By John Rogers
I watched the movie “Contagion” on a recent flight to Asia. It tends to dampen the enthusiasm for culinary adventures.
In reality, it’s a lot more likely that our next global contagion will come from financial markets, and not from some butcher shop in Asia. Everything we know about financial systems points to continued globalization and interdependence. With that comes the near certainty that a systemic crisis in one major market will cause severe consequences in other markets.
Financial crises truly are ill winds that blow no good. As a counterbalance, the need for coordination among regulators, legislators, and others responsible for financial stability has never been higher.
The Process Has Already Begun
As a member of the U.S. Systemic Risk Council, I urge a renewed commitment to international coordination on key issues of systemic financial risk. As financial markets struggle to rebuild, it has become all too clear that no one can safely go it alone. Domestic politics and agendas often distract us from the importance of working across borders to build better markets. It is all too easy to “take a pass” on the difficult decisions and compromises required to build international agreements. Waiting until markets unravel or banks fail to take action is a costly mortgage on future investors and taxpayers.
Back in 2009, the Investors’ Working Group (co-sponsored by CFA Institute and the Council for Institutional Investors) highlighted the importance of international coordination. It called for a consensus on key elements of regulation of global markets, players and products—all with the focus on raising standards. The Group of 20 and the Basel Committee on Banking Supervision, among others, also have recognized the fact that uncoordinated regulatory regimes are insufficient to identify and manage global systemic risk. To oversee a capital market in isolation is not only shortsighted, it also increases the vulnerability of our individual and collective economies to virulent and damaging crises.
In Europe, the Financial Stability Board has taken the lead in coordinating the work of national financial authorities and international standard-setting bodies. It has gotten out front in urging authorities to focus on teamwork when mapping out financial market reforms. Some of these recommendations have gained traction with various bodies. Separately, the Bank of England and U.S. FDIC have issued a joint paper on ways to cooperate in dealing with a future crisis in the banking sector. This is a welcome sign, but at the moment it lacks the legal and jurisdictional clarity required to instill confidence that this set of proposals has teeth.
The Road Ahead
For regulators in 2013, three areas in particular are worthy of focus for international coordination:
Derivatives: As one of the prime suspects in the global financial crisis, the immense and often murky derivatives market needs greater transparency and standardization. We need more robust, transnational clearinghouses that coordinate on process, documentation, and risk control, and are subject to a set of coordinated regulations. International recognition of, and progress toward establishing a legal entity identifier (LEI) system on a global basis is a critical and welcome step on this journey.
Capital adequacy: The tribulations involved in implementing Basel III speak volumes about international coordination. U.S. regulators and the European Union have recently advised they would not meet the January 2013 target date for implementation, leaving 10 countries (including China and Japan) in compliance, but 17 lagging behind. Moreover, the minimum capital requirements that are risk-based vary, with the United States requiring “gold-plated” standards that exceed the minimum threshold of Basel requirements. A fully functioning and therefore useful system requires full and timely compliance and agreement to a system that thwarts regulatory arbitrage.
Financial Reporting: Efforts to harmonize, converge, and improve accounting standards on a global basis have stalled. There is no clear timetable or methodology for U.S. GAAP to come together with the International Financial Reporting Standards, and without that leadership other key regulators are likely to move slowly. The polyglot nature of financial reporting makes doing business more complex and confusing for both issuers and investors. As the G20 has noted, a high-quality set of global accounting standards is an important and worthwhile objective, and it should be made a priority for regulators.
Although policymakers and politicians continue to struggle with their countries’ immediate economic challenges, we cannot afford to become distracted from the long-term importance of coordinating the regulatory framework that supports global financial markets. The health and sustainability of the global economy are worth the effort.
John Rogers is president and chief executive officer of CFA Institute, the global association of investment professionals that sets the standard for professional excellence. He is also a member of the Systemic Risk Council.
The Council is an independent non-partisan group which monitors and encourages regulatory reform of U.S. capital markets focused on systemic risk. It is comprised of a diverse group of prominent academics, financial experts and former government officials. For more information please visit, http://www.pewtrusts.org/systemicrisk and http://www.cfainstitute.org/ethics/integrity/Pages/src.aspx.
(Editor's Note: This is the third in a series of op-ed columns by members of the Systemic Risk Council on a variety of financial reform topics. The views expressed are their own.)