New International Initiatives – Levelling the Playing Field?

One of the key international responses to the recent financial crisis has been to look at the extent to which enhanced regulation and supervision of the finance sector can prevent similar crises in the future.

Previously, whilst there was a plethora of international standards, whether for banking, insurance securities etc, the method of enforcing such standards has been, at best, patchy, with some of the most powerful jurisdictions being some of the worst culprits. Standard setters had few, if any, teeth and relied very heavily upon consensus to achieve their goals. It was comparatively simple to push for change in the so-called offshore centres, but to tackle the issues of supervision of the US insurance market?

One way of resolving this has been to significantly extend the remit of key supervisory monitoring bodies. The most important of these is likely to be the Financial Stability Board (FSB).

The FSB formally replaced the Financial Stability Forum (FSF) and held its inaugural meeting in Basel in June 2009. The FSB has a much wider remit, with an expanded membership and a broader mandate to promote financial stability.

The FSB was established to “coordinate at the international level the work of national financial authorities and international standard setting bodies, and to develop and promote the implementation of effective regulatory, supervisory and other financial sector policies.”

Its membership comprises the G20 countries, together with a number of international bodies and standard setters, such as the Basel Committee on Banking Supervision (BCBS), International Association of Insurance Supervisors (IAIS), International Accounting Standards Board (IASB) and the International Organisation of Securities Commissions (IOSCO). The Financial Action Task Force (FATF) is not a member.

A number of countries have more than one body as members. For example, the UK has the Bank of England, Financial Services Authority and HM Treasury. The number of seats a jurisdiction has is designed to reflect the size of their national economy, financial market activity and national financial stability arrangements.

This breadth of the FSB’s membership may cause some logistical difficulties. With 70 members there is a risk of delays and inefficiencies. This risk is reflected in the FSB’s charter, which even sets out the seating arrangements for plenary meetings, stating:

Delegations with more than one seat have one representative seated at the back. Representatives sitting at the back have the rights of the table. Representation at the table can be changed according to the topic discussed.

The FSB has been tasked with a number of key initiatives, one of which is in relation to uncooperative jurisdictions. The FSB is doing this by encouraging the adherence of all countries and jurisdictions to international financial standards, including by identifying non-cooperative jurisdictions and assisting them to improve their adherence.

This initiative responds to a call by the G20 Leaders at the April 2009 London Summit.

The initial focus of the initiative is on adherence to international cooperation and information exchange standards in the financial regulatory and supervisory area.

The initiative is part of a framework that the FSB is putting in place for encouraging stronger adherence to international standards more broadly. In this framework, FSB member jurisdictions have committed to lead by example. This includes agreeing to implement international financial standards, participate in international assessments, and disclose their degree of adherence. In addition, FSB members will undergo periodic peer reviews focused on the implementation and effectiveness of international financial standards and of policies agreed within the FSB.

The FSB is following a far more detailed and consistent approach for evaluating adherence to international cooperation and information exchange standards in the financial regulatory and supervisory area than the FSF did.

In the view of the FSB, the three key financial regulatory and supervisory standards are the BCBS Core Principles for Effective Banking Supervision, the IAIS Insurance Core Principles, and the IOSCO Objectives and Principles of Securities Regulation.

The FSB has prioritised a pool of jurisdictions to be further evaluated, based on their importance in the financial system and the available information on their compliance with the relevant standards. These jurisdictions are to be invited to engage in a confidential dialogue with the FSB in order to further evaluate their adherence and identify ways to improve adherence. The identities of the jurisdictions invited to engage in a confidential dialogue have not been disclosed outside the FSB.

To determine the jurisdictions to be engaged in dialogue, two criteria were used:

• financial importance has been gauged based on a combination of economic and financial indicators; and
• existing information on adherence to international cooperation and information exchange standards based on the Reports on the Observance of Standards and Codes (ROSCs) prepared by the IMF and World Bank, as well as signatory status under the IOSCO Multilateral Memorandum of Understanding (MMoU).

The first source of information on compliance is the detailed assessment from ROSCs related to BCBS, IAIS and IOSCO standards, which may be part of a Financial Sector Assessment Program (FSAP) or a stand-alone report. If a jurisdiction publishes the detailed assessment, then the grades can be used to assess directly the degree of compliance with the relevant principles for the three key regulatory and supervisory standards. A jurisdiction is not to be further evaluated if it was assessed by the IMF and World Bank and found to be “compliant” or “largely compliant” with all, or all except one, of the relevant principles in the three standards considered collectively, or with the relevant principles in those standards for which the jurisdiction’s activity in that sector is of systemic importance relative to its GDP.

Signatories to the IOSCO MMoU who have been assessed as compliant or largely compliant with all, or all except one, of the relevant principles in the BCBS and IAIS standards considered together need not be further evaluated. Signatories are listed in Appendix A of the IOSCO MMoU. In cases of an IOSCO member listed on Appendix B of the IOSCO MMoU as having committed to becoming a signatory to the MMoU, the FSB will consult with IOSCO to understand the obstacles and discuss possible ways forward. The jurisdiction being evaluated will be informed about the results of these consultations.

In order to lead by example, all FSB member jurisdictions for which there is not at present sufficient existing evidence of strong compliance will be assigned a high priority for further evaluation. The FSB has also begun to launch its first country peer reviews. These focus on the implementation and effectiveness of financial sector standards and policies agreed within the FSB, notably through systematic and timely follow-up to relevant recommendations arising from a recent IMF-World Bank FSAP. Based on the schedule of recently completed FSAPs, Italy, Mexico and Spain will undergo a country peer review in 2010. Peer review reports will be published once they are approved by the FSB Plenary.

To undertake an evaluation, the FSB’s approach will be similar to that of the IMF. It will form an expert team to examine all relevant, existing information, including information provided by the authorities on developments since the latest IMF-World Bank ROSC. The expert team will be composed of specialists in banking, insurance and securities regulation and supervision as appropriate. The expert team will engage in dialogue with the jurisdiction and, if needed, encourage the authorities to request a new assessment of compliance from the IMF-World Bank, either through an FSAP or through stand-alone ROSCs.

The expert team will then prepare a preliminary evaluation report, on which the jurisdiction will be invited to comment. The report will evaluate compliance and recommend a timetable of actions to address the weaknesses identified. The FSB will then approve the report and the measures to promote adherence, including whether to list the jurisdiction as non-cooperative.

Given the acknowledged lack of teeth in previous review processes, the FSB has established a “toolbox “of measures to promote adherence. The toolbox is a balance of both positive and negative measures.

The appropriate measures to promote adherence will vary from jurisdiction to jurisdiction, depending on the types of weaknesses in adherence that are identified. The FSB will seek to use positive measures in the first instance, such as policy dialogue and technical assistance, where possible and likely to be effective.

After a jurisdiction is listed as non-cooperative, the FSB has stated that the following negative measures could be appropriate to safeguard the global financial system and to apply additional pressure to improve jurisdictions’ adherence. In particular, if one year after the approval of the evaluation report by the Plenary a jurisdiction has not made sufficient progress towards adherence, then FSB could call upon its members to take further measures, including:

• suspension of membership privileges: jurisdictions publicly listed as non-cooperative could be suspended from participating in the FSB and other bodies;
• advisory letter to financial institutions: an advisory letter could be published to serve as a warning letter to financial institutions to be careful in conducting business in the identified non-cooperative jurisdiction;
• increased regulatory requirements on financial institutions: increased “know-your-customer” obligations could be applied for financial institutions doing business with individuals or legal entities established or registered in non-cooperative jurisdictions. Also, increased reporting requirements could be applied for financial institutions doing business with individuals or legal entities established or registered in non-cooperative jurisdictions;
• increased supervisory examination: home country supervisors could consider location in a non-cooperative jurisdiction as a factor in deciding to increase examinations of its financial institutions’ operations in the jurisdictions;
• increased audit requirements: home country supervisors could consider location in a non-cooperative jurisdiction as a factor in deciding to require increased external audit requirements of its financial institutions’ operations in the jurisdictions;
• higher capital requirements: supervisory bodies could be asked to apply stricter requirements, such as higher capital requirements, to financial institutions operating in jurisdictions that are publicly listed as non-cooperative;
• restrictions on financial institutions: home country supervisors, in a manner consistent with the legal framework of each country and with their international obligations, could refuse to allow their financial institutions to open new operations in jurisdictions that are publicly listed as non-cooperative, or could require them to close existing operations in jurisdictions that are publicly listed as non-cooperative;
• restrictions on transactions by international financial institutions: the FSB could ask international financial institutions to review their policies for investment in non-cooperative jurisdictions and for conducting financial transactions through intermediaries operating in non-cooperative jurisdictions. Any such actions by international institutions would have to be taken in a manner consistent with their respective articles and rules;
• restrictions on cross-border financial transactions: in extreme cases of continued non-adherence to international standards, governments or supervisory authorities, as appropriate and according to the legal framework of each country and in a manner consistent with international law and international obligations, including those under the Articles of Agreement of the IMF, could restrict or even prohibit financial transactions with counterparties located in non-cooperative jurisdictions. Measures could include restrictions on home financial institutions from entering into correspondent banking relationships with counterparties located in non-cooperative jurisdictions.

The overriding message is clear. The crisis has finally woken the international community to the truth that systemic and other risks lie primarily, not in the smaller specialist centres, but in the major centres. Maybe at last we will have the level playing field we have sought for so long.

Marcus Killick OBE
Marcus is Chief Executive Officer at ISOLAS LLP and is a retired English Barrister and member of the New York State Bar as well as a Chartered Fellow of the Chartered Institute for Securities and Investments. Prior to joining ISOLAS, Marcus was Chief Executive Officer of the Gibraltar Financial Services Commission. Marcus also sits as a non-executive director on a number of boards including the Gibraltar International Bank and BetVictor. He is also a non-executive member of the Independent Monitoring Authority set up to safeguard EU citizens’ rights in the UK and Gibraltar post the UK leaving the EU. Marcus was awarded the OBE in the 2014 New Year’s Honours List.