It certainly makes sense to involve private bodies and the representatives of business when creating standards. The technical expertise of these bodies is valuable for ensuring that the goals of the regulation are feasible and achievable.

However, standards are not neutral, they not only provide a public good of a market framework which lowers transaction costs and deters fraudulent behaviour, they also serve those who are setting the standards. One interest of a private body could be to exclude competitors from gaining market share by obligating standards which these competitors can’t fulfill.

In the debate on the causes of the sub-prime crisis, media and academia are discussiong the incentives set by standards. They claim that Basel II has encouraged pro-cyclicality of Bank lending, or that reliance on Credit Rating Agencies in regulation has reduced the banks effort to conduct their own diligent risk management. The overall criticism is levered at governments, central banks and regulators for setting up the wrong system of financial regulation.

Attached to this criticism is the challenge that the current system of co-ordinating financial regulation is not working. Calls for a World Financial Architecture (see book by John Eatwell and others) are being heard.

However, it is often ignored that for standards to be functional, the private sector needs to be a consistent advocator of good standards. This should be reflected in a financial architecture which involves the private sectors in the crucial decisions on standard-setting, impact assessment, implementation and enforcement. Such an involvement is only possible if the private sector can give a coherent response to the demand for consultation coming from the public sector.

What is most striking is that the private sector does not speak with one voice. With ICMA, SIFMA and the IIF there are three private institutions speaking on behalf of the capital market. The G30, as a quasi corporative think-tank, ammends these views on serves as a coordinating body between highly influential individuals in the international financial institutions.

It would be interesting to have a closer look at this network of institutions and individuals:

• Which companies are members of which institution?
• Which individuals are members of which institution?
• Which companies and which individuals are key nodes in this network?
• Is there an overlap of tasks of the private institutions?
• Which formal and informal coordination groups exist between the bodies representing the views of the financial actors?

Would financial institutions disclose this kind of information?

How the global financial architecture evolved and how that influences the probability of crisis is very rarely discussed. In the analysis, the network structures of the global financial architecture is often forgotten.

The financial architecture is the system of public and private bodies which try to influence the regulation and standards required for financial markets to function. These are the the main types of actors in the financial architecture:

• Governments
  1. National governments, in particular finace ministers
  2. Informal meetings of government officials, such as the G7
  3. Supra-national government organisations, such as the EC
  4. International organisations representing the interests of governments, such as the IFM, World Bank, OECD.
• Central banks
  1. National Central Banks
  2. Informal Meeting of Central Bank Governors, such as the G10
  3. Supra-National Central Banks, like the ECB
  4. International Organisations of Central Banks, such as the BIS
• Regulators
  1. National Regulators responsible for
     • Banks and other financial intermediaries
     • Securities Firms and other type of trade of financial derivatives
     • Insurers
  2. Supra-National Meetings of Regulators
     1. with specific regulatory tasks, such as CEBS, CESR or CEIOPS
     2. with over-arching regulatory tasks
  3. International Meetings of Regulators
     1. with specific regulatory tasks, such as BCBS or IOSCO
     2. with over-arching regulatory tasks
• Private Bodies
  1. National Lobbying Group of Financial Institutions
  2. Surpa-National Lobbying Group of Financial Institutions
  3. International Lobbying Group of Financial Institutions
• Academic Consultancies and Think Tanks
• NGOs

The heuristics still has some weakness, but it helps to get a first picture of the financial architecture.

It is difficult to get a meaningful categorization of the private bodies because scope and membership of these private bodies are overlapping. Some of these organizations have identical aims but conflicting interests because they represent financial actors from different regional constituencies without however saying this in their statutes.

The categorization concerning NGOs and Academic Institutions lacks details because they are not the main actors in standard-setting, which is the second part of the financial architecture. So in addition to the actors, a list of standards would be needed which then can be attributed to particular organisations.

There are quite a few hybrid bodies and it is difficult to put them into the system above, such as the FSF. Also the disction between public and private organisations are not as sharps, because many public bodies have advisory councils consisting of representatives from banks or other large financial institutions.

The distinction between regulation, standards and lobbying is also quite blurred. In financial markets, self-regulation and technical standards agreed upon without government intervention play an important role. Regulation sometimes reflects either the attempts of the industry to self-regulate (for instance in Codes of Conduct) or serves the interests of certain part of the industry to keep their competitors out of certain market segments.

The Mapping-Project undertaken here aims to get a better understanding on how standards are produced, how the financial actors communicate and co-operate and how the financial architecture is being build.

Key Questions to be asked will be:

• Decision-Making Process
• Established by law or statute

The existence of risk is a necessary feature of markets. The existence of systemic risk is a necessary feature of highly integrated markets. Both on the national and the international level, there is always the potential for a system-wide collapse of markets because a large number of market participants reassess their risk profiles and act accordingly, for instance by disinvesting from certain asset classes which then leads to decreased liquidity in some parts of the markets.

Market participants should be aware of the existence of systemic risk and price in in their investor decisions. There are several reasons why this is difficult:

• Firstly, it is not easy to locate the first domino-stone which brings a market to a collapse, even if all market participants agree that a collapse is immanent.
• Secondly, it is not easy to price the effects of market collapse on individual asset classes.
• Thirdly, it is very difficult to predict the political economy of market collapses and the bail-out attempts by policy-makers.

Given these difficulties, there is considerable possiblity that market attempts fail to correctly price systemic risk, even if their intentions are well. Also, given these difficulties, it is quite likely that regulators will not necessarily ex-ante be able to predict the right measures to avoid systemic risk.

Another issue needs to be kept in mind: financial products with the highest yields are at the edge of financial regulation. Financial institutions are most competitive where regulation is contradictory, available for regulatory arbitrage or simply not spelled out yet. Therefore most market participants, especially banks, do not mind that systemic risk exists. Systemic risk allows them to make a business.

In essence: systemic risk is not a negative externality that needs to be re-internalized through regulation, as Kern, Eatwell and Dhumale suggest. Systemic risk should be seen as the break up of network-communication inside a system and regulation needs to ensure that communication channels are promptly restored after a market collapse.

In the post-Bretton-Woods-Era, banks and financial instutions have adopted innovative financial instruments to diversify earnings and to hedge against credit and market risk.
[Is this really the case? Wasn't it rather to hedge primarily against exchange rate movements?]
This has led to increased international banking activity and to the rise of multifunctional universal banks. These developments [produced] economic growth and development. But they also made financial institutions more dependent and exposed to systemic risk [...]. [T]hese forces of financial globalisation [led to] efforts to strengthen the institutional framework of financial regulation.

They define Global Financial Governance using three principles (p.15):

• Effectiveness in devising efficient regulatory standards and rules
• Accountability in the decision-making structure and chain of command
• Legitimacy (those subject to international regulatory standards have participated in creating them.

None of these three dimensions are particular to financial markets, so the authors introduce (p. 16) the concept of Systemic Risk, which is an underpricing of risk that spreads through the markets. According to the authors, financial regulation has the task to promote the efficient pricing of risks.

The authors follow (p. 17) the route of Political Economy (especially Douglas North) and Game Theory (especially Robert Axelrod) by looking at the role of institutions in financial regulation. However, in Game Theory and Political Economy, institutions are often defined as “regularities in social behavior” (Axelrod: 1984). Accordingly, international institutions can be defined as “a set of rules that govern the ways in which states cooperate and compete with each other” (Kahler: 1995).

Such a definition would also encompass all kinds of informal or tacit arrangements and agreements. But the authors add a legall dimension to their definition of International Financial Institutions (IFIs). Applying the concept of an institution to the current financial architecture, the authors state “international public- and private sector bodies that are involved in setting standards and rules to govern financial markets” (p. 17) have been created. In other words, the authors use the concept of “institution” dynamically: regularities of behaviour will lead to a set of rules which in turn create a public or private body receiving the mandate to create further rules.

Normally, “global governance” is defined in opposition to “global government”: in the absence of any clear-cut global institutions to act as legislative, executive and judiciary, states create binding international rules. “Global governance” is the process of creating “global institutions” without a “global government”.

The authors however chose to discuss the shortcomings of “Global Governance” in a principal-agent-framework through the “creation and operation of rules at [international] level through the involving transnational and subnational actors” (p. 18). These rules are intended to avoid systemic risk and create financial stability, a “public good [which] will never be provided adequately by the market without regulatory intervention” (p. 18).

Despite their economic background, the authors interestingly seem to have a different notion of “public good” than often used in economic textbooks. Normally, a public good is a non-rival, non-excludable good which means that everybody can have access to it and consuming the good does not diminish the possibility of other users to access it. Yet there are some arguments why financial stability does not necessarily need public regulatory intervention, and even with public regulatory intervention is not necessarily a non-excludable good.

The authors definition of “financial system” clearly shows the ambiguity of having to use a different understanding of a public good. They define a financial system (p. 20) through:

1. the extent of intregation of relevant financial sectors
2. the scope and design of financial regulation and legislation

The authors would hopefully agree that in this sense of financial governance, financial stability becomes a public good for a certain financial systems that are defined through integration and legislation. Global financial governance is providing a public good of financial stability through global integration and global legislation (for instance by setting standards).

The G7 finance ministers asked the FSF at their October 2007 meeting (statement) to analyze the underlying causes of the turbulence, which the FSF did in the first chapter of the report.

The G7 also asked the FSF to offer proposals for liquidity and risk management; accounting and valuation of financial derivatives, role of credit rating agencies in structured finance; supervision of banks and the treatment of off-balance sheet vehicles.

At their February 2008 meeting, they redefined the agenda of the FSF. They urged financial institutions (especially the banks) to disclose their losses. They called for a better liquidity risk management inside Basel-II and to address the problem of off-balance-sheet-vehicles. The G7 Finance Ministers said they were not hostile to a reform of the Basel II capital adequacy framework. They wanted to change the incentives of the originate-to-distribute-modell and address the conflict of interests in the credit rating agencies. They also called for a review of national and international supervisory mechanisms.

Prudential Oversight

Basel II and Minimum Capital Requirements

The report of the FSF calls for a timely implementation of the Basel-II-framework, despite its deficiencies. In 2006 in a response to a questionnaire by the FSI, 95 countries indicated plans to implement Basel II in their jurisdiction (for members of the European Union, Basel II is mandatory). National supervisors are called for evaluating the impact of Basel II and adjust minimum capital levels accordingly.

The BCBS is called to reform Basel II by increasing capital requirements for complex structured credit products such as Colleratlized Debt Obligations of asset-backed securities (ABSs). Together with IOSCO, the BCBS will propose regulation for a better representation of these structured credit products in the trading books of banks and securities firms. The BCBS also wants to strengthen the capital treatment for banks’ liquidity facilities to off-balance sheet asset-backed commercial papers (ABCPs).

On the national level, supervisors are called for to continue to develop the risk assessment framework inside Basel II and the compliance of the banks. One main debate in the financial world is whether the risk-based mininum capital requirements in Basel II encourages procyclicality and supervisors are called to address that.

The role of monoline insurers and financial guarantors is going to be assessed by the IAIS and regulation to be introduced to reflect their relation to structured credit products.

Liquidity risk and liquidity management

Regulators are urged to be more strict in enforcing adequate liquidity risk management. Supervisors and central banks are called to examine an internationally consistent liquidity approach for cross-border banks. Pillar 2 (supervision) is strengthened to avoid that banks build up excessive exposures to liquidity risk.

The BCBS together with national supervisors is going to reassess the use of internal risk-models to ensure comparability between financial institutions. One priority is the guidance relating firm-wide risks, including concentration risks. Again, this includes liquidity risk associated with off-balance-sheet-vehicles, securitisation business and exposure to leveraged counterparties (such as Hedge Funds). Institutional investors are urged to be more cautious when investing in structured products.

Regulators are also called to review compensation models to avoid giving incentives for inappropriately risky conduct of financial business and more focus on long-term, firm-wide profitability.

Over-the-Counter Derivatives

The FSF calls for Market participants to improve the standards for credit derivative trade documentation in accordance with the not yet implemented cash settlement protocol. Standards for the accuracy and time lineless of trade data submissions for OTC derivatives should be improved. The financial industry as a whole is urged to develop reliable operational infrastructure supporting OTC derivatives.

Transparency and Valuation

Accounting, Disclosure and Auditing

Financial institutions should disclose their risks aand supervisors should enforce risk disclosure requirements under Pillar 3 of Basel II (with the help of the BCBS). Financial institutions are encouraged to disclose their losses in their upcoming mid-year 2008 reports.

The IASB is asked to propose an international disclosure standard for off-balance sheet vehicles and strengthen the standards to achieve better disclosures about valuations, methodologies and the uncertainty associated with valuations. The IASB is also called to improve its guidance on valuing financial instruments when markets have dried up (an advisory panel will be set up for that). The BCBS is called to enhance the supervisory assessment of banks’ valuation processes and help supervisors reinforce sound practices.

The auditing of complex or illiquid financial products needs to be improved. Therefore the International Auditing and Assurance Standards Board (IAASB) and major national audit standard setters are required to rexamine the standards in that area.

Transparency in securitisation processes and markets

Securities market regulators and the securities need access to more information on securitised products and their underlying assets. Originators, arrangers, distributors, managers and Credit Rating Agency need to be more transparent at each stage of the securitisation chain by standardising information about assets underlying structured credit products. Securities market regulators will set up a comprehensive system for post-trade transparency of the prices and volumes traded in secondary markets for credit instruments.

Changes in the role and uses of credit ratings

Rating process

Credit Rating Agencies (CRAs) should improve the quality of the rating process and manage conflicts of interest in rating structured products. IOSCO will revise its Code of Conduct Fundamentals for Credit Rating Agencies and CRAs will revise the implementation of this code.

CRAs are called to differentiate ratings on structured finance from those on bonds, and expand the initial and ongoing information provided on the risk characteristics of structured products. They should expand the information on the risk characteristics of structured products.

CRAs should enhance their review of the quality of the data input and of the due diligence performed on underlying assets by originators, arrangers and issuers involved in structured products.

Uses of ratings by investors and regulators

The over-reliance on ratings by investors needs to be decreased. Ratings should not replace appropriate risk analysis and management on the part of investors.

Authorities will also review the use of ratings in the regulatory and supervisory framework. by checking the roles assigned to ratings in regulations and supervisory rules and their consistency with theobjectives of having investors make independent judgment of risks and perform their own due diligence.

Strengthening the authorities’ responsiveness to risks

Translating risk analysis into action

The FSF criticizes that Supervisors, regulators and central banks need to have adequate resources and expertise to oversee the risks associated with financial innovation and to ensure that firms they supervise have the capacity to understand and manage the risks. They should communicate to firms’ boards and senior management at an early stage their concerns about risk exposures and the quality of risk management and the need for firms to take responsive action.

The FSF will increase its own risk analysis and recommendations, both directly and through the actions of its members through a mechanism for regular interaction at senior level with private sector participants, including investors and CRAs, for prompting mitigating actions to identified risks and weaknesses.

The use of international colleges of supervisors will be expanded so that for each of the largest global financial institutions a college of supervisors exist.
To increase the speed of supervisory responsiveness to developments that have a common effect across a number of institutions, supervisory exchange of information and coordination in the development of best practice benchmarks needs be improved at both national and international levels.

To facilitate central bank mitigation of market liquidity strains, large banks will be required to share their liquidity contingency plans with relevant central banks.

International regulatory, supervisory and central bank committees will strengthen their prioritisation of issues and, for difficult to resolve issues, establish mechanisms for escalating them to a senior decision-making level. As part of this effort, they will establish timetables for required action and action plans for addressing delayed or difficult issues.

National supervisors will, as part of their regular supervision, take additional steps to check the implementation of guidance issued by international committees.

The FSF will encourage joint strategic reviews by standard-setting committees to better ensure policy development is coordinated and focused on priorities.

The FSF and IMF will intensify their cooperation on financial stability, with each complementing the other’s role. As part of this, the IMF will report the findings from its monitoring of financial stability risks to FSF meetings, and in turn will seek to incorporate relevant FSF’s conclusions into its own bilateral and multilateral surveillance work.

Robust arrangements for dealing with stress in the financial system

Central bank operations

Central bank operational frameworks should be sufficiently flexible in terms of potential frequency and maturity of operations, available instruments, and the range of counterparties and collateral, to deal with extraordinary situations. To meet an increased but uncertain demand for reserves, monetary policy operational frameworks should be capable of quickly and flexibly injecting substantial quantities of reserves without running the risk of driving overnight rates substantially below policy targets for significant periods of time.

Policy frameworks should include the capability to conduct frequent operations against a wide range of collateral, over a wide range of maturities and with a wide range of counterparties, which should prove especially useful in dealing with extraordinary situations.

To deal with stressed situations, central banks should consider establishing mechanisms designed for meeting frictional funding needs that are less subject to stigma.

Central banks should have the capacity to use a variety of instruments when illiquidity of institutions or markets threatens financial stability or the efficacy of monetary policy.

To deal with problems of liquidity in foreign currency, central banks should consider establishing standing swap lines among themselves. In addition, central banks should consider allowing in their own liquidity operations the use of collateral across borders and currencies.

Arrangements for dealing with weak banks

Authorities will clarify and strengthen national and cross-border arrangements for dealing with weak banks. Domestica authorities will review the division of responsibilities of different national authorities for dealing with weak and failing banks.

National authorities should agree a set of international principles for deposit insurance systems. National deposit insurance arrangements should be reviewed against these agreed international principles, and authorities should strengthen arrangements where needed.

For the largest cross-border financial firms, the most directly involved supervisors and central banks should establish a small group to address specific cross-border crisis management planning issues. Authorities should share international experiences and lessons about crisis management. These experiences should be used as the basis to extract some good practices of crisis management that are of wide international relevance.

The Chicago Board of Trade set up the Chicago Board Options Exchange in 1973, the American Stock Exchange and the Philadelphia Stock Exchange began trading stock options in 1975, the Pacific Exchange in 1976.

Mental note: find out when other Stock Exchanges (in the other G7 countries) opened their options markets and see if that relates to the profound changes in the markets going on after the end of fixed exchange rates (and if so why exchange rate regimes suddenly have an impact on the organization of stock markets).

• Institution: International Capital Market Association
• Abbreviation: ICMA
• Type: Private
• Founded: 2005 (History: In 1969, banks and securities houses established the Association of International Bond Dealers (AIBD). In 1984, IPMA, the International Primary Market Association, was established by AIBD member banks as the separate trade association for the leading banks and investment banks. In 1991, AIBD became the International Securities Market Association (ISMA). In July 2005 the International Securities Market Association (ISMA) and the International Primary Market Association (IPMA), created ICMA.
• Members Total: 400 Financial Institutions.
• Membership in: IOSCO (SRO Consultative Committee), ICSA (see also ICMAs membership in international organisations)
• Membership of:
• Description: The International Capital Market Association (ICMA) is the self-regulatory organisation and trade association representing the financial institutions active in the international capital markets worldwide.
• Working Group:
• Outreach: not applicable
• Reporting to:
• Website:http://www.icmagroup.org/
• Highest Organ: General Meeting (Organisation)
• Chair: Hans-Joerg Rudloff, Barclays Capital Securities Limited
• Seat: Zurich and London
• Function:
• Standards:

• Institution: Institute of International Finance
• Abbreviation: IIF
• Type: Private
• Founded: 1983
• Members Total: 350 members headquartered in more than 60 countries. Mostly commercial banks, but membership is also open to Securities firms, Fund managers. Law firms, Multinational companies, Stock exchanges, Trading companies, Central banks, Advisory firms, or Rating agencies, Multilateral agencies, or National agencies.
• Membership in: none
• Membership of: World Bank
• Description: The Institute of International Finance was created in 1983 in response to the international debt crisis. Members include most of the world’s largest commercial banks and investment banks, as well as a growing number of insurance companies and investment management firms.
• Working Group: Steering Committee on Regulatory Capital, Steering Committee on International Insurance Regulation, Steering Committee on Effective Regulation, Group of Trustees, Committee on Market Best Practices
• Outreach: Does not apply
• Reporting to: Does not apply
• Website: www.iif.com
• Highest Organ: Board of Directors
• Chair: Josef Ackermann
• Seat: Washington, DC
• Function: Lobbying body of the multinational banks
• Standards: Principles for Stable Capital Flows and Fair Debt Restructuring in Emerging Markets

• AIBD – Association of International Bond Dealers, now ICMA.
• BCBS – Basel Committee on Banking Supervision
• BIS – Bank for International Settlements
• CEBS – Committee of European Banking Supervisors
• CEIOPS – Committee of European Insurance and Occupational Pensions Supervisors
• CESR – Committee of European Securities Regulators
• CGFS – Committee on Global Financial Stability
• CPSS – Committee on Payment and Settlement Systems
• DC – Development Committee of the IMF and World Bank
• EBR – European Bank for Reconstruction and Development
• ECB – European Central Bank
• EIB – European Investment Bank
• ECSDA – European Central Securities Depositories Association
• FATF – Financial Action Task Force
• FSF – Financial Stability Forum
• FSI – Financial Stability Institute
• G5 – Group of Five
• G7 – Group of Seven
• G8 – Group of Eight
• G10 – Group of 10
• G20 – Group of 20
• G22 – Group of 22
• G24 – Group of 24
• G30 – Group of 30
• G33 – Group of 33
• IAASB – International Auditing And Assurance Standards Board
• IADI – Internatioal Association of Deposit Insurers
• IAIS – International Assocation of Insurance Supervisors
• IASB – International Accounting Standards Board
• IASC – International Accounting Standards Committee
• IC – Interim Committee of the Board of Governors on the International Monetary System
• ICMA – International Capital Market Association
• IFC (BIS) – Irving Fisher Committee on Central Bank Statistics
• IFC (World Bank)- International Finance Corporation
• IFIAC – International Financial Institutions Advisory Commission
• IIF – Institute of International Finance
• IMF – International Monetary Fund
• IMFC – International Monetary and Financial Committee
• IOSCO – International Organization of Securities Commissions
• ISSA – International Securities Services Association
• IWCFC – Interim Working Committee on Financial Conglomerates
• JF – Joint Forum
• London Club
• OECD – Organzation for Economic Cooperation and Development
• Paris Club
• World Bank

Standards

• ISSA Recommendations
• G30 Recommendations

Evolution

1999

• Work of IFIAC (Meltzer-Report)