Financial Reform Watch

With the G20 meeting in Washington, DC (also dubbed “Bretton Woods II”) only a couple of days away, world leaders are working to maintain a balance between managing excessive expectations and scrambling to develop consensus solutions that will allow them to claim at least limited success. While the organizers of the original Bretton Woods meeting in the early 1940s had the luxury of abundant time to develop the blueprint for the world’s financial architecture, present summiteers are squeezed between rapidly falling markets and, at least in the United States, a political power vacuum. President-elect Barack Obama will not attend the summit, nor will he meet with any of the world leaders separately. The Obama transition team has provided few details other than to say the president-elect’s aides will attend the summit and may meet separately with some of the foreign representatives over the weekend.

Several European stakeholders have in the past days issued their suggestions for the development of a new global financial architecture, many of which no doubt will impact the final outcome. The EU leaders met on 7 November and agreed to a common position for the G20 meeting, outlining actions to be implemented within 100 days, starting this Saturday:

• Submit rating agencies to registration, surveillance, and rules of governance.
• Adopt the principle of convergence of accounting standards and examine the fair value accounting rule’s effects on the financial sector and whether it should be modified.
• Establish that no market segment, no territory, and no financial institution should escape proportionate and adequate regulation or oversight.
• Establish codes of conduct to avoid excessive risk-taking in the financial sector, including in the area of executive compensation, where some maintain that current incentives are biased toward high-risk, short-term behaviour.
• Assign the International Monetary Fund (IMF) the initial responsibility, together with the Financial Stability Forum, of recommending the measures needed to restore confidence and stability.
• Give the IMF the necessary resources and appropriate instruments to support countries in difficulty and conduct macroeconomic surveillance.

Not to be seen dragging its feet any further, the European Commission on 12 November put forward a proposal for new legislation concerning rating agencies. The proposal, which had been in preparation for some time, contains new and far-reaching rules that, if enacted, will alter the mechanics of the industry. Separately, the Centre for Economic Policy Research (CEPR) on 10 November issued a report, “What G20 Leaders Must Do to Stabilise Our Economy and Fix the Financial System,” with 17 articles written by leading economists, including Nobel laureates.

Treasury Secretary Henry Paulson provided the list of issues the United States wishes to address this weekend:

• risk management practices;
• compensation practices;
• oversight of mortgage origination and the securitization process;
• credit rating agencies;
• OTC derivative market infrastructure; and
• regulatory practices in the various countries.

He characterized the summit as an “important step” and cautioned, “If we only address particular regulatory issues—as critical as they are—without addressing the global imbalances that fuelled recent excesses, we will have missed an opportunity to dramatically improve the foundation for global markets and economic vitality going forward.” While acknowledging that attendees at the summit will represent the 20 largest economies in the world and over 77 percent of global GDP, Paulson tried to limit expectations, explaining, “This weekend provides opportunity for nations to take an important step, but only one step, on the necessary path to reform.”

The G20 meeting could become the starting point for a new wave of regulation, as many predict. The skeleton of the new global financial architecture could become discernable in a few days time as the meeting in Washington closes. Or, depending on the response of the incoming Obama Administration, the summit may merely be a preview of more meetings to come over the next several months.