U.S. Treasury - Office of International Affairs

Monday, June 29, 2009
Deputy Assistant Secretary for International Monetary and Financial Policy Mark Sobel
Remarks to the European Forum of Deposit Insurers at the Fédération Bancaire Française
The Global Crisis Response and the Role of US-EU Cooperation

Thank you. The crisis has underscored that sound deposit insurance systems are critical and this conference is important because EFDI plays a key role in contributing to the stability of regional financial systems and promoting cooperation among member countries in the field of deposit guarantees. I also appreciate EFDI’s collaboration with the International Association of Deposit Insurers and the U.S. Federal Deposit Insurance Corporation.

Amidst the most severe crisis in generations, Secretary Geithner has remarked that we each may not be in the same boat, but we are in the same storm. Today, I will touch upon the origins of the crisis and highlight some of the key elements of the global response. I will reflect on the work that lies before us, and the critical importance of global cooperation in achieving further progress.

My themes will be: that although regulation is a national activity, global approaches are needed to address the challenges of our global financial system; that countries, through the Financial Stability Board and G-20, are succeeding in putting forth a robust strategy; but that more remains to be done. In advancing this agenda, the United States and the European Union will have critical roles to play in striking the right balance between promoting sound regulation and preserving market dynamism, while ensuring that their actions are firmly anchored in the global system.

The origins of the largest financial crisis in generations are complex and will be written about for many years to come. But while historians will have the benefit of time to reflect, policymakers faced an urgent need for action. Useful assessments by the BIS in its annual reports and by the IMF in its Global Financial Stability Report informed our efforts in real-time.

These assessments focused on three dimensions. First, global macroeconomic drivers, including the uneven distribution of global demand as reflected in the emergence of large persistent current account imbalances. Second, these imbalances and their financing interacted with market dynamics – large capital flows depressed yields, setting off a reach for yield, which in turn spawned the development of complex and opaque instruments, carry trades, increased leverage, and other manifestations of effervescence. These dynamics combined with a third driver, regulatory and supervisory failures.

Let me be clear, I am not pointing fingers. In hindsight, neither market participants nor regulators adequately appreciated the risks inherent and embedded in financial products, let alone the aggregation of risks across the system. Supervisors and regulators were hindered in their assessments by virtue of the fact that they are always behind the markets and they took an institution-by-institution approach, depriving them of a more encompassing view of the forces at play.

An analysis of the macroeconomic origins of the crisis is beyond the scope of today’s presentation. But the issue of regulatory and supervisory lapses offers a good starting point for discussion.

As the crisis broke out in the fall of 2007, the United States put forward an international strategy to tackle the roots of the crisis which was quickly embraced by the G-7. That strategy put the Financial Stability Forum (now the Financial Stability Board) in a key role.

The U.S. strategy was premised on the reality that, on the one hand, regulation is a national activity and the responsibility for sound regulation begins at home, and on the other, that our financial system is global and financial stress can spread easily and quickly across national boundaries. The benefits of dynamic and efficient global financial markets also need to be preserved. Yet the challenge we face is how to square the circle – how do we preserve the dynamism of our markets while strengthening and respecting the national character of regulation? The answer is to be found in robust regulation at home and strong cooperation internationally, working especially through standard setting bodies and the informal coordination of the FSB, with a view to ensuring more consistent and convergent approaches and avoiding regulatory gaps, spillovers, and regulatory arbitrage. The IMF is also an essential actor in this strategy, as it can bring its critical macroeconomic and systemic focus to bear.

The strategy is working. Impressive progress is being made on two fronts. First, the FSB seized the challenge, producing excellent reports in April and October 2008 which set forth comprehensive recommendations for increasing the resilience of markets and institutions. Importantly, the reports were reflected in the November and April G-20 Leaders Declarations. Second, vigorous national actions are being taken. Let me cite some of the accomplishments starting with the FSB’s work.

Systemic Risk: A key lesson of the crisis is that it is not enough to address the potential insolvency of individual institutions – we must also insure the stability of the system itself. To this end, the international community is enhancing its macro-prudential approach, especially among large interconnected firms. We are extending the regulatory perimeter by ensuring oversight of all financial institutions, instruments, and markets that could pose a significant risk to the financial system. Further, hedge funds or advisors to hedge funds above a minimum size will be registered and required to disclose appropriate information. The infrastructure for derivatives trading is being strengthened, and actions are underway for smooth clearing of standardized CDS through central counterparties while ensuring enhanced disclosure of information on OTC derivatives.

Prudential oversight: We are strengthening the international framework for prudential regulation. While policy-makers are not seeking to strengthen capital adequacy in the midst of the crisis, they have embraced the principle of stronger capital and liquidity cushions to ensure that financial regulation dampens rather than amplifies economic cycles. The Basel Committee on Banking Supervision announced proposed increases in regulatory capital requirements for bank trading book exposures, including complex and illiquid credit products. G-20 Leaders also agreed that risk-based capital requirements should be supplemented with a simple, transparent, non-risk based measure that is internationally comparable and can help contain the build-up of leverage. U.S. regulators already employ a leverage ratio, which is a critical component of our regulatory regime. Guidelines for harmonization of the definition of capital are expected by end-year.

Risk Management: The agenda encompasses strengthened risk management. Firms failed to embrace a comprehensive assessment of risk in their institutions, and risk management tools often proved limited. Compensation practices at some firms created a misalignment of incentives that amplified a culture of risk-taking. Major institutions are now assessing strengths, weaknesses, and gaps in their risk management practices in relation to public and private sector recommendations. In addition, the FSB published principles intended to reduce incentives towards excessive risk taking caused by the structures of compensation schemes. Going forward, supervisors will assess large financial firms’ compensation policies as part of their overall assessment of their soundness. Also, the Basel Committee has published principles that aim to increase banks’ resilience to liquidity stress.

Transparency/Disclosure: Strengthened transparency and disclosure are critical in recognizing and identifying emerging risks. Improved and converged accounting standards are a critical component of this effort and the IASB and FASB have published consistent guidance on the application of fair value accounting in illiquid market conditions. The US is strongly committed to a global set of high quality accounting standards; progress on the FASB and IASB convergence work will be important to meet this objective. Credit rating agencies play a key role in offering standardized assessments of risk to markets, but more effective oversight of their activities is essential. All major credit rating agencies have adopted codes of conduct based on the IOSCO Code of Conduct Fundamentals, which have been strengthened to directly address conflicts of interest relating to structured products. Further, the Code is now being imported into national legislation so that it can be enforced by local regulators.

Strengthening Supervisory Cooperation: We have also acted to improve supervisory cooperation. Supervisory colleges are up and running for the thirty most significant global financial institutions. In addition, the IMF, FSB, World Bank, and Basel Committee are working together to develop an international framework for cross-border bank resolutions. At a national level, regulators are implementing the FSB principles for cross-border crisis management.

Our successes in international cooperation are also being backed up by fundamental changes at home. Our countries have acted aggressively to support systemically important financial institutions, unfreeze credit markets, and ensure that financial institutions have adequate capital.

In the United States, we extended guarantees under an FDIC program and capital under the Troubled Asset Relief Program. As you know, we recently undertook detailed bottom-up stress tests of the health of our nation’s 19 largest banks. The process projected future losses to ensure that banks had enough capital to sustain lending even in the face of a deeper recession. Since the results were published, banks have repaid $70 billion and raised equity capital of $85 billion. It is clear that the rigor and transparency of this exercise have been beneficial in reducing uncertainty and strengthening the resilience of our markets. President Obama has also set forth a bold proposal to create a new foundation for financial regulatory reform. It will:

Our regulatory reform initiatives align closely with those advocated by the FSB and G-20 Leaders. As part of our efforts, we are fully committed to strengthening the integrity of the global financial system. President Obama has tabled plans to get tough and curb abuses from tax havens and remove incentives for shifting jobs overseas. Further, the G-20 Leaders endorsed a U.S. “Trifecta” proposal, which aims to raise international standards in the areas of prudential supervision, tax information exchange, and anti-money laundering/terrorist financing. Our proposal aims to do so through reliance on peer review processes in the relevant fora – the FSB, the OECD Global Forum on Taxation, and the FATF – on the basis of fairness, due diligence, and objective assessment.

This is a major record of accomplishment achieved rapidly, and one which highlights the strong binds among major countries. There is more work to be done, of course, but these changes will transform the supervisory and regulatory landscape across the world. In this spirit, we welcome the enlargement of the FSB to include all G-20 members and remain confident that its evolution should help strengthen global financial system for many years to come.

We recognize that the EU is now addressing many of the same issues that we are coping with daily. Indeed, the EU is strengthening its focus on systemic risk regulation and on supervisory consistency across its member states. It is only fitting that this effort has been named after Jacques De Larosiere, the author of the eponymous Report, because he is one of the world’s greatest and most gracious financial statesmen of our time.

Since I am in Europe, I must emphasize that the U.S. and the EU have been critical engines of this successful strategy and have been at the heart of the effort to balance regulation and dynamism. This is not a new role for us, but one that we have long cultivated. For seven years, the U.S.-EU Financial Markets Regulatory Dialogue has worked through a number of critical issues, minimizing inconsistencies and major spillover effects. The Dialogue worked through the third country effects of the Financial Conglomerates Directive, facilitated accommodations to Sarbanes-Oxley, resulted in a U.S. roadmap to accept public listings by EU firms using IFRS, and addressed European concerns related to de-registration from U.S. markets and U.S. concerns that the Markets in Financial Instruments Directive reflect the realities of global trading. Looking forward, the U.S.-EU Financial Markets Regulatory Dialogues faces a large and complex agenda.

National regulators on the front lines, under the pressure of a crisis, will inevitably feel the pressure first and foremost to take care of the home market. None of us are immune. But just as we shoulder the immense burden of returning the financial sector to stability and modernizing our regulatory regimes, the U.S. and the EU also have a special responsibility to intensify cooperation and reaffirm our commitment to preserving the global nature of markets, while ensuring sound and consistent regulation.

We will never be identical. But there is much that can go wrong if we do not respect our differences while working to forge consistency around high quality standards and practices anchored in the global financial system. Further in a world of mobile capital, no single jurisdiction can achieve its regulatory objectives in isolation. Hence, we cannot go our own ways, deviating significantly from international standards or practices, and exposing global markets to the risk of fragmentation. Nor should we impose standards on one another if we are not identical. Rather, we should pragmatically ensure that both sides achieve high quality and similar outcomes in our regulatory and supervisory practices and that our firms can operate in each others’ jurisdiction without encountering needless friction. Fortunately, given our collaboration in standard setting bodies, the FSB, and other global fora, this should not be a tall order.

In this spirit, we must maintain momentum on the agenda before us. We must keep the convergence work of the FASB and IASB on track towards the goal of a single set of high quality global accounting standards. Credit rating agencies must be subjected to a more rigorous supervisory regime, consistent with the IOSCO Code of Conduct, but we cannot go so far as to prevent them from operating globally when they adhere to strengthened standards. For hedge funds, we must register them and make sure they are not posing a threat to financial stability, while letting them pursue global strategies on the basis of sound management practices. We should deal with the differences in the business models of hedge funds and private equity. We also must continue our collective work to achieve comprehensive reform of OTC derivatives, while respecting the work to achieve greater integration of global payments systems. We must also work together to address trans-Atlantic concerns over the operation of globally active insurance firms. Lastly, consistent with the spirit of our collaboration, we must continue to strengthen supervisory cooperation, in part by facilitating cross-border crisis management arrangements and resolution mechanisms.

In conclusion, we have come a long way since the onset of market turbulence two years ago. But it is also clear that much more remains to be done.

I cannot emphasize enough the importance of preserving the strong international coordination and convergence that have been the driving forces behind our swift and effective response to this global crisis. I can assure you that the proposed U.S. regulatory reform has international cooperation at its heart and we remain committed to working bilaterally with the EU and multilaterally through the G-20, FSB, and standard setting bodies to advance our shared agenda. As President Obama has stated, we did not choose how this crisis began, but we do have a choice in the legacy this crisis leaves behind.

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