INTRODUCTION

The U.S. financial regulatory architecture works to meet the country's unique objectives. However, there are certain universal themes that characterize the approach toward financial regulation across all jurisdictions. Further, there are regulatory challenges that can only be addressed through international planning and coordination. This chapter provides an introduction to several key international regulators and standards that facilitate international approaches and coordination.

After you read this chapter you will be able to:

• Understand the importance of the Financial Stability Board.
• Describe the Basel Accords.
• Understand the role of the European Systemic Risk Board.
• Describe the Principles for Financial Market Infrastructures.

THE FINANCIAL STABILITY BOARD

The Financial Stability Board (FSB) is an organization, made of the member institutions presented in Table 8.1, that works to promote international financial stability. The FSB was formed by the G20—an international forum consisting of 20 major economies—following the Credit Crisis. Before the crisis, international coordination in relation to issues of financial stability was limited. There was an organization—the Financial Stability Forum—that worked to promote international financial stability, but it was ineffective. This is illustrated in the following quote from an article by Stuart P.M. Mackintosh, the executive director of the Group of Thirty:¹

Before 2008, there was no effective mechanism to overcome (or at least mitigate) the tendency to diverge from, instead of converge on, common goals. An entity did exist, called the Financial Stability Forum, but it had no power or authority. In addition, its mission was unclear, it was unrepresentative, it lacked balanced advanced and emerging market membership, its resources were minimal, it did not oversee other actors' output, and it did not report upwards to political leaders.

The FSB identifies financial systemic risks, generates policy responses, and monitors the execution of responses through the following three standing committees:

1. It identifies financial systemic risks through its Standing Committee on Assessment of Vulnerabilities.
2. It generates policy responses through its Standing Committee on Supervisory and Regulatory Cooperation.
3. It monitors the execution of responses through its Standing Committee on Standards Implementation.

The FSB's policy responses, while influential, are “soft laws” that are not legally binding on its member jurisdictions. Member jurisdictions have a number of obligations, which include periodic peer reviews and the implementation of key standards for sound financial systems as presented in Table 8.2.

A characteristic of the FSB that is distinct from other international finance regulators is the heavy participation of elected politicians or political appointees, as noted by law professor Stavros Gadinis in an article published in the Texas International Law Journal.³ Gadinis observes that approximately a quarter of the participants in the FSB's plenary, the main decision-making authority of the FSB, is made up of finance ministers and treasury secretaries. The ability of politicians to intervene in international financial regulation represents a shift away from the pre–financial crisis approach, which focused on regulatory independence.

THE BASEL ACCORDS

The Basel Accords are multinational accords that set minimum capital requirements for banks. They are referred to as the “Basel Accords” as they were established by BIS's Basel Committee on Banking Supervision, otherwise known as the “Basel Committee.” The Basel Accords have evolved over time in response to new risks and challenges. Basel I set the original minimum capital adequacy ratio requirements. Basel II revised Basel I's capital framework and is organized with the three pillars of minimum capital requirements; supervisory review of the bank's internal assessment of its capital adequacy; and market discipline through minimum disclosures requirements. Basel III implemented additional revisions to the capital framework, examples of which are constraints on the bank's ability to payout earning; a countercyclical capital buffer; standards, and monitoring in relation to liquidity; and new requirements for global systemically important banks.

This book explores the Basel Accords in detail in Chapter 13.

THE EUROPEAN SYSTEMIC RISK BOARD

The European Systemic Risk Board (ESRB) provides macroprudential oversight of the EU's financial system and works to mitigate systemic risk. The creation of the ESRB, which occurred in 2010, was driven by the 2009 de Larosière report, which is a report by a group formed by the EU that was chaired by Jacques de Larosière. The de Larosière report argued that the financial crisis was driven by several failures, including a lack of adequate macroprudential supervision; ineffective early warning mechanisms; failures to challenge supervisory practices on a cross-border basis; and no means for supervisors to take common decisions, among others.⁵ To address these failures, the de Larosière report recommended the creation of a new entity at the EU level. The creation of the ESRB occurred as a result. The ESRB plays a role in EU similar to the role of the Financial Stability Oversight Council (FSOC) in the United States, and both were established in response to the Credit Crisis of 2007–2009.

The voting and non-voting members of the ESRB are presented in Table 8.3. The ESRB provides guidance and recommendations in relation to the EU's Capital Requirements Directive (CRD) and Capital Requirements Regulation (CRR). EU directives, such as the CRD, allow the Member States of the EU individually to decide how to transpose the directive into national laws. EU regulations, such as the CRR, have binding legal force throughout the EU.

To work toward its objective of mitigating systemic risk, the ESRB has identified four sources of risk to financial stability as follows, as well as indicators of each source of risk and instruments through which it can be addressed:⁷

1. Excessive credit growth and leverage: This source of risk is addressed through capital buffers and minimum loan-to-value and loan-to-income requirements.
2. Excessive maturity mismatch and market illiquidity: This refers to the risks associated with funding of long-term investments in illiquid assets using short-term funding. This source of risk is addressed through stable funding restrictions and liquidity charges.
3. Direct and indirect exposure concentrations: This source of risk is addressed through large exposure restrictions.
4. Misaligned incentives and moral hazard: This source of risk is addressed through capital surcharges for systemically risky institutions as well as a systemic risk buffer.

PRINCIPLES FOR FINANCIAL MARKET INFRASTRUCTURES

The Principles for Financial Market Infrastructures (PFMI) are international standards for the management of financial market infrastructures (FMIs), which are entities that facilitate the clearing, settlement, and recording of financial transactions. Specifically, the PFMI target the following entities:⁸

• Systemically important payment systems
• Central securities depositories
• Securities settlement systems
• Central counterparties
• Trade repositories

The PFMI were established by the Committee on Payments and Market Infrastructures (CPMI) and the Technical Committee of the International Organization of Securities Commissions (IOSCO). The CPMI is the BIS committee that promotes the safety and efficiency of payment, clearing, settlement, and related arrangements.⁹ The IOSCO is an international organization of securities regulators that sets standards for securities markets. The main objective of the PFMI is to enhance the safety and efficiency that the CPMI promotes, with the broader objectives of limiting systemic risk, facilitating transparency, and financial stability.¹⁰

The PFMI are structured as 24 principles and 5 responsibilities, organized as follows:

• General organization principles
• Credit and liquidity risk management principles
• Settlement principles
• Central securities depositories and exchange-of-value settlement systems principles
• Default management principles
• General business and operational risk management principles
• Access principles
• Efficiency principles
• Transparency principles
• Responsibilities of central banks, market regulators, and other relevant authorities for financial market infrastructures

Table 8.4 presents all of the PFMI's principles and responsibilities.