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Progress on G20 Financial Regulatory Commitments from Washington 2008 until Toronto 2010

Ivan Savic and Nick Roudev, G20 Research Group
June 22, 2010

1. Summary of Findings

The efforts to implement G20 commitments to reforms of financial regulation have only begun in the last six to twelve months. These efforts have varied a great deal across financial systems but on the whole they have been largely conservative. The chief reasons for this have been the ongoing economic crisis, a divergence of opinion on how far the reforms need to go, and very different national circumstances. Nevertheless, the steps that have been taken are important and their long term impact on global financial stability will crucially depend on sustaining this process.

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2. Scope of this Report

This report focuses on changes to financial regulation which have been enacted or begun since the first commitments were made at the November 2008 G20 Leaders Summit in Washington. It looks at the United States, the European Union (as well as national developments in the United Kingdom, Germany, France and Italy), Japan and Canada, rather than all members of the G20 or at all financially important states. The justification for this limited scope is threefold. First, the selected countries have the some of the largest and most complex financial markets and the most sophisticated financial regulatory systems. They are also models for countries with “shallower” markets whose financial regulation typically mirrors the framework of one of these state (i.e,. it major economic partner). Second, these countries are the most vulnerable to the kind of financial crises that the G20 commitments are meant to address. This is particularly true of the US (and to a lesser extend the UK) which was sources of the current crisis. Finally, these counties have a very long history of financial cooperation that stretches back to 1975 and which is continued today though the biannual meetings of G7 finance ministers and central bank governors.

This report specifically focuses on progress made in four areas of financial regulation: accounting standards, banking supervision, credit rating agencies, and derivative markets. These areas have been identified by the G8, G20 and the Financial Stability Board (FSB) as key areas that need to be addressed. They are also the most relevant issues for regulatory reform.

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3. Overall Progress on Financial Reform since November 2008

There are three general characteristics of the progress that has been made on financial regulatory reform. First, this progress is largely very recent. With the exception of a few shop-gap measures enacted in late 2007 and early 2008, the vast majority of reforms that have been proposed in late 2009 and early 2010. Many more are still in the discussion phase. Second, the reforms that have been enacted or proposed have largely been less ambition then some of the ideas originally proposed in late 2008. Finally, there has been a great deal of variation in national response in terms of the scope of reforms, their general approach, and specific content.

In the lead up to the 2010 G20 meeting in Toronto the G20 discussed the possibility of enacting the IMF’s proposed bank tax. The purpose of this tax on banks and bank-like institutions is to ensure that governments’ have a reserve fund to deal with any future financial problems. The idea that such a tax would be universally adopted by the G20 was abandoned in May 2010, but it is still being unilaterally considered by the US and the member of the EU.

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4. Individual Country Progress

4.1 United States

Very little action was taken by the US until May 20, 2010 when the Senate passed (59-39) the Restoring American Financial Stability Bill. This bill still needs to be reconciled with the House before it can be signed into law by President Obama. If enacted, it would be the biggest overhaul of the American financial regulatory system since the 1930s. The legislation is broadly designed to close the regulatory gaps and end the speculative trading practices that contributed to the 2008 financial crisis.

If passed the bill would:

At this stage it is still uncertain how many of these provisions will survive reconciliation and be signed into law. In particular there is a great deal of opposition to the creation of new regulatory agencies.

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4.2 European Union

The EU began discussions on regulatory reforms as early as the beginning of 2009. However, European governments and institutions have so far been unable to agree on a common approach to financial reform.

On September 23, 2009, following the recommendations of the Larosiere report, the Commission proposed a comprehensive legislative package for new EU financial regulation. This included the proposals for:

At the time of writing this report all of these proposals are still stalled in the EU Parliament.

In addition, on April 23, 2010 a Proposal for a Directive on Alternative Investment Fund Managers (i.e. hedge fund managers) was unveiled. This directive will require all EU hedge fund managers to be subject to harmonized regulatory standards on an ongoing basis. It will also enhance the transparency of their activities. More recently, on May 5 2009, the Council of Ministers approved the Regulation on Credit Rating Agencies, which aims at improving the quality of services and transparency of credit rating agencies.

If any of these proposed reforms are implemented they will render most of the regulations enacted or proposed by the UK, Germany and France largely moot.

4.2.1 United Kingdom

On May 12, 2010, the new Conservative government announced its plans for a sweeping overhaul of the country’s financial regulatory system that has been in force since 1997. The proposal will end the current “tripartite” model, where responsibility for financial regulation is shared between three regulator bodies, and will make the Bank of England responsible for spotting asset bubbles. However, the new set-up will still be overshadowed by EU centralization when the Union establishes three new financial regulatory bodies in 2011.

4.2.2 Germany

Frustrated with the slow pace of EU actions, Germany took unilateral steps to tightening financial regulation in the beginning of 2010. On May 18, 2010 the German Federal Supervisory Financial Authority (BaFin) proposed plans for a levy on bank credit exposure positions to create a crisis response cushion fund, as well as the banning of naked short sales of euro-denominated government bonds, credit default swaps based on those bonds, and shares in Germany's 10 leading financial institutions. On June 2, 2010, the German cabinet approved a proposed law that, if passed by parliament, would statutorily ban: all short sales of stocks that have a primary listing in Germany; naked short selling of the euro; and the use of so-called credit-default swaps to bet against European government bonds.

4.2.3. France

France has followed Germany’s lead in acting unilaterally to curb some aspects of financial activity it considers detrimental. On June 11, 2010, the lower house of the French Parliament passed a new finance regulation law (“Loi Lagarde” after the French minister of economic affairs, Christine Lagarde), which will empower AMF, the French finance regulator to ban short-selling on all financial instruments in exceptional circumstances. The new French law could also help prevent some naked short-selling. The AMF would also be able to fine parties guilty of market abuse in the credit default swap (CDS) market and could monitor and fine credit ratings agencies.

4.2.3. Italy

The Italian government has discussed reforms largely in line with the measures considered and implemented by France. However, to date no concrete actions have been taken.

4.3 Japan

Japan has taken no action to tighten its regulations because it already has one of the tightest regulatory environments of any advanced industrialized economy. The reason for this is that Japanese regulations have been progressively tightened since its financial meltdown of the late 1990s. Most recently in 2006 Japan’s finance regulator instituted a “temporary” full ban on naked short sales that continues to this day.

4.4 Canada

Canada has not enacted any reforms to its financial system that can be directly connected to the commitments made at various G8 and G20 summits. The reason for this is that the Canadian financial system was left remarkably untouched by the US sub-prime mortgage crisis. Thus the Canadian government concluded that no regulatory reforms were needed.

However, two significant regulatory reforms have been proposed recently. On May 26, 2010, the federal government proposing a new Canadian Securities Act which would establish a federal securities regulator by the middle of 2011 to replace the current system of provincial regulators. Canada, virtually alone in the developed world, does not have a national securities regulator. However, there are outstanding challenges to the constitutionality of such a national securities regulator. Three provinces (Alberta, Quebec and Manitoba) have refused to participate in the discussions altogether.

Second, on June 12, 2010, the federal government proposed a set of three new finance regulations on: deposit type instruments, registered products, and prescribed products. However, these largely technical proposals have been anticipated since late 2007 under the 2007 Bill C-37 and they do not represent a dramatic change to the regulatory environment.

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5. Explanation of Findings

There are three primary reasons for the limited progress on financial reform and for the observed variations. The first is the ongoing economic crisis. In November 2008, when the first commitments were being made it seemed to most that the crisis had been largely contained and that the time was right to begin a process of financial reforms. Thus a board outline of reforms was proposed at the advice of the Financial Stability Forum (now the Financial Stability Board)

and the April 2009 G20 Summit in London was set as the first check point at which leaders would assess progress in implementing these reforms. However, by early 2009 it became clear that the G20 had underestimated the extent of the economic crisis they were facing. As a result, even before the London Summit, the G20 shifted its focus from financial reforms to economic stimulus. It was necessary to put regulatory reform on hold because of the inherent conflict between efforts to tighten financial regulation on the one hand and to stimulate the economy on the other. The later requires an expansion of liquidity and the promotion of easy lending while the former requires the reining in of lending practices and thus a contraction of liquidity.

The second reason is the difference of opinion on what reforms are necessary and the dominance of the status quo in policymaking. At the time of the Washington Summit there was much excitement about the possibility of using the crisis as an opportunity to make dramatic changes to financial markets. Some even went so far as to call the Summit a second Bretton Woods Conference. However, once the process of designing regulatory reforms began it because clear that there was a great deal of disagreement not just among but also with the countries of the G20. Thus, while there were many different ambitions proposals, few could get more support then maintaining the status quo. As a result most reforms are rather conservative and are adopted nationally or regionally rather than by the G20 as a whole.

The third reason for the observed progress is that there was a great deal of national variation in terms of the need for reform as well as the economic and political circumstance that policymakers find themselves in. Countries like Canada, Japan, Australia and China were not directly affected by the crisis; most of the EU was indirectly affected; and the US and the UK experienced serious domestic financial crises. In addition there was a great deal of variation in terms of the political obstacles to enacting reforms. In the US proposed reforms still face potently strong legislative opinions. Efforts among the member of the EU are complicated by the fact that they are happening at both the national and the supranational level. And in the case of Canada there is a federal vs. provincial dimension to the issue.

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6. Implications for Future Financial Stability

Since the current process of financial regulatory reforms is still largely a work in progress it is too early to assess its final impact on future financial stability. However, it is important that the process has begun and while not as ambition as some would have hoped, it nevertheless represents a positive beginning. Its impact on future global and national financial stability will depend on the G20 sustaining these reforms in a process that may take years.

In terms of the national variation we have observed, this should not be a cause for much concern. The fact remains that there is no global financial system. Rather we have a series of linked national financial systems. They are highly and increasingly connected but they are still very different in terms of their goals, structures and operations. Thus there remains a need for variation in domestic financial regulation but with an eye to the adoption of best practices and increased transparency.

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