G-20 Takes First Steps on Global Regulatory Reform

In this, the second installment of abfjournal.com�s Web-exclusive content, Christopher Moraff reports on the G-20 Summit in Pittsburgh to provide our Web readers with first-hand coverage of the event as the heads of the world�s 20 largest economies gathered to tackle a number of issues ranging from giving greater oversight to the IMF to addressing compensation issues with executives at the major finance houses.By Christopher Moraff
Associate Editor at Xander Media Group, Inc., Publisher of ABF Journal and the MonitorAt the end of September, the heads of state of the world�s 20 largest economies gathered in Pittsburgh — the third such meeting since the start of a global credit crisis plunged much of the world into a recession. But where the prior meetings of the G-20 were concerned with performing triage on a rapidly worsening economy, this time the focus of discussion was largely on how to prevent such a disaster from happening again.

�Our key objective for the summit is to establish consensus on much stronger standards across our financial systems,� said Treasury Secretary Timothy Geithner, speaking to reporters on the evening of the first day. �We are not going to walk away from the greatest economic crisis since the Great Depression and leave unchanged, and leave in place, the tragic vulnerabilities that caused this crisis.�

On the table at the two-day summit — which ran from Sept. 24-25 at Pittsburgh�s David L. Lawrence Convention Center — were a series of reforms aimed at standardizing fiscal accountability and trade practices among the world�s leading and emerging economic powers.

The official agenda included proposals to balance trade, give a more robust oversight role to the International Monetary Fund (IMF), boost capital requirements for large banks and tie compensation to performance at the world�s major finance houses. The delegates made progress on each of these issues to varying degrees.

The G-20 also announced an expanded role for developing nations in crafting global economic policy going forward. Following the official dinner on the opening night, the White House announced that the delegates had reached a historic agreement to make the G-20 the primary forum for international economic cooperation — a role that was traditionally the domain of the G-8. The move means more input from countries like Australia, Indonesia and Brazil, which under President Luiz Lula De Silva has been emerging as a main player on the world stage.

But the key agenda issue, by far, was to reach some agreement on a unified regulatory regime to establish basic levels of fiscal discipline across the world economy. In its communiqu�, released at the end of the summit, the G-20 outlined how it plans to do that.

�We committed to act together to raise capital standards, to implement strong international compensation standards aimed at ending practices that lead to excessive risk-taking, to improve the over-the-counter derivatives market and to create more powerful tools to hold large global firms to account for the risks they take,� the leaders said. �Standards for large global financial firms should be commensurate with the cost of their failure. For all these reforms, we have set for ourselves strict and precise timetables.�

Among other things the G-20 nations committed to developing international rules to improve both the quantity and quality of bank capital and to discourage excessive leverage by the end of 2010. The rules will be phased in as financial conditions improve and economic recovery is assured, with the aim of implementation by 2012.

In making its determination the G-20 deferred largely to recommendations set forth by the Basel Committee on Banking Supervision, which had met on Sept. 6 — less than three weeks before the summit — to issue a set of proposals that it said would �substantially reduce the probability and severity of economic and financial stress.�

Among these proposals are steps to standardize the definition of capital across jurisdictions to allow for easy comparisons to be made across institutions. The Basel Committee said the predominant form of Tier 1 capital must be common shares and retained earnings, while appropriate principles need be developed for non-joint stock companies to ensure they hold comparable levels of high-quality Tier 1 capital.

The Committee�s oversight body reached agreement on key measures including national implementation of higher level and better quality capital requirements, counter-cyclical capital buffers, and higher capital requirements for risky products and off balance sheet activities.

�These measures will result, over time, in higher capital and liquidity requirements and less leverage in the banking system, less procyclicality, greater banking sector resilience to stress and strong incentives to ensure that compensation practices are properly aligned with long-term performance and prudent risk-taking,� said Nout Wellink, chairman of the Basel Committee and president of the Netherlands Bank.

The summit has not been without its critics, most of which say that while the G-20 may have drafted a timeline for a set of viable principles, getting everyone on the same page going forward will be a challenge.

�The Pittsburgh meeting affirmed the need for this new regime, but the timetable for reform is vague and the G-20 partners have different ideas about what happens next,� wrote commentator Clive Crook in the National Journal. �Right now, U.S. banks are better capitalized than many of their European counterparts, so Europe is complaining that it will be harder for its banks to execute [the] proposal. This disagreement is liable to slow the introduction of new rules and might lead to their being watered down.�

Central to their criticism is that a lack of mechanisms for enforcing the new rules leaves too much open to interpretation and relies to heavily on the honor system. Instead of concrete benchmarks the framework calls for �peer review� where members meet periodically to gauge each nation’s policies.

�Without sanctions, this agreement doesn’t mean anything,� said University of Maryland economist Peter Morici in The Wall Street Journal. �The countries will just discuss changes and make statements.�
A Global Leadership Forum

The G-20, which was founded in 1999 with its inaugural meeting in Berlin, has traditionally been a coalition of finance ministers, as well as representatives from the IMF, the World Bank and the International Monetary and Financial Committee. But with the financial crisis, the summits have evolved into a global leadership forum of developed and developing nations.

In November 2008, President George W. Bush convened the first G-20 meeting of heads of government in an emergency session in Washington to focus on fixing the global economy. The leaders met again in April 2009, in London, laying the groundwork for Pittsburgh by detailing a list of goals that would be addressed. These included: reform of the global regulatory system, climate change, a global accounting standard, corporate governance and executive compensation, bank capital requirements, and reform of the international financial institutions like the IMF and World Bank.

The ministers also used the April summit to expand the mandate of the Financial Stability Forum � a coalition of central bankers formed in 1999 � to create the Financial Stability Board (FSB). The FSB is charged with monitoring vulnerabilities in the global financial system and, along with the IMF, developing and implementing regulatory, supervisory and other policies in the interest of financial stability.

The FSB was also given the task of drafting compensation principles for bank executives.

On Sept. 25 the FSB issued its report, �Implementation Standards for the FSB Principles for Sound Compensation Practices,� which called for aligning compensation with long-term value creation, not excessive risk-taking.

Specifically the proposal calls for avoiding multi-year guaranteed bonuses, and requiring a significant portion of variable compensation — as much as 40%-60% — to be deferred, tied to performance and subject to appropriate clawback. The FSB also suggested that a portion of bonuses be vested in the form of stock or stock-like instruments. The proposals also recommend ensuring that compensation for senior executives and other employees having a material impact on the firm�s risk exposure is aligned with performance and risk.

�Compensation at significant financial institutions is one factor among many that contributed to the financial crisis that began in 2007,� the FSB said. �Given the commitment to ensure a level playing field, these implementation standards must be rigorously and consistently implemented by significant financial institutions throughout the world.�

But again, in adopting the FSB principles the G-20 deferred the creation of any enforcement regime to ensure the recommendations are put into practice. The FSB said it will periodically review actions taken by firms and by national authorities to implement its principles, but in reality it has little teeth to enforce them. Instead it depends on each nation to develop and enforce its own standards.

Here at home, the Obama administration�s �pay czar,� Kenneth Feinberg is expected to issue by mid-October his determination on compensation packages for 175 of the most-highly compensated executives and employees at the seven firms he oversees. The companies are: American International Group, Bank of America, Citigroup, General Motors, GMAC Financial Services, Chrysler and Chrysler Financial.

Feinberg is planning to shift a chunk of an employee’s annual salary into stock that cannot be accessed for several years, The Wall Street Journal reported.

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