies to repair the features of the regulatory and supervisory structures that were liable for the crisis outbreak and its contagion. The dynamic of adverse developments did not allow systematic overhaul of the entire system prior to that, nor did it facilitate a comprehensive institutional discussion. As a result we face the danger of curing only what is visible and not necessarily what is the most important. For the same reason the risk of introducing more inconsistency into the system has substantially increased.

As the credit crisis has shown, even ambitious regulation and tight supervision can failin this case especially in the banking sector, but the point is generally valid for all regulated activities. The impact of the problems first arising in the U.S. mortgage markets which then engulfed the banking sectors of most developed and many emerging countries also resulted in an extremely challenging period for those connected to the insurance industry. And while most insurance managers were trying to minimise the impact of the crisis on their business and their clients, those concerned with financial regulation and supervision became hyperactive, driven by policymakers who were worried that the impact on insurance could be worse than it ultimately turned out to be. Suddenly, highly sophisticated and complex issues became a subject matter of a heated political debate in public as well as private. Key actions taken in the midst of the soaring financial crisis gained in relevancy, especially when they were concerned not only with immediate fire-fighting, but also with longer-lasting contributions to more stable and resilient financial systems.

The credit crisis and its consequences have doubtlessly inspired the systemic reviews recently undertaken worldwide. As is often the case after major financial infrastructure failures this caused a regulatory explosion. It is therefore no surprise that the problems revealed by the crisis are now being actively addressed. Some observers, however, seem to be surprised at the speed and intensity with which this has, and still is, occurring. However, we would posit that the bigger the failure, the more sweeping reforms are proposed and subsequently implemented. Consequently, given that the world was faced with the most devastating financial crisis since the Great Depression, it

1. Introduction

Introduction


should not be surprising that we are going to experience a commensurately significant regulatory and supervisory overhaul.

It is also surprising how the insurance industry has been drawn into some regulatory and supervisory discussions where it should play no (or at least a much less prominent) role as the key problems emanated from other parts of the financial services sector. It is equally surprising how much insurers are excluded from other discussions where they are very much affected by the outcome but considered to play no significant role. In this regard, there is something new in the current process: the global reach of the current considerations and the growth of existing institutions in scope and impact. This is an important new quality to our current endeavours to set the financial services sector right.

The aim of this report is to map out and review the history and recent changes in the global institutional framework for financial regulation and supervision. The report does not suggest potential changes or make recommendations for change in the global institutional framework for financial regulation and supervision. As the title indicates, our focus is chiefly on insurance although it is self evident that the existing framework for global supervision and regulation is overwhelmingly a cross-sectoral one. Seen from a financial system-wide point of view, the same global set-up is in operation for the banking, insurance and securities sector. Such a situation has its idiosyncrasies and with it come positive and negative consequences. On the positive side, an overarching approach is expected to decrease any potential regulatory inconsistencies and reduce cross-sectoral arbitrage challenges. It should also limit the existence of regulatory loopholes. In practice we can actually observe that some of these effects indeed happen. On the negative side, however, it may increase the risk of regulatory capture by stronger interest groups or stronger sectors and may result in a poor reflection of the specificity of various financial sectors and actors, services and products. Given the situation the world economy and its institutional arrangements are in now, it should not be surprising that most of the global attention as well as specialised wisdom is focused on banking activities. Insurance, therefore, needs to protect its particularities and defend its business in complex global circumstances. It needs more effort than banks do to effectively deliver its message and be listened to, as it is much less known to the global decision-making bodies.

It is important for the development of the insurance sector that its constituents have a thorough understanding, not only about the current regulation and its proposed revisions, but also of where new regulatory elements might come in and how existing and new institutions might deal with them. Sound business strategies demand a careful analysis of future scenarios and their impact. This requires market intelligence as much as it does regulatory intelligence. It also opens up the possibility of influencing future rules and norms in order to increase their quality and possibly in such a way that they are more readily compatible with the exigencies of companies.

The Geneva Association has worked on regulatory and supervisory issues in insurance for many years, chiefly through the PROGRES Research Programme but at times also through other initiatives. It recently published a book on The Future of Insurance Regulation and Supervision (Liedtke and Monkiewicz, 2011), organises several conferences and seminars each year (including the annual High-Level Meeting between the worlds leading insurance supervisors and the CEOs of the largest insurance companies) and publishes articles and papers, including the biannual PROGRES Newsletter.1

This report is essentially split into two parts, one theoretical and one analytical. In the first part, Sections 2 and 3, it provides the background knowledge and theoretical explanation for the evolving institutional regulatory set-up. It pays particular attention to the theory of transnational networks which should help to understand the way the current system operates as well as its limitations. In part two, covering Sections 4 to 9, it concentrates on the analysis of the principal

1 The PROGRES Newsletters are available for free from www.genevaassociation.org, as are many other publications and information on insurance regulation and supervision.

5insurance-related components of the global architecture. In Section 10 it draws some conclusions and provide an outlook. The report is also supported by a set of annexes which provide more detailed information on the individual institutions and to serve as a reference.

Introduction

7PART I:

Understanding financial regulation and its wider context

9Evolution of the global financial setting after World War II: from treaties to networks

The contemporary global financial architecture is a direct outcome of the assumptions underlying post-war reform of the financial and economic architecture adopted in Bretton Woods, New Hampshire, back in 1944. In essence their philosophy was built up around three pillars (Leong, 2010, p. 1):

liberal international trade regimes;

currency convertibility with fixed exchange rates;

closed domestic financial systems.

Adopted rules aimed at the prevention of international economic instabilities, which were observed in the interwar period, were intended to offer a conducive framework for growth prospects.

The new system was meant to be based as far as possible on formal, i.e. hard law arrangements in the form of governmental treaties and special purpose intergovernmental institutions. A central role in the financial arena was assigned to the IMF with the World Bank as an assisting body in post-war reconstruction and development finance. Neither, however, had any direct responsibility regarding financial systems, markets and institutions. These were left entirely to national jurisdictions being considered as unimportant for the world community. In effect, no formal international institutional framework in this area was established. The only truly global forum which played some role remained, paradoxically, the Bank for International Settlements (BIS), an interwar institution, which in spite of initial ideas of having it dissolved after World War II, continued throughout the entire post-war period to be the most valuable contact and discussion point of central banks.

Trade liberalisation issues in the new set-up were supposed to be taken by the treaty-based International Trade Organisation. It turned out, however, rather quickly to be a politically unfeasible initiative and hence it was replaced with the General Agreement on Tariffs and Trade (GATT) negotiating platform. The original idea was only reborn 50 years later with the establishment of the World Trade Organization (WTO). In his Primer on The Essential Role of Insurance Services for Trade Growth and Development, Julian Arkell explains how trade issues, growth and insurance are intertwined. He makes a strong case for how relevant insurance services are around the world, not only in their own right, but as necessary and facilitating services for many other activities that impact trade.2

The collapse of the monetary part of the Bretton Woods architecture in the early 1970s saw the suspension of the convertibility into gold of the U.S. currency and a departure from the fixed exchange rates into flexible exchange rate systems. This led, on the one hand, to the de facto redefinition of the original role of the IMF, and on the other hand, to the progressive growth

2 Arkell (2011).

2. Evolution of the global financial setting after World War II: from

treaties to networks

10


of international financial activities and transactions. It is worth noting perhaps that their rapid development outside national regulations and the risks they posed to the financial world were noticed by the international community quite late. As a result, international regulatory initiatives in the financial sector were largely absent from the political agenda throughout the 1950s and the 1960s. The 1970s heralded a new approach in this regard. At the regional level the scene setter became the European Union (EU) with its Single Financial Market project. The project which was launched in the late 1960s, led after some years, to widespread coordination of the financial regulations across member jurisdictions. In the insurance area, it was already seen in 1973 in the adoption of the first coordination directive of the insurance laws and regulations of the member countries with regard to non-life business. In 1979, a parallel coordination directive on life business which inter alia declared the mandatory separation in the operational activities of life and non-life businesses, came into force. Both defined principal regulatory standards to govern insurance activities and established binding supervisory rules for the member nation states. They were followed later on by other regional normative actions leading as a result to the situation in which the ever-growing part of the insurance regulatory and supervisory architecture in EU member countries had its regional framework. The coordination was initially largely motivated by market liberalisation rather than financial stability.

At the global level, the need for some international regulatory intervention emerged contrary to European experience not as a drive towards more liberalisation and more freedom of national market access but as a reaction to stability concerns. However, it was not obvious before the spectacular failure of the privately-owned Herstatt Bank in Germany in 1974 which was intensively involved in cross-border currency settlement trading. Its liquidation, enforced by German regulators on 26 June 1974, led to some unexpected international financial turbulences having thier causes in the time differences between the home country and the countries of operational activities situated on the other Atlantic coast. While closed down in Germany, it still continued to take assignments in New York thus increasing its future bankruptcy obligations. This made the international community strongly aware of the necessity of some cross-border cooperation in financial activities.

At the end of 1974, the G-10 countries responded to the cross-jurisdictional implications of this incident by mandating their central bank governors to set up at the BIS, the Committee on Banking Regulation and Supervisory Practicesrenamed afterwards the Basel Committee on Banking Supervision (BCBS). Members of the new committee were only the central bank governors of the G-10 countries. The Committee was perceived from its start exclusively as a platform for international cooperation on prudential regulation and supervision rather than as a supranational authority with some direct supervisory powers. It turned out after some years to be the most effective institutional innovation recorded in the regulatory area of the financial industry in the post-war period.

The Committee became widely known in the financial world particularly because of some of its initiatives. It included inter alia the 1975 adoption of the principles of cross-border banking supervision based on group-wide approach (so-called Basel Concordat), the introduction in 1988 of the first ever international capital standard for banks (so called Basel I), subsequently refined in 2004 as Basel II and in 2010 as Basel III, and the development in 1997 of the Core Principles for Effective Banking Supervision (BCBS, 2006)comprehensive guidelines on effective supervisory systems in banking.

Its original members were G-10 countries (Belgium, Canada, France, Germany, Italy, Japan, The Netherlands, Sweden, U.K. and the U.S.) and Switzerland, and at a later stage Luxembourg and Spain. In the wake of the current crisis the BCBS seriously expanded its membership in March 2009 to 20 countries by adding Australia, Brazil, China, India, Korea, Mexico and Russia. It did so again in June 2009 by adding to the list Argentina, Hong Kong, Indonesia, Saudi Arabia, Singapore, South Africa and Turkey. Thus, all G-20 member countries plus seven

11

Evolution of the global financial setting after World War II: from treaties to networks

more have become represented in the body. The Committee has control over the formulation of supervisory standards, releasing guidelines and recommendations as well as endorsement of best practices in the field of banking in the expectation that they will be subsequently implemented in domestic banking systems. The regulatory output of the BCBS is entirely optional both for its non-members, which is understandable, as well as for its members which is less so. At the same time the experience has proven that its output is, by and large, voluntarily domesticated by most of the international community. Its recommended Basel I capital standard for instance has been adopted by over 120 jurisdictions.

Interestingly enough the new body has not received any interstate treaty mandate. It currently does not rely on any bylaws either. Its principle is informality and flexibility. Initially BCBS exhibited a very low level of transparency in its activities. The original Basel I capital accord of 1988 was a result of the confidential international negotiations which were presented to local authorities as a fait accompli only after they had been finalised (Verdier, 2009, p.169). Gradually it became more open but until now the Committees only observers are the European Central Bank, the European Banking Authority, the European Commission, the IMF and the Financial Stability Institute. Its works are supported by a small secretariat headed by the Secretary General assisted by around 20 professionals.

The apparent success of the BCBS led to the spread of similar initiatives to non-banking financial sectors: securities, insurance and pensions. In 1983 the International Organization of Securities Commissions (IOSCO) was set up and 10 years later, in 1994, the IAIS was born. Initially more of a platform for supervisors to exchange views and develop best practice approaches, the IAIS quickly became interested in promoting effective and globally consistent supervision of the insurance industry in order to develop and maintain fair, safe and stable insurance markets for the benefit and protection of policyholders. More recently, it added the desire to contribute to global financial stability to its official objectives.

It took another 10 years, until 2004, before the International Organisation of Pension Supervisors (IOPS) was established. All of them began to play a leading role in the provision of international regulatory and supervisory codes and standards. In sharp contrast to BCBS however, they all displayed much more transparency in their operational models and were based on a principle of broad and open membership. Since 1999 these sectoral global standard-setting bodies have been complemented by another cross-sectoral vehiclethe Financial Stability Forum (FSF)set up at a G-7 initiative in the reaction to the Russian and Asian financial crises of 1998-1999. Its stated purpose was to:

promote international financial stability;

reduce systemic risk through enhanced information exchange and international cooperation in financial supervision and surveillance; and,

improve the functioning of the financial markets.

It has since become a specialised network structure focusing on the systemic aspects of financial activities, and a dedicated coordination platform in this regard. It brought together four types of members: representatives of the national authorities (treasury, central banks, supervisory agencies) from the member jurisdictions (Australia, Canada, France, Germany, Hong Kong, Italy, Japan, Netherlands, Singapore, U.K. and U.S.), international financial institutions (IMF, World Bank, BIS, Organisation for Economic Co-operation and Development [OECD]), regulatory and supervisory groupings (BCBS, IOSCO, IAIS) and the two special purpose committees of central banks experts existing at BIS. In implementing its programme, the FSF created a number of ad hoc working groups focusing on specific issues and developing recommendations. It included in particular, highly leveraged financial organisations, off-shore financial centres, deposit insurance and e-finance (Arner and Buckley, 2011, pp. 18-19).

12


In addition, on 8 February 1999, the governors of the G-10 central banks approved the creation of a special Committee on the Global Financial System as a central banks forum for the monitoring and examination of issues related to the stability of the financial markets and systems. Specifically it was supposed to:

identify and assess potential sources of stress in the global financial environment by a regular and systematic monitoring of developments;

enhance the understanding of the functioning of financial markets and systems through monitoring and analytical activities; and,

promote the development of effective and stable financial markets and systems through inter alia elaboration of corresponding policy recommendations.

In its analysis the Committee had to focus on interlinkages between monetary policy and financial stability, between institutions, markets and infrastructures as well as on the potential changes in financial intermediation. The purpose of the Committee was also to contribute to the increased transparency of financial markets by promoting the design, production and publication of statistics and other information by central banks, including through the BIS. In spite of such a broad mandate, the Committee has never ventured directly or indirectly into the insurance domain but has instead concentrated its efforts entirely on the banking sector.

13

Modern financial services regulation and the theory of transnational networks: an explanatory framework

As a result, the global regulatory governance in the financial sector, which has gradually emerged, has come to rely chiefly on network-like bodies. Such development received its theoretical explanation in the theory of transnational networks developed and formulated at the end of the last century and the beginning of the current one. The theory remains particularly associated with the names of Anne-Marie Slaughter (Slaughter, 2004), Kal Raustiala (Raustiala, 2002) and David Zaring (Zaring, 1998). The theory basically claims that government networks are a key feature of world order in the twenty first century (Slaughter 2004, p. 1). In the most general sense they represent a pattern of regular and purposive relations among like government units working across the borders that divide countries from one another and that demarcate the domestic from international sphere (Slaughter 2004, p. 14). They may cover in such a broad approach a variety of areas such as regulation, judicial matters, executives level and legislation. In a more specific sense, these transnational regulatory government networks may be defined as informal multilateral forums that bring together regulatory agencies or departments to facilitate multilateral cooperation on issues of mutual interest within the authority of the participants (Verdier 2009, p. 118).

The network theory claims that the state is not the only actor in the international system. With the development of networks, it is not disappearing either but it is disaggregating the conduct of its international activities into its component institutions. These in turn are increasingly interacting with their foreign counterparts (Slaughter 2004, p. 18). With the help of this disaggregation, the said networks are able to solve the globalisation paradox which we are facing today. Its essence lies in the need for more globally coordinated responses to various global challenges, on one hand, and inappropriateness of the centralised unitary world government, on the other hand (Slaughter 2004, p. 8). Thus, instead of a world government, they permit us to have global governance. This is because networks are decentralised and dispersed and involve the participants who are domestically accountable (Verdier 2009, p. 115). On the other hand, their apparent insulation from domestic political pressures and informal nature allows them to act with more efficiency than traditional international organisations (Arner and Buckley, 2011).

Networks may be either horizontal or vertical (Slaughter 2004, pp. 18-21). Horizontal networks operate between the same political level governmental officials and units. They may be either information networks serving the purpose of information exchange, enforcement networks to help circumvent enforcement problems, or harmonisation networks for converging standards and norms. These last two are precisely the most representative for the financial regulatory area. Vertical networks on the other hand are principally enforcement networks. They emerge as an effect of governments delegating their jurisdictional authority in some areas to some supranational authority (Slaughter 2004, p. 21). Examples include delegation of some powers from national anti-monopolistic bodies to the European level or International Criminal Court which may take up and pursue the actions if the national level is unable or unwilling to carry out prosecution. With

3. Modern financial services regulation and the theory of transnational networks:

an explanatory framework

14


regard to financial regulations, it should be stressed perhaps that as of today the new phenomenon in the financial regulatory arena is the growing role and involvement of the top level political networks in the form of various Gs: G-7, G-10, G-20 (or G-20+ as it now stands).

The potential of global financial regulatory networks is however not unlimited and they display certain deficiencies. First, they include limited democratic legitimacy and imperfect global representation. When, for example, the Basel Committee had developed and was enforcing its Basel I capital standard worldwide it represented only 11 jurisdictions selected in a non-transparent way. The network arrangements also include local accountability of national regulators making these to some degree politically dependent and thus impacting their ability for independent non-political thinking and action. Other deficiencies were the soft nature of the standards that were developed and the lack of formal and transparent enforcement mechanisms that could have been applied to implement them. Finally, it explains also their poor preparedness for resolving emerging conflicts and, more generally, managing crisis resolution (Verdier 2009, p. 115). Perhaps it is worth stressing that during the last financial crisis trans-border regulatory networks remained completely inactive and had nothing to offer apart from responding to political requests and delivering their proposals (Zaring, 2010).

Addressing the weaknesses without destroying the merits of trans-border regulatory networks is a complex and demanding task. In some instances, however, it is a rewarding exercise. That is precisely the case with the soft nature of standards set by networks and the lack of their own enforcement mechanism. In this regard the international community was able to charge the IMF together with the World Bank with this task.

The balance of interests among differing constituents changes over time and with regard to the institutional framework around them. As active agents in the networks they appreciate the discussion and decision processes as these exist right now. However, they also react to expectations about future developments, thus shifting their points of view with regard to expected changes in the framework around them or the institutional relations directly or indirectly affecting them. This is normal behaviour. Yet, it is more present in network structuresespecially those that have greater degrees of freedomthan more rigid arrangements.

As a result, the current international financial architecture, taken as a totality of specialised organisations and arrangements supported by state-to-state contact groups, consists of various mechanisms and legal solutions. There are both, the hard law as well as the soft law provisions. Eric Pan, a recognised researcher in this area, has identified five different types of what he calls legal frameworks (see Table 1). These range from state-to-state contact groups, international organisations, trans-governmental regulatory networks, bilateral and regional networks to finally private sector standards-setting bodies. Still one more type of institutions of substantial importance should be added to the picture, the assessment and valuation establishments widely known as credit rating agencies.

As seen from the following table, these various arrangements have a very diversified legal nature and different legal bases, spanning from hard law treaty-based bodies to soft law club-like agreements. They also have different organisational characteristics: from very large organisations employing thousands of people, to virtual creations with no standing employment. Additionally they perform very different tasks ranging from arranging political regulatory initiatives, to accomplishing standards development, their implementation and finally their quality assessment.

15

Table 1: Current international arrangements in global financial architecture

Source: based on Pan (2010), p. 248

Legend: IMFInternational Monetary Fund; WTOWorld Trade Organization; OECDOrganisation for Economic Development and Cooperation; G-7, G-8, G-10, G-20Group of Seven, Eight, Ten, Twenty; BCBSBasel Committee on Banking Supervision; IOSCOInternational Organisation of Securities Commissions; IAISInternational Association of Insurance Supervisors; FSBFinancial Stability Board; FMRDEU-U.S. Financial Markets Regulatory Dialogue (2002); RRDEU-Japan Regulatory Reform Dialogue (2001); HLMFIEU-Japan High Level Meeting on Financial Issues (2001); ECRDCEU-China Regulatory Dialogue and Cooperation (2004); ERDFSEU-Russia Dialogue on Financial Services (2006); EUIEU-India Dialogue on Financial Services Regulation (2010).

It should be noted perhaps that within the various indicated arrangements, the principal role in the regulatory production process is attributed to trans-governmental regulatory networks. Their efficiency however is dependent on political support. On the other hand, existing big international financial organisations seem to play useful but only supporting roles in the management of international financial systems (Pan, 2010, pp. 248-251). The main reason for this is the structure of their legal powers that largely still reflects the Bretton Woods philosophy focused on sovereign financial issues: effective state liquidity financing and the maintenance of the foreign exchange regime whereas global financial markets have shifted since then to become largely private. Their principal regulatory task has as a result become regulation of cross-border transactions by private firms and persons and ensure the safety and soundness of financial institutions and intermediaries that operate the financial markets (Pan, 2010, p. 250).

These various cooperation vehicles are, from a functional perspective, both independent but interdependent and interconnected bodies. They frequently participate in each others activities providing specialised information, supplying idiosyncratic knowledge and offering a different perspective. They are linked to each other in many different ways: through operational activities, coordination, oversight linkages or information linkages. They may be both substitutive and complementary to each other. They also frequently have the same or similar constituencies. Some of them were set up via political kick off, some others however, have come into existence via secondary level decisions of existing bodies. Their principal composition within the current global regulatory set-up, together with their principle linkages, is displayed in Chart 1.

Modern financial services regulation and the theory of transnational networks: an explanatory framework

13

Table 1: Current international arrangements in global financial architecture

International organisations State-to-state

contact groups Trans-governmental

networks Bilateral and

regional networks

Private standard setting

and opinion making bodies

Examples

IMF World Bank WTO OECD BIS

G-7 G-8 G-10 G-20

BCBS IOSCO IAIS FSB

FMRD RRD HLMFI ECRDC ERDFS EUI

IASB S&P

Characteristics

Treaty-based Large

secretariats Policy

administration Limited policy

making

Protocols No secretariats Policy-making

MOU/informal Small secretariats Information sharing Policy coordination Policy administration

MOU/informal No secretariats Information

sharing Policy coordination

Private sector experts

Regulatory tasks

Sovereign loans Economic

development Technical

assistance Standards

enforcement

Crisis response Regulatory

initiatives Networks

creation

Rules and standards on prudential aspects of banking

Securities Insurance

Approximation of rules and standards

Mutual recognition

Market access provision

Technical standards

Examples of achievements

FSAP Creation of BCBS

FSB

Development of sectoral prudential standards

Opening of Russian market

IFRS roadmap

IFRS New

supervisory tools

Source: based on Pan E. (2010), p. 248

Legend: IMF - International Monetary Fund WTO - World Trade Organisation OECD - Organisation for Economic Development and Cooperation G-7, G-8, G-10, G20 - Group of Seven, Eight, Ten, Twenty BCBS - Basel Committee on Banking Supervision IOSCO - International Organisation of Securities Commissions IAIS - International Association of Insurance Supervisors FSB - Financial Stability Board FMRD - EU-U. S. Financial Markets Regulatory Dialogue (2002) RRD - EU-Japan Regulatory Reform Dialogue (2001) HLMFI- EU-Japan High Level Meeting on Financial Issues (2001) ECRDC - EU-China Regulatory Dialogue and Cooperation (2004) ERDFS - EU-Russia Dialogue on Financial Services (2006) EUI - EU-India Dialogue on Financial Services Regulation (2010)

As is seen from the table attached these various arrangements have very diversified legal nature and legal base, spanning from hard law treaty-based bodies to soft law club like agreements. They have also different organisational characteristics: from very large organisations employing thousands of people, to virtual creations with no standing employment. Additionally they perform very different tasks ranging from arranging political regulatory initiatives, accomplishing standards development, their implementation and finally their quality assessment.

It should be noted perhaps that within the indicated various arrangements principal role in the regulatory production process is attributed to trans-governmental regulatory networks. Their efficiency however is dependent on political support. On the other hand, existing big

16


Chart 1: Institutional set-up of global financial regulatory architecture

Source: The Geneva Association elaboration, Jan MonkiewiczLegend: SSSSectoral Standard Setters; SPVSpecial Purpose Vehicles; CSSSCross Sectoral Standard Setters; BISBank for International Settlements; CGFSCommittee on Global Financial Systems; CPSSCommittee on Payment Settlement Systems; FATFFinancial Action Task Force on Money Laundering and Terrorism Financing; IOPSInternational Organization of Pension Supervisors; WTOWorld Trade Organization.

Todays international financial architecture is based on numerous institutions with different legal bases, mandates and powers. Prominent among them for the insurance sector are five bodies: the G-20, the FSB, the IMF, the OECD and the IAIS. We will consider them one by one in our subsequent analysis.

14

international financial organisations seem to play useful but rather only supporting role in the management of international financial systems (Pan E., 2010, pp. 248-251). The main reason for this is the structure of their legal powers that largely still reflect Bretton Woods philosophy focused on the sovereign financial issues: effective state liquidity financing and the maintenance of the foreign exchange regime whereas global financial markets have shifted since then to become largely the private ones. Principal regulatory task has become as a result regulation of cross-border transactions by private firms and persons and ensure the safety and soundness of financial institutions and intermediaries that operate the financial markets (Pan E., 2010, p. 250). This contention perhaps requires some balancing as a result of the current understanding of the role of the macroprudential surveillance and macroprudential policy which allocates our attention back to macroeconomic elements. This may also affect the future balance of power in the global financial regulatory set-up.

It is worth noting perhaps that these various cooperation vehicles are from the functional perspective both independent, but interdependent and interconnected bodies. They are frequently participating in each others activities providing specialized information, supplying idiosyncratic knowledge and offering a different perspective. They are linked to each other in many different ways: through operational activities, through coordination, through oversight linkages or through information linkages. They may be both substitutive and complementary to each other. They also frequently have the same or similar constituencies. Some of them were set up via political kick off, some other however have come into existence via a sort of a secondary level decisions of already existing bodies. Their principal composition within the current global regulatory set up together with their principles linkages is displayed in Chart 1 on the next page.

Chart 1: Institutional set-up for global financial regulatory architecture

G-7, G-8, G-20 Political steering

BCBS IOSCO IAIS IOPS

CGFS CPSS

FSB Joint Forum

FATF

IMF

BIS World Bank

OECD

IASB

ECB

WTO

SSS

SPV

CSSS

17

PART II

Analytical appreciation of developments under way

at key institutions

18


19

BackgroundThe G-20 is currently the most important global forum for discussing, elaborating and

coordinating international economic policies and giving direction for financial regulations. The G-20 members include Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, U.K., the US. and the EU which is represented by the President of the European Council and the President of the European Central Bank. Collectively the G-20 countries account for over 80 per cent of the world gross national product, over 80 per cent of the world international trade including intra-EU trade and over two thirds of the world population.

Table 2: The leading groups of states platforms

Source: Banque de France (2010), p. 125

Its history goes back to the G-7 Summit in Cologne in 1999 during which, in the wake of the Asian crisis, the G-7 decided to set up a special contact platform of finance ministers in order to facilitate better coordination of economic policies of leading advanced and emerging economies. At that time, the G-7 was the most important global economic coordinating body having reached this position in 1986 when it superseded the G-5. The G-5 was historically the

4. The G-20from crisis committee to global steering committee

G-20from crisis committee to global steering committee

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PART II Analytical appreciation of developments under way at key institutions

4. G20 - from crisis committee to global steering committee Background The G20 is currently the most important global forum for discussing, elaborating and coordinating international economic policies and giving directions of financial regulations. The G20 members include Argentina, Australia, Brazil, Canada, China, France, Germany, India, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, Turkey, the United Kingdom, the United States and the EU which is represented by the President of the European Council and the President of the European Central Bank. Collectively the G20 countries account for over 80% of the world gross national product, over 80% of the world international trade including intra EU trade and over two thirds of the world population.

Its history goes back to the G-7 Summit in Cologne in 1999 during which in the wake of the Asian crisis the G-7 decided to set up a special contact platform of finance ministers in order to facilitate better coordination of economic policies of leading advanced and emerging economies. G-7 was at that time the most important global economic coordinating body. It came to this position in 1986 when it superseded the G-5. Actually, the G-5 was historically the first state contact group which was arranging since 1975 regular heads of states summits focusing on global economic developments.

After the end of the Asian crisis the G20 played rather modest role in the global economic governance and it has come into the prominence again only in 2008 when it finally replaced the G-7 in its global coordinating and steering capacity. This development initiated at the request of the G7 was a clear recognition on its part of the need to better accommodate key emerging market countries in the framework of global economic discussion and governance. It is worth noting perhaps that the national composition of various Gs - G-5, G-7, G-8 or G-10 - was essentially based on the same hard core group of states. The G20 alters entirely this proposition (see table 2).

Table 2: The leading Groups of States platforms

G-5 G-7 G-8 G-10 G20 Germany Germany Germany Germany Germany Japan Japan Japan Japan Japan France France France France France U.S. U.S. U.S. U.S. U.S. U.K. U.K. U.K. U.K. U.K. Italy Italy Italy Italy

Canada Canada Canada Canada Russia Belgium Russia

Sweden Argentina Netherlands Australia Switzerland Brazil China

India Indonesia Mexico Saudi Arabia South Africa South Korea Turkey

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first state contact group which since 1975 had arranged regular heads-of-states summits focusing on global economic developments.

After the end of the Asian crisis, the G-20 played a rather modest role in global economic governance and it came into prominence again only in 2008 when it finally replaced the G-7 in its global coordinating and steering capacity. This development initiated at the request of the G-7 was a clear recognition on its part of the need to better accommodate key emerging market countries in the framework of global economic discussion and governance. The national composition of various GsG-5, G-7, G-8 or G-10was essentially based on the same hardcore group of states. The G-20 alters this proposition entirely (see Table 2).

Thus it definitely creates a new qualitative situation. As the group itself states, economic weight and broad membership gives it a high degree of legitimacy and influence over the management of the global economy and financial system. In addition to the G-20 members, several international organisations and institutions participate regularly in the meetings. They include the IMF represented by its managing director and chairman, the International Monetary and Financial Committee of IMF, the World Bank, OECD, the European Commission, WTO and the FSB. The G-20 also typically extends invitations to selected invitees who are formally chosen by the chairing country. In 2010 these invitations were offered to Ethiopia (chair of the New Partnership for Africas DevelopmentNEPAD), Malawi (chair of the African Union), Spain and Vietnam (chair of the Association of South-East Asian NationsASEAN). In 2012, the invitations were extended to Benin, Cambodia, Chile, Colombia and Spain.

Governance and activitiesThe G-20, like its predecessors, operates without a permanent secretariat or staff. Each year

a selected G-20 country serves as the Chair. It is a responsibility of the Chair to establish a temporary office and take care of the secretarial, clerical and administrative affairs. The secretariat is responsible during its term for the coordination of the Groups various meetings taking place at different political and technical levels. All decisions of the Group must be taken unanimously, hence no formal voting system is in place. The meetings of the Group are closed-doors, but after each meeting a communiqu or declaration is published. Because of its informal nature, the G-20 has no formal enforcement mechanism at its disposal. All of its commitments are officially non-binding (Nelson 2009, pp. 8-9).

Between November 2008 and November 2010 the leaders summits have been organised twice a year reflecting urgency of necessary actions. Since 2011, however, only one annual summit has taken place. Up until 2012, the G-20 has held seven leaders summits: in Washington in November 2008, in London in April 2009, in Pittsburgh in September 2009, in Toronto in June 2010, in Seoul in November 2010, in Cannes in November 2011 and in Los Cabos in June 2012. Three next meetings are tentatively planned in Russia (2013), Australia (2014) and Turkey (2015).

The Washington Summit held on 15 November 2008, focused primarily on immediate crisis management issues. G-20 leaders agreed also on the need to reform financial regulation in order to avoid future crises. In their Declaration on the Summit on Financial Markets and the World Economy (G-20, 2008a) the G-20 countries pledged inter alia to strengthen their regulatory regimes, prudential oversight and risk management, as well as to ensure that all financial markets, products and participants are regulated or subject to oversight. They announced future strong oversight of the credit rating agencies and committed themselves to transparent assessments of their national regulatory systems (G-20, 2008a). The Summit has also tasked the G-20 finance ministers to give priority in their agenda to six specific regulatory areas:

1. mitigating against pro-cyclicality in regulatory policy;2. reviewing and aligning global accounting standards;

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3. strengthening the resilience and transparency of credit derivative markets and reducing their systemic risk;

4. reviewing compensation practices in financial institutions;5. reviewing the mandates, governance and resource requirements of the international

financial organisations; and,

6. defining the scope of systemically important institutions and determining their appropriate regulation or oversight.

The declaration also included the set of defined actions to be taken in various areas. With regard to financial regulatory regimes, it requested the IMF and FSF and other regulators to urgently develop recommendations to mitigate pro-cyclicality. It further requested member countries to evaluate their regulatory systems via the Financial Sector Assessment Program in order to align them with modern requirements. It called for a review of the differentiated nature of regulation in the banking, securities and insurance sectors and the provision of necessary regulatory improvements. It demanded the inclusion of all systemically important institutions in the regulatory framework. Additionally, it requested national and regional authorities to review their resolution regimes and bankruptcy laws. With regard to prudential oversight, it announced the need for ensuring appropriate oversight of the credit rating agencies. It recommended the development of internationally consistent approaches for liquidity supervision by supervisors and central banks. It detailed several measures to be taken with respect to risk management including the need for financial firms to strengthen their internal controls and policies for sound risk management, better management of their liquidity risk and reassessment of their own risk management models. The Washington Summit also requested an urgent expansion of the FSF membership base to include the G-20 member countries which were not among its constituency. To better organise its broad area of activities the G-20 set up four working groups in Washington on:

1. enhancing sound regulation and increasing transparency (co-chaired by India and Canada);

2. reinforcing international cooperation and promoting integrity in financial markets (co-chaired by Mexico and Germany);

3. reforming the IMF (co-chaired by South Africa and Australia); and,

4. the World Bank and other multilateral development banks (co-chaired by Indonesia and France).

The second G-20 leaders Summit took place on 2 April 2009 in London. It concentrated on addressing the issues related to the financial crisis and resulting economic crisis (Arner and Buckley 2011, p. 27). The G-20 leaders committed to increase the funding of IMF and the multilateral development banks by US$1.1tn including a tripling of the IMF lending capacity from US$250bn to US$750bn. They also pledged US$5tn in fiscal stimulus spending. On the regulatory front the G-20 countries agreed to strengthen financial supervision and regulation not only by ensuring that their domestic systems are strong but also by establishing the much greater consistency and systematic cooperation between countries, and the framework of internationally agreed high standards that a global system requires (G-20, 2009a). In their declaration the leaders instructed regulators and supervisors among others, to protect consumers and investors, support market discipline, reduce the scope of arbitrage, avoid adverse impact on other countries and support competition and dynamism. In (yet another) Global Plan for Recovery and Reform (G-20, 2009b) the G-20 announced the establishment of a new bodythe FSB replacing the old Financial Stability Forum, with an enhanced mandate and powers. It also tasked the FSB and the IMF with providing an early warning system for macroeconomic and financial risks. Furthermore it called for the extension of regulation and oversight to all systemically important financial institutions, instruments and markets including hedge funds. It pledged to implement the FSF new principles on pay and compensation. Finally, it requested action to improve the quality, quantity


22


and international consistency of capital in the banking sector. Additionally it called upon the accounting standard setters, mentioning in particular the IASB, to work urgently with regulators and supervisors to improve standards on valuation and provisioning and achieve a single set of global accounting standards. Finally it reiterated its determination to extend regulatory oversight to the credit rating agencies.

In their third Summit in Pittsburgh 24-25 September 2009, the G-20 leaders concentrated their attention on global economic governance issues. They declared themselves the premier forum for international economic cooperation thus officially taking over the responsibilities from the G-7 and the G-8. They have further designated the FSB to be responsible for coordinating and monitoring the progress in financial regulation (Leaders Statement: The Pittsburgh Summit, G-20, 2009c). They also announced plans for reforming governance and tasks of the IMF and the World Bank and increasing the role of emerging markets in these institutions. It was a clear indication of the perception that the crisis was over and that more long-term elements needed to be tackled.

The fourth G-20 Summit held in Toronto 26-27 June 2010 was the first gathering of the group in its new capacity as the premier forum for international economic cooperation. It focused its attention on four major areas: sustainable and balanced growth, financial sector reform, international financial institutions and development, fighting protectionism and promoting trade and investment (The G20 Toronto Summit Declaration, G-20, 2010a). With regard to the financial sector reform, the G-20 leaders agreed four pillars of the reform agenda, providing some framework for their various initiatives so far. The first pillar, covering regulatory issues, embraced new regulatory frameworks in banking and particularly work towards preparation of Basel III capital model. Additionally, it requested acceleration of the implementation of strong measures to improve regulatory oversight of hedge funds, credit rating agencies and over-the-counter derivatives. It also mentioned global accounting standards and FSB standards for sound compensation. The second pillar referred to an effective supervision. The leaders tasked FSB with preparing recommendations to strengthen its role, mandate, powers and resources. The third pillar referred to international assessment and peer reviews. The third pillar is resolution and issues related to systemically important financial institutions. The FSB was asked to consider and develop concrete policy recommendations to effectively address problems associated with, and resolve, systemically important financial institutions. The fourth pillar refers to transparent international assessment and peer reviews. The G-20 leaders expressed their support for IMF/World Bank Financial Sector Assessment Program and pledged to support peer reviews through Financial Stability Board. (G-20 2010a, pp. 4-5). Generally speaking the debates in Toronto were a continuation of the issues discussed before. At the same time it laid the ground for the next summit in Seoul.

The fifth G-20 Summit took place in Seoul 11-12 November 2010. It was a significant development in many respects. It was the first summit held in Asia and also the first one hosted by an emerging economy. Interestingly enough it was also the first summit preceded by the meeting of G-20 parliamentarians and G-20 business summit. With regard to the regulatory agenda, the biggest achievement of the Seoul meeting was an endorsement of the Basel III BCBS new capital requirements proposal with its liquidity and leverage elements. It also included the adoption of the timeline for its implementation worldwide. With this a major reform of the banking system had taken place. The meeting was also able to advance the issue of systemically important financial institutions and cross-border resolution regimes. The Seoul Summit Document has made it very clear in this regard: We reaffirmed our view that no firm should be too big or too complicated to fail and that taxpayers should not bear the costs of resolution (G-20, 2010b, p. 7). The document also outlined the need for special regulations with regard to global systemically important financial institutions (G-SIFIs) including their higher loss absorbency capacity to reflect their greater risk and more intensive supervisory oversight. The leaders agreed to subject these institutions to a mandatory process of international recovery and resolution planning. At the same time the meeting endorsed the need for overall increased supervisory intensity and effectiveness, and identified a set

23

of necessary measures. Addressing the issue of the reform of international financial institutions, the Summit accepted inter alia modernisation of the IMF quota system to enhance the role of emerging economies. It also underscored the need for further reforms of the IMF mission and mandate. In particular it emphasised the need to review and modernise its surveillance function.

The Cannes Summit, held a year later, 3-4 November 2011, focused primarily on macro development issues like growth, employment, energy, climate, international monetary system and the like. With regard to regulatory area, there was a clear continuation of the programme outlined during earlier summits. In its Communiqu (G-20, 2011), the G-20 leaders underlined in particular the importance of the too big to fail issue, the need for oversight of shadow banking and control of compensation practices. They also announced the agreement on the reform of the FSB to improve its ability to coordinate and monitor the financial regulation agenda. Last but not least, they underlined the need to eliminate existing gaps in the regulatory and supervisory domain. In addressing the issues of systemically important financial institutions, the G-20 approved the FSB proposed policy framework in this regard based on more effective and intensive supervision, requirements for cross-border cooperation and resolution planning, as well as new international standards on resolution regimes and additional loss absorbency. At the same time, the G-20 leaders endorsed the first list of G-SIFIs prepared by the FSB to be amended annually. Based on this work G-20 leaders instructed the FSB to prepare, in cooperation with BCBS, a report on extension of G-SIFIs framework to domestic systemically important banks by the G-20 finance meeting in April 2012. Finally they tasked the FSB to prepare in cooperation with BCBS, IOSCO and IAIS methodologies to identify systemically important non-bank financial institutions by the end of 2012.

With respect to the FSB, the G-20 leaders underlined the key positive role of this body in promoting development and implementation of financial sector regulation. They decided to strengthen its capacities, resources and governance by:

1. giving it a legal personality and greater financial autonomy;2. reforming its steering committee to reflect better global financial systems and ensure its

effectiveness; and,

3. strengthening its coordinating role vis--vis other standard-setting bodies.

The G-20 leaders recommended actions to develop consumer protection in the context of stability of the financial sector and the need for the development of macro prudential policy framework and tools. They called for cooperation with the OECD and authorised FSB, IMF and BIS to continue their involvement in this area. They reiterated at the same time the need for high quality global accounting standards and called on IASB and FSB to complete their convergence project.

The seventh summit held in Los Cabos, Mexico, 18-19 June 2012, continued to concentrate on macro development issues in particular on the need to support growth and jobs creation and alleviate poverty. In this context the G-20 leaders specifically addressed the eurozone crisis. They called upon eurozone members of the G-20 to take all necessary policy measures to safeguard the integrity and stability of the area, improve the functioning of financial markets and break the feedback loop between sovereigns and banks(G-20, 2012a). The G-20 endorsed the steps for more integrated EU financial architecture, covering banking supervision, resolution regime and deposit insurance, recently called a banking union. These actions are believed to constitute an important part of the G-20 recipe for the support of economic stabilisation and the global recovery. With regard to the international financial architecture the leaders decided to substantially increase the financial resources placed at the disposal of the IMF and provided commitments exceeding US$450bn. They also reaffirmed at the same time the implementation of the Quota and Governance Reform of the IMF by January 2013 and to revise it again by January 2014. They also agreed on the enhancement of the current surveillance framework and a proposed an integrated surveillance


24


decision. All this meant additional resources and powers for the IMF. As for the reform of the financial sector, the Mexican summit has not produced any new revolutionary ideas. The G-20 leaders basically reaffirmed their current priorities and workstreams: the Basel capital framework, the framework for G-SIFIs, resolution regimes, over-the-counter (OTC) derivatives, shadow banking and compensation practices. In this context the G-20 leaders requested that the FSB finalise, in consultation with the IAIS, its work on identification and policy measures for global systemically important insurers by April 2013. Additionally they tasked the FSB and IOSCO to prepare methodologies to identify other systemically important non-bank entities by the end of 2012 and the Committee on Payment and Settlement Systems (CPSS) and IOSCO to continue work on systemically important market infrastructure. At the same time, the G-20 requested that the IAIS develop a common framework for the supervision of internationally active insurance groups by the end of 2013. With regard to financial sector reform, the G-20 also endorsed the directions of the FSB reform and called for the full implementation of the recommendations by the next summit in St. Petersburg. Overall however, it is worth observing that the financial sector reform clearly had a back seat at the summit.

OutlookTo sum up, one can see a key role of the G-20 as a global steering interstate group. While some

critics, especially from civil society and NGO environment, have focused on the problems of democratic legitimacy and representativeness, sometimes including a call for different governance, significant progress has been made in recent years.3 In contrast to its predecessors the G-20 is far more representative of the global community and it is also far more transparent while continuing to be very flexible and informal. To increase its legitimacy it supports such initiatives as on-site summits of parliamentarians, businesses and trade unions. It is also much better organised in terms of analytical and monitoring activities with the use of the IMF and FSB in particular.

However, formidable challenges remain: so far the prime target of G-20 attention and action has been the recent global financial crisis that also gave birth to its current form. It seems that the cohesive forces that keep the group together and aligned for joint action are less present when other issues are dealt with than the fundamentals of global financial (and to a lesser extent economic) interests. It remains to be seen how far the G-20 will continue to be driven by chiefly financial themes and whether it can branch out successfully into other areas. It is also largely open at this stage whether the current composition of the G-20 (with the G-20+ as a sideline) will remain stable or whether it needs to open up further, perhaps creating a G-25 or G-30 in the process.

The G-20 has, until now, spent a long time on discussions of regulatory and supervisory issues in finance and was able to trigger far-reaching reforms in a relatively short period of time; even while the crisis it wanted to address is still unfolding. From an insurance perspective, however, the most significant effects stem from new rules for global finance in general rather than specific insurance projects. The methodology of identifying G-SIFIslargely complete for bankingis still underway in insurance. It is not yet clear how significant a role insurance has in stabilising the economy and how much systemic risk is created by some insurance activities.

Currently, the G-20 does not play as significant a role in some areas that are of critical importance to the well-being of citizens around the globe: sustainability, old-age security, long-

3 As the current Mexican Presidency of the G-20 explains (G-20, 2012b): It ...attaches great importance to strengthening the Groups dialogue and ties with countries and organizations outside of the Group. To this end, a Special Representative of the Mexican Presidency of the G20 has been appointed, who is responsible for exchanging views with groups not directly represented in the Group, such as non-member countries, international organizations, civil society with particular emphasis on young people, academia, and the business community, among others. The Mexican Presidency of the G20 hopes this approach will make the work of the Group more effective, inclusive and transparent.

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term care, health services provision, climate risks, natural catastrophes, etc. Interestingly enough, the Mexican Presidency of the G-20 wanted to address these shortcomings and explained its project Rethinking G20: Designing the Future (G-20, 2012c), which is an initiative of the Government of Mexico, set against the backdrop of the G20 Summit so that leaders in different disciplines may engage in a reflection on social, economic, political, environmental, scientific and world financial futures, and generate contributions to the design of future public policies of innovation and efficiency.

Much will depend on how the bigger countries see the role of the G-20 developing and whether current outsiders tolerate a set-up that largely excludes them from (at least) the inner decision-making process. It seems highly likely that the G-20 will expand its area of focus as well as its composition and governance. Consequently, the insurance sector will have a significant interest in closely monitoring the G-20.


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27

BackgroundThe FSBa reincarnation of the FSF that has existed in the global financial architecture

since the Asian crisis in 1999came into operation in 2009 due to a decision taken by the G-20 summit in London. It has become the direct successor of the FSFs portfolio of tasks and powers. The intention of this change was, as stated in the London Summit Declaration on Strengthening the Financial System (G-20, 2009d), to give the new body a stronger institutional basis and enhanced capacity to perform its functions better. Stronger institutional basis addressed the legitimacy concerns and enhanced capacity addressed its effectiveness concerns. This process had already been initiated before the London summit. In March 2009, the membership of the FSF was substantially expanded to include all G-20 countries. At its inception the FSF was an intergovernmental forum whose purpose was the promotion of financial stability in the international financial system by assessing its vulnerabilities, addressing and overseeing actions to address them and promoting coordination and information exchange among authorities responsible for financial stability. Its mandate and its organisational structure were largely determined by a special report prepared in 1998 by the then Bundesbank President, Hans Tietmeyer, at the request of the G-7. The first meeting of FSF took place in April 1999, the last in March 2009.

TasksAs follow-up to the London G-20 summit, the members of the FSB adopted a new charter of

the organisation. Under the general provisions it spelled out new objectives as well as its mandates and tasks. It specified that the objective of the new body was to coordinate at the international level the work of national financial authorities and international standard setting bodies (SSBs) in order to develop and promote the implementation of effective regulatory, supervisory and other financial sector policies. It also indicated that the new organisation will address vulnerabilities affecting financial systems in the interest of global financial stability (FSB, 2009, Article 1). The charter lists eight mandates and tasks for the organisation. In addition to the original mandate of the FSF which focused on global standard-setting activities as well as coordination and information exchange among authorities responsible for financial stability, the FSB is mandated to:

...

(c) monitor and advise on market development and their implications for regulatory policy;

(d) advise on and monitor best practice in meeting regulatory standards;

(e) undertake joint strategic reviews of the policy development work of the international standard setting bodies to ensure their work is timely, coordinated, focused on priorities and addressing gaps;

(f) set guidelines for and support the establishment of supervisory colleges;

5. The Financial Stability Board: a rebranded new global regulatory pillar

The Financial Stability Board: a rebranded new global regulatory pillar

28


(g) support contingency planning for cross-border crisis management, particularly with respect to systemically important firms;

(h) collaborate with the International Monetary Fund (IMF) to conduct Early Warning Exercises; and

(i) undertake any other tasks agreed by its Members in the course of its activities and within the framework of this Charter. (FSB, 2009, Article 2)

The standard setting will undoubtedly remain an important part of the FSB agenda and it will continue, in particular, to administer its Compendium of Key Standards for Sound Financial Systems which became a powerful tool of global regulatory harmonisation and a source of cross-sectoral consistency.

Table 3: 12 key regulatory standards of the FSF/FSB

Source: FSB.

These are the standards designated by the FSF and taken over subsequently by the FSB as key for sound financial systems and recommended for priority implementation. They are believed to represent minimum requirements for good practice in a given area. In order to be approved by the FSB, the standards need to meet several criteria including their relevance for a robust financial system, their universality in applicability, their flexibility in implementation, their broad endorsement and their assessability by national authorities. The list of the standards is periodically reviewed and updated in order to avoid obsolescence (http://www.financialstabilityboard.org/cos/key_standards.htm). To be effective the approved standards are matched with their implementation enforcement. Until recently it relied on the close cooperation of the FSF with the IMF and the World

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Area Standard Issuing body

Macroeconomic Policy and Data Transparency (3)

Monetary and financial policy transparency

Code of Good Practices on Transparency in Monetary and Financial Policies

IMF

Fiscal policy transparency Code of Good Practices on Fiscal Transparency IMF

Data dissemination Special Data Dissemination Standard/General Data Dissemination System

IMF

Institutional and Market Infrastructure (7)

Insolvency Insolvency and Creditor Rights WB

Corporate governance Principles of Corporate Governance OECD

Accounting and auditing International Financial Reporting Standards (IFRS/International Standards on Auditing (ISA)

IASB/IAASB

Payment, clearing and settlement

Principles for Financial Market Infrastructures CPSS/IOSCO

Market integrity

FATF Recommendations on Combating Money Laundering and the Financing of Terrorism & Proliferation

FATF

Crisis resolution and deposit insurance

Core Principles for Effective Deposit Insurance Systems BCBS/IADI

Financial Regulation and Supervision (3)

Banking supervision Core Principles for Effective Banking Supervision BCBS

Securities regulation Objectives and Principles of Securities Regulation IOSCO

Insurance supervision Insurance Core Principles IAIS

Source: Jeong Y. , 2010 Seoul summit and future of Financial Stability Board (FSB) as the fourth pillar, Yonsei Law School, August 30, 2010, pp. 24- 25 and own sources

These are the standards designated by the FSF and taken over subsequently by the FSB as key for sound financial systems and recommended for priority implementation. They are believed as representing minimum requirements for good practice in a given area that countries are encouraged to meet. To be approved by the FSB the standards need to meet several criteria including their relevance for a robust financial system, their universality in applicability, their flexibility in implementation, their broad endorsement and their assessability by national authorities. The list of the standards is periodically reviewed and updated in order to avoid its obsolescence (www.financialstabilityboard. org). To be effective the approved standards are matched with their implementation enforcement. Until recently it relied on the close cooperation of the FSF with the IMF and the World Bank in using their powers materialized principally in the Financial Standards Assessment Program (FSAP) and Reports on the Standards Observance and Compliance (RSOC) and the conditionality instrument applied by the IMF in its financial lending assistance. Since April 2009 London Conference the FSB members committed themselves to implement the standards and avail additionally themselves to periodic peer reviews in this regard. Apart from maintaining its

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Bank in using their powers materialised principally in the Financial Sector Assessment Program (FSAP), the Reports on the Observance of Standards and Codes (RSOC) and the conditionality instrument applied by the IMF in its financial lending assistance. Since the April 2009 G-20 London Summit, the FSB members have committed themselves to implement the standards and additionally avail themselves to periodic peer reviews in this regard. Apart from maintaining its standard-setting involvement, the FSB received enhanced analytical and operational powers. It will also be responsible each year for the designation of systemically important global financial institutions.

GovernanceMembership of the FSB includes three categories of members: regulatory, supervisory

and central bank bodies; international financial institutions and international standard setters. It currently has 36 members and is based at BIS headquarters from which it receives clerical, financial and research support. Much of its 20-people secretariat is seconded and there is a critical need for expansion. After the G-20 Cannes summit, the FSB was granted a legal personality status.

Member jurisdictions must meet certain commitments which will be evaluated and made available by the FSB. These commitments include:

maintenance of financial stability;

maintenance of the openness and transparency of the financial sector;

implementation of international financial standards; and

availability for periodic peer reviews using evidence of IMF/WB public FSAP reports.

Chart 2: Corporate set-up at FSB

Source: Jeong (2010), p. 22.

The Financial Stability Board: a rebranded new global regulatory pillar

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Source: Jeong Y. 2010, p. 22

The Chair is appointed by the Plenary for a fixed term of three years renewably once. It has broad powers

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Geneva Association_Global Supervision 2012

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