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Abstract A Deloitte sponsored Bretton Woods International Committee event on financial reform, on October 8, 2010 in Washington, D.C., brought industry leaders together to discuss serious issues. The discussions among these government and industry leaders focused on complex reform design and implementation challenges following the recent financial crisis that undermined system and economic stability worldwide. Whether speaking globally or domestically, the issues were essentially the same - progress has been made on reforms, but challenges remain on further defining reform regiments and in implementing the reforms in a consistent manner. Governing bodies have been established to attain and sustain financial system stability, regulate all systemically important financial institutions, heighten capital and liquidity standards, and establish cross-border recovery and resolution regimes. The consistency of implementation is critically important with the interrelationships and international nature of the financial services industry, as well as the volume and velocity of daily transactions on a worldwide basis. Without consistent implementation, including macro-prudential regulation, supervisory arbitrage could result thereby undermining reforms involving systemically important financial institutions and orderly recovery and resolution regimes. The confidence expressed by the leaders in progress made toward meaningful reforms was encouraging, with the admonitions for working together within the domestic reform structures, as well as across international bodies providing worthy caution, advice and ideas for how to sustain the system and economic stability universally desired.
On October 8, 2010 in Washington D.C., the Bretton Woods Committee (BWC) hosted its annual International Committee meeting, with Deloitte as a strategic sponsor for the event, its content, and tenor. BWC and Deloitte were able to bring leaders from governments and financial services organizations from across the world to discuss the implications of global financial and economic reform for government and industry. Three panels of distinguished speakers presented viewpoints from around the world on policy choices impacting microeconomic challenges; the status, progress and direction of global financial regulatory reform; and the risks and vulnerabilities for sustaining financial stability. Christine Lagarde, Minister for Economy, Industry and Employment of France, captured the theme of the event in saying: “Our leaders had committed that there would be no market, no product, no player that would not be either regulated or supervised, and we need to make sure that we continuously deliver on that commitment, given that there is a lot of invention in the financial markets. We need to make sure that the regulations and supervisory authorities adapt to this creativity.” Following are summaries of the discussions. For more detailed information, please go to http://www.deloitte.com/us/globalreforms.
Disclaimer: The views and opinions expressed in this document are not those of Deloitte, but of the conference participants. As used in this document, “Deloitte” means Deloitte LLP and its subsidiaries. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries.
Panel 1 Microeconomic Challenges: Policy Choices and Global Cooperation — Regional Perspectives
• James D. Wolfensohn, Bretton Woods Committee Co-Chair (moderator) • Tharman Shanmugaratnam, Minister for Finance, Singapore • Christine Lagarde, Minister for Economy, Industry and Employment of France In this broad policy and economic discussion, panelists addressed a question posed by the moderator on the importance of sustaining the economic recovery and regulatory reform momentum through macroeconomic policy. Panel members told the audience that there needs to be more of a focus on long-term structural issues than shortterm headlines, such as the deleveraging that is currently taking place and interacting with economic slowdowns. Without a long-term focus, countries are likely to veer from one short-term crisis to another. The long-term structural issues pre-date the recent crisis, but are complicated by the need to recover from the economic slowdowns in the crisis. To improve long-term prospects, the panel identified three points that need to take place: • Develop strategies that lay the basis for optimism in the most advanced countries in the world. Demand from leading economies inspires a whole set of supply chains and what keeps everyone wanting to catch up with the advanced players. This includes strategies to grow economies and overcome unacceptably high levels of unemployment. • Tackle the growing problem of social cohesion, with median income for households having stagnated for nearly two decades. This has resulted in two-tier labor markets, where a significant number of people, principally the young, women, and minorities, are left either without entry into the market or with inferior jobs. It is no longer tenable if you want to recreate optimism in both the advanced and emerging markets. • Respond to the challenge of a new phase of globalization, characterized by the growth of an emerging market middle class seeking education, health, clothing, better food, and entertainment. In countries like China, rising wages are being driven by those moving up the skills ladder and entering the global market in medium to high skilled jobs beyond the traditional production industries to knowledge-based services. The panel also called for countries to continue to sustain economic recovery by coordinating regulatory reform efforts through forums like the G-20 thereby avoiding protectionism. In that vein, the panelists discussed three priorities for these forums: actual enforcement and implementation of the agreed upon regulatory and supervisory environment; sustain the momentum on non-corporate jurisdictions including the exchange of information relative to prudential obligations; and enhance global governance to avoid temptation for protectionism. • International monetary system loopholes compel greater organization, coordination, and diversification among the G-20 and G-7, including tempering currencies to protect developing countries and reducing risk when currencies are not diversified—rebalancing what is obviously out of balance now. • Commodities in terms of price-setting, light focused on visibility and predictability, and market organization relative to raw materials, tangibles, and intangibles. This includes stocks, inventories, and reserves for good supervision of commodity derivative products. • Sustain the momentum on global governance involving issues like implementing the 2008 Quota reform and the review of the IMF board composition. This includes combining the appropriate ownership of the G-20 and representation within it, and working with the other global organizations such as the WTO, IMF, FSB, OECD, and others.
Panel 2 Financial Regulatory Reform: Current Status, Implementation and Harmonization Globally
• Richard Spillenkothen, Financial Services Director, Deloitte & Touche LLP (moderator) • Jaime Caruana, General Manager of the Bank for International Settlements • Daniel Tarullo, Member, Board of Governors of the Federal Reserve System • Barry Zubrow, Chief Risk Officer and Executive Vice President of JPMorgan Chase & Co. • Mark Carney, Governor of the Bank of Canada This panel discussion covered a wide range of regulatory questions posed by the moderator, including principal changes in Basel III, the importance of institutional issues, implementation issues that banks will face under the new global capital standards, and the need for a common resolution framework. The principal changes that Basel III will introduce include significantly higher quality and greater amounts of capital, and liquidity standards as buffers for banks to withstand shocks. Key elements of reform, especially through Basel III and other organizations include the quality and level of capital as well as expected liquidity ratios. The difference in the quality of capital was emphasized as being even more important than the higher levels required, with risk-weighted assets and risky products factored into the standards along with a leverage ratio as a backstop. The increased levels include a macro-overlay, which provides two additional buffers. One buffer deals with systemic risk by conserving or restricting some asset benefit distributions; and the other, which still needs to be refined, is to avoid the pro-cyclicality of risk-based capital requirements. The decision to phase-in the new capital standards and liquidity ratios afford a transition to prevent interfering with economic recoveries. A theme of institutional changes needed for an efficient and effective organization of international financial regulatory activity was discussed, including working out relationships among the various international bodies particularly in light of broadening activities. • The various international bodies that are directly or indirectly involved in global financial regulation will need to develop effective working relationships, particularly in light of the broadening of activities resulting from the metamorphosis of the Financial Stability Forum into the Financial Stability Board (FSB) and because of the very increased membership of the FSB and the Basel Committee on Banking Supervision. • The Financial Stability Board and Basel Committee will need to embrace the new members who were added in 2009. The panel called for the new members, who represent emerging market countries, to take leadership roles numerous subcommittees and working groups within both bodies. • The Basel Committee will need to monitor effectively the implementation of the new capital and liquidity standards. Panel members noted that there appears to be considerable variation in the risk weightings that are being applied by different banks around the world. This suggests that institutional mechanisms will need to be employed to help insure the strengthened capital standards lead to consistency in the minimum amount of capital actually held by firms, as well as in the provisions of the regulations that are applicable to them. The panel also addressed the effects of the new capital ratios, noting that 1% of Tier 1 capital under existing standards will become 7% effective under Basel III when the new capital
buffers and other elements are better defined and taken into consideration. Success in implementing these elements will be important to the success of the overall Basel package, as a lack of success will cause countries to rethink minimum capital and what is an appropriate level for their respective country. In addition, the panelists said that contingent capital or bail-ins are central to addressing moral hazard. There is a firm conviction among policy makers that losses in any future crisis should be borne by the institutions themselves— management, creditors, shareholders—rather than taxpayers. The question raised is, how do you do that? There were two options discussed: one based on contingent capital and the other on bail-inable capital. The contingent capital would apply to a “gone concern” when it reaches the point of non-viability and is depleting its capital, promoted by a statutorily authorized supervisory decision. An advantage is it provides an incentive to existing shareholders to monitor, discipline management and avoid the situation. The second option, on the other hand, involves moving up the credit stack, basically going to unsecured debt and put in the indenture, a pre-set haircut. This would actually provide an incentive for existing debt holders to discipline management. In any event, the systemically important financial institutions (SIFI’s) must be subjected to one of these options in the future. The Basel III changes in risk weighted capital (RWC) for SIFI’s may mean the minimum common equity capital is five times higher than pre-crisis levels. Those capital levels, along with the focus on the calculation of RWA, should provide sufficient capital for SIFI’s to support the type of business and economic growth around the world desirable for these institutions. The commonality in the application of the capital
rules is considered important and a clear ordering of priorities for SIFI’s to operate on a level playing field internationally. There remains a lot of work to be done both domestically and internationally to get all the reforms defined and implemented, with industry tracking as many as 453 mandates for rulemaking across the regulatory landscape and something like 60 studies to be completed to inform the rulemaking. So, the calibration of the rules continue, including around liquidity, as does the responsibility for industry and governments to work together to make sure they do not lead to adverse, unintended consequences on our various economies. The same themes were raised in answers to questions from event participants on subjects like the Volcker Rule, contagion, accounting rule alignment, and information sharing. Advice that was offered was to have: the right people at the table, like the Financial Stability Oversight Council; proactive, mandated information sharing; and a role in financial stability for each of the agencies to ensure balance. The right data and analytical framework was emphasized over and over again as being critical, especially for identifying counterparties and contagion.
Panel 3 Sustaining Financial Stability: Risks and Vulnerabilities — Central Banker and IMF Perspectives
• Donald L. Kohn, Former Vice Chairman, Board of Governors of the Federal Reserve System and Senior Fellow, Brookings Institution (moderator) • Dominique Strauss-Kahn, Managing Director of the International Monetary Fund • Henrique de Campos Meirelles, Governor of the Central Bank of Brazil • Zhou Xiaochuan, Governor of the People’s Bank of China • Jean-Claude Trichet, President of the European Central Bank The final panel peered into the future from the panelists’ various perspectives through questions posed by the moderator. Among the topics: the future of global regulation; macro-prudential regulation; slow growth and sustained low interest rates; and emerging market implications. Panel members acknowledged the global banking organizations’ accomplishments have reduced uncertainties about reform, thereby bringing greater stability to the financial system, while acknowledging that more definition is necessarily under development, and expressing concern about remaining cognizant of reform implications on both industrial and emerging economies. Questions were raised by panelists about whether macro-prudential regulation is simply a worthy concept or theory, or one that would become a reality through consistent implementation of reforms both domestically and internationally. Consistent supervision, within and across jurisdictions, is key to macro-prudential regulation becoming a reality through heightened standards and orderly resolution processes. Central banks have played a critical role in using monetary policy tools for implementing macro-economic policies and the low interest-rate environment in which banks are operating. Sustaining such extraordinarily low interest rates over a long period of time along with slow economic recovery, growth, and resource utilization may have implications for systemic stability, especially when associated with accumulating loan problems and declining property values. A challenge, especially for industrial economies, may be to maintain financial stability when it is time to once again begin normalizing monetary policy. Panel members also expressed concern about systemically important financial institutions (SIFI’s), and called for increased cooperation among regulators, supervisors, and investors to provide greater transparency and incent everyone to do their homework. Closing regulatory loopholes through SIFI regulation and supervision was cited as critically important to systemic stability. They also said that supervisory discretion is important, both nationally and globally, which can be accomplished through the consistent implementation of standards along with appropriate sharing of information. The last crisis showed that, even within jurisdictions, problems of sharing of information undermines otherwise sound institution supervision and resolution and precludes critically important systemic insights. One way to mitigate SIFI risks offered was to apply the standards to all subsidiaries, which would make each sustainable within their own capital and make resolution regimes easier to implement. However, resolution regime cooperation across jurisdictions may be reliant on clear definitions on who is going to absorb losses, take haircuts, and share in resolution costs. Resolution regimes were
thought to be important on both global and national levels to make sure they are consistent and everyone knows what each entity will have to pay in case of failure. The compromises between jurisdictions was discussed as having struck the right balance along with the right calibration and transition for implementation to make sure stronger capital and liquidity standards do not adversely impact systemic and economic recovery. Addressing the issue of liquidity, the panel discussed the need for greater balance of liquidity in advanced and emerging economies, or risks the build-up of liquidity in the financial system, households and corporations. Excess liquidity as well as currency mismatched poses different problems somewhat unforeseen before this crisis both in the market place and industrial and emerging economies. Capital and reserves are among the tools to deal with excess liquidity along with strengthening risk analysis procedures. At the end of the day, the recent crisis has demonstrated the importance of paying close attention to high liquidity and high growth during good economic times as that is when the problems are built but not necessarily detected. Members also said that the global banking system cannot rely simply on efficient-market theory to provide financial stability — there is a need for macro-prudential regulation. Before the crisis, regulators assumed that if all financial institutions were healthy and well-supervised, the financial system in the aggregate would be healthy. But such micro-supervision of individual financial institutions proved inadequate. Central banks may need to pay more attention to market competition and financial institution health, rather than relying on monetary policy to keep interest rates and inflation low, which may reduce the reliance on
being the lender of last resort and increasing responsibility for crisis management. Panel members also said they welcomed more academic studies and newly instituted peer reviews to help the global banking system improve. In concluding remarks, the panel called for the members of the international banking community to continue to cooperate as they did during the financial crisis. Panelists said that by working together, they were able to create innovative solutions to address the crisis and take steps to preclude a crisis of this global magnitude again. This crisis represented about 25% to 27% of GDP on both sides of the Atlantic which demonstrated it was a global problem intensely impacting all of the advanced economies. With taxpayers at risk and moral hazard problems evident, it is apparent we cannot afford the exceptional measures taken that were necessary to avoid a depression on a global basis. Also critically important is involving and engaging both industrial and emerging markets in the international bodies, with everyone taking responsibility and fully participating and cooperating for global ownership. This is important for a level playing field and for avoiding supervisory arbitrage. Addressing the new capital requirements, panelists agreed that much work remains to be done, specifically regarding SIFI’s and the issue of resolution. The discussion recognized the need for a level playing field that would avoid regulatory arbitrage, and concluded by noting there is no time for complacency in the movement to achieve consistent and effective global banking regulation.
Bretton Woods Panelists
Panel 1 — Macroeconomic Challenges: Policy Choices & Global Cooperation — Regional Perspectives • James D. Wolfensohn, Bretton Woods Committee Co-Chair (moderator) • Christine Lagarde, Minister for Economy, Industry and Employment of France • Tharman Shanmugaratnam, Minister for Finance, Singapore Panel 2 — Financial Regulatory Reform: Current Status, Implementation and Harmonization Globally • Richard Spillenkothen, Senior Advisor, Deloitte & Touche LLP (moderator) • Jaime Caruana, General Manager of the Bank for International Settlements • Daniel Tarullo, Member, Board of Governors of the Federal Reserve System • Barry Zubrow, Chief Risk Officer and Executive Vice President of JPMorgan Chase & Co. • Mark Carney, Governor of the Bank of Canada Panel 3 — Sustaining Financial Stability: Risks and Vulnerabilities — Central Banker and IMF Perspectives • Donald L. Kohn, Former Vice Chairman, Board of Governors of the Federal Reserve System and Senior Fellow, Brookings Institution (moderator) • Dominique Strauss-Kahn, Managing Director of the International Monetary Fund • Henrique de Campos Meirelles, Governor of the Central Bank of Brazil • Zhou Xiaochuan, Governor of the People’s Bank of China • Jean-Claude Trichet, President of the European Central Bank
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