Stability board holds key to implementing G20 regulatory measures

The Group of 20 Summit in Pittsburgh last week saw government leaders agree on important regulatory measures concerning bank capital and compensation, resolution of cross-border institutions and trading of over-the-counter derivatives, a top U.S. official said in congressional testimony this week.

It also spotlighted the enhanced stature and key future role played by the Financial Stability Board, founded as an informal group of regulators in 1999 and now outfitted with a charter, a membership expanded to include the entire G20, and a mandate to watch over global finance and coordinate regulation internationally.

Highlighting the role of the U.S. in establishing and shaping the FSB, Treasury official Mark Sobel said before a Senate panel: “We can be confident knowing that the international machinery to strengthen the international financial system is in place, has set forth principles and standards for reform that are consistent with the administration's plans for reform, and is working to bring global standards up.”

It was the FSB that drafted the regulatory principles and agreements discussed at the G20 summits in Washington last November and in London in April, as well as in Pittsburgh, Sobel said.

“Since the onset of the current financial crisis, the FSB has been a critical mechanism for setting forth a comprehensive agenda for reform, reflecting an international consensus, and monitoring the implementation of G20 leaders' action points,” said Sobel, who is acting assistant secretary of the Treasury for International Affairs.

It was when he was responsible for international affairs at Treasury, Sobel noted, that the current secretary, Timothy Geithner, was instrumental in setting up the Financial Stability Forum in the wake of the Asian financial crisis to improve international regulatory coordination.

Federal Reserve Board Gov. Daniel Tarullo, testifying at the same hearing this week before Senate Banking’s subcommittee on Security and International Trade and Finance, likewise emphasized the importance of the FSB.

“The financial crisis has underscored the importance of the original motivation for creating what is now the FSB,” Tarullo said. “The connections among financial market sectors, and between macroeconomic policy and financial markets, mean that efforts to ensure international financial stability must incorporate a breadth of perspectives.”

Axel Weber, president of the German central bank and a member of the European Central Bank’s governing council, left no doubt when he met with a group of U.S. journalists last week that the FSB is where consensus on regulatory matters is hammered out.

Weber is a member of the FSB steering committee that helped draft the measures put before the G20 leaders. While FSB chairman and Bank of Italy governor Mario Draghi is considered the leading contender to succeed ECB president Jean-Claude Trichet in 2011, Weber is also a candidate. Together, the two central bank governors bring a lot of firepower to the FSB.

In his testimony, Treasury’s Sobel was at pains to stress that the policies of the U.S. and the FSB are in sync, and that the U.S. has a major role in shaping the FSB policies. In addition to Treasury, the Fed and the SEC are also represented on the board.

“The agendas pursued by the FSB and United States have been and are closely aligned,” Sobel said. The President’s Working Group on Financial Markets, headed by Treasury, makes sure the U.S. speaks with one voice at the group, he said.

The FSB nonetheless has its critics. Simon Johnson, an MIT professor and former chief economist at the International Monetary Fund, has been a consistent critic of the administration’s handling of the financial crisis, arguing that it has gone too easy on the banks.

He also sees the efforts of the FSB and the G20 summits as promoting so much bureaucratic double talk that will not lead to any significant changes.

“This is a sophisticated delaying action and you are seeing masters of economic policy spin at work,” Johnson wrote ahead of the G20 summit in his blog, Baseline Scenario. His forecast for the outcome: “Nothing meaningful.”

The measures agreed upon do remain vague. In his testimony, Sobel lists four areas where the Pittsburgh summit achieved significant agreement:

• Capital. G20 leaders agreed to develop rules to improve the quantity and quality of bank capital and to discourage excessive leverage by end-2010. The agreement recognizes that capital standards are at the core of the reform effort, in line with the priorities set out by Geithner at the G20 ministerial meeting in London ahead of the summit.
• Compensation. G20 Leaders endorsed standards to help financial institutions and regulators better align compensation with long-term value and risk management.
• Cross-border banking resolution. G20 leaders agreed to establish crisis management groups for the major cross-border firms and to strengthen their domestic frameworks for resolution of financial firms. Prudential standards for the largest and most-interconnected firms should be commensurate with the costs of their failure.
• OTC derivatives. G20 leaders built on the work already undertaken in this area, agreeing that all standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms and cleared through central counterparties by end-2012.

Just how effective any of these measures will be depends on their implementation, and here again the FSB is expected to play a crucial role.

“The FSB will be an important forum via which we will assess progress, and thematic peer reviews of members are planned on the implementation of many of the G20 action items,” Sobel said.

The Financial Times reported already this week one area where U.S. officials might be interpreting new G20 rules differently than other major countries.

The agreement said a “substantial portion” of bonus payments, such as 40 to 60 percent, should be paid out over several years. According to the FT, the U.S. considers the 40 to 60 percent a suggestion, but not a definitive limit for what constitutes a substantial portion, so that some bonuses could have a bigger portion paid out more quickly.

This should give MIT’s Johnson more grist for his mill as evidence that the G20 measures are a smokescreen of reform rather than any substantive change. The FSB will have the burden of proof as the main executor of the G20 resolutions to show whether he is wrong.