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Towards a new architecture of the international
and European financial system after the recent
financial turmoil A systematic approach
concerning the range of the pragmatic
choices Christos Vl. Gortsos Associate
Professor of International Economic Law,
Panteion University of Athens, Secretary
General, Hellenic Bank Association January 2009
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Table of Contents

• A. Observations Considerations
• B. Annex 1 Current regulatory initiatives in
  order to address the reasons of the financial
  turmoil
• C. Annex 2 The institutional governance of the
  international architecture of the financial
  system
• D. Annex 3 The institutional governance of the
  European architecture of the financial system
  (the example of the banking sector)

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A. Observations - Considerations

• Basic assumptions
• 1.1 The view that the financial system functions
  without the existence of regulatory or
  supervisory framework or that it is
  self-supervised does not correspond to the
  reality
• 1.2 The neoclassic model according to which the
  modern financial system is structured includes
  the assumption of market failures, i.e.
• the absence of information asymmetry, and
• the absence of negative externalities
• The objective of the regulatory intervention is
  to address them

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A. Observations Considerations (cont.)

• 1.3 In the developed economies the existing
  regulatory intervention in the financial system
  consists of strict rules that seek to ensure the
  following policy requirements
• Ensuring the stability of the financial system as
  a whole and of its specific sectors and
  infrastructures (banking sector capital markets
  insurance markets payment systems, clearing
  and settlement)
• Ensuring the effectiveness of capital markets and
  investor protection
• Ensuring the effectiveness of payment systems
• Ensuring the protection of consumers of financial
  services
• Combating the financial crime

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A. Observations - Considerations (cont.)

• 2. The existing international architecture of the
  monetary and financial system
• 2.1 International monetary system
• global system of floating foreign exchange rate
• regional monetary unions
• pegging monetary crises

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A. Observations - Considerations (cont.)

• 2.2 International financial system
• 2.2.1 Institutional framework (the law-making
  process)
• rules are produced by international organisations
  and fora with the participation of national
  central banks and supervisory authorities (see
  below diagram, under C) the predominant role of
  the Financial Stability Forum G-20
• rules of international soft financial law with
  strong indirect mechanisms of enforcement the
  predominant role of the International Monetary
  Fund
• 2.2.2 Supervisory framework
• absence of supranational supervisory authorities
  the principle of decentralisation
• 2.2.3 Regulatory framework
• Fragmented rules for the satisfaction of certain
  requirements of regulatory intervention

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A. Observations - Considerations (cont.)

• 3. The existing European architecture of the
  monetary and financial system
• 3.1European monetary system regional monetary
  union
• 3.2 European financial system
• 3.2.1 Institutional framework three levels of
  law-making process (Lamfalussy process)
• basic legal acts (Co-decision procedure European
  Parliament Council (EcoFin))
• implementing measures (European Commission with
  the assistance of regulatory committees and
  structured pan-european networks with the
  participation of sectoral supervisory authorities
  (CEBS CESR CEIOPS), see below the diagram,
  under D)
• Soft law rules CEBS CESR CEIOPS

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A. Observations - Considerations (cont.)

• 3.2 European financial system (cont.)
• 3.2.2 Supervisory framework
• absence of European supervisory authorities the
  principle of decentralization
• rules for the allocation of competencies between
  national competent authorities
• rules of collaboration between national competent
  authorities
• 3.2.3 Regulatory framework
• structured system of rules of financial law
  concerning all the abovementioned requirements of
  regulatory intervention

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A. Observations - Considerations (cont.)

• 4. The current financial turmoil / Basic
  assumptions
• distinction between crisis (e.g. US and Great
  Britain) and turmoil (eg in Greece), direct and
  indirect risks
• distinction between rescue and recovery plans
• the function of the monetary system enhancement
  of the liquidity in the economy / liquidity trap
• differentiation of interest rates / interbank
  market
• regulatory developments in order to address the
  specific reasons of the financial turmoil

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A. Observations - Considerations (cont.)

• 5. The responsiveness to the current financial
  turmoil
• 5.1 The current financial turmoil is due to
  specific reasons and the regulatory intervention
  has to address them via adequate instruments
• 5.2 The financial turmoil is due mainly to
• the extent of use (and not the use as such) of
  the securitisation
• the extent of leverage
• the criteria of credit rating by Credit Rating
  Agencies
• the conditions of trading of certain categories
  of financial instruments
• the evaluation of financial transactions
• the management of liquidity risk

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A. Observations - Considerations (cont.)

• 5.3 Issues arising with respect to the
  initiatives already undertaken or under
  preparation
• 5.3.1 Differences with the crisis of 1929
• 5.3.2 Review of the objectives of the deposit
  guarantee schemes protection of retail
  depositors vs. ensuring of the systemic stability
  
• 5.3.3 Market failure vs. public sector failure

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A. Observations - Considerations (cont.)

• 5.3 Issues arising with respect to the
  initiatives already undertaken or under
  preparation (cont.)
• 5.3.4 The adequacy of regulatory intervention
• risk of (provisory) overregulation
• emphasis on the effectiveness of regulatory
  intervention
• different treatment of systemic important
  providers of financial services
• the adequate horizon of the regulatory
  intervention handling the time inconsistency
  problem

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A. Observations - Considerations (cont.)

• 6. Elements of a new international architecture
• 6.1 International monetary system
• The choice not to return to an international
  system of fixed exchange rate à la Bretton Woods
• Reinforcing of regional monetary unions
• 6.2 International financial system
• 6.2.1 Institutional framework two alternatives
• Amendments to the governance of international
  organisations and international fora
  International Monetary Fund G-7
• The creation of an International Financial
  Organization (the model of the World Trade
  Organization)

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A. Observations - Considerations (cont.)

• 6.2 International financial system (cont.)
• 6.2.2 Supervisory framework
• Establishment of colleges of supervisors
• 6.2.3 Regulatory framework
• Adoption of new rules in order to address the
  reasons of the financial turmoil proposals of
  the Financial Stability Forum (see below Annex 1,
  under B)
• Reinforcement of the existing regulatory framework

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A. Observations - Considerations (cont.)

• 7. Elements of a new European architecture
• 7.1 European monetary system
• Redetermination of the objectives of the ESCB (?)
• Limitation of the institutional independence of
  the ECB (?)
• Policy of collaterals for the provision of
  liquidity
• 7.2 European financial system
• 7.2.1 Institutional framework
• Broader review of the European Economic
  Governance
• Review of the Lamfalussy process

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A. Observations - Considerations (cont.)

• 7.2 European financial system (cont.)
• 7.2.2 Supervisory framework
• Establishment of colleges of supervisors
• 7.2.3 Regulatory framework
• Broader use of the principle of maximum
  harmonisation
• Adoption of new rules in order to address the
  reasons of the financial turmoil proposals of
  the Financial Stability Forum (see below Annex 1,
  under B)
• Reinforcement of the existing regulatory
  framework
• 7.2.4 The perspective of the creation of
  pan-european supervisory authorities

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B. Annex 1 Current regulatory initiatives in
order to address the reasons of the financial
turmoil

• Initiatives already undertaken in international
  and European level
• Enhancement of the European supervisory framework
  of the financial sector (under 1)
• Enhancement of liquidity (under 2)
• Enhancement of the capital requirements framework
  (under 3)
• Enhancement of the exchange of information and
  cooperation between supervisory authorities
  (under 4)
• Enhancement of liquidity risk management (under
  5)
• Review of deposit guarantee schemes (under 6)

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B. Annex 1 Current regulatory initiatives in
order to address the reasons of the financial
turmoil

• Initiatives already undertaken in international
  and European level
• Ensuring adequate valuation of financial
  instruments (under 7)
• Review of the role of Credit Rating Agencies
  (under 8)
• Enhancement of transparency in financial markets
  and securitization process (under 9)

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1. Enhancement of the European supervisory
framework of the financial sector

• European level
• European Commission
• Action
• The European Commission has set up a High-Level
  Expert Group (de LAROSIERE Group) to examine
• How the supervision of European financial
  institutions and markets should be best organized
  to ensure the prudential soundness of
  institutions, the orderly functioning of markets
  and thereby the protection of depositors,
  policy-holders and investors
• how to strengthen European cooperation on
  financial stability oversight, early warning
  mechanisms and crisis management, including the
  management of cross border and cross sectoral
  risks
• how supervisors in the EU's competent authorities
  should cooperate with other major jurisdictions
  to help safeguard financial stability at the
  global level.

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2. Enhancement of financial institutions
liquidity

• European level
• European Commission
• Actions
• Communication of the European Commission The
  recapitalization of financial institutions in the
  current financial crisis limitation of aid to
  the minimum necessary and safeguards against
  undue distortions of competition
• Decision of the European Commission concerning
  the Greek law For the enhancement of liquidity
  of the economy in response to the impact of the
  international financial crisis (State Aid N
  560/2008)

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3. Enhancement of the capital requirements
framework of credit institutions

• European level
• European Commission
• Action
• 1st October of 2008 Publication of EU
  Commissions Proposal for a Directive amending
  Directives 2006/48/?C and 2006/49/?C
• The main proposed amendments relate to the
  following issues
• the improvement of the management of large
  exposures,
• the improvement of the supervision of
  cross-border banking groups,
• the improvement of the quality of banks' capital
  there will be clear EU-wide criteria for
  assessing whether 'hybrid' capital is eligible to
  be counted as part of a bank's overall capital,
• the improvement of liquidity risk management, and
• the improvement of the risk management for
  securitized products.

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3. Enhancement of capital requirements framework
of credit institutions (cont.)

• European level
• Committee of European Banking Supervisors (CEBS)
• Action
• On 17th October of 2008 CEBS published its
  Advice in response to the European Commissions
  Call for Technical Advice on the reduction of
  options and national discretions in the Capital
  Requirements Directive.

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4. Enhancement of the exchange of information and
cooperation between supervisory authorities

• International level
• Financial Stability Forum
• Action
• Protocols for establishing supervisory colleges
  for each of the major global financial
  institutions. Colleges will improve information
  exchange and cooperation in addressing
  cross-border issues and will strengthen the
  authorities responsiveness to risks.
• A review of these arrangements will be
  undertaken in 2009 once enough experience has
  been gathered.

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4. Enhancement of the exchange of information and
cooperation between supervisory authorities
(cont.)

• European level
• European Parliament
• Action
• Proposal for a Resolution setting out
  Recommendations to the European Commission on
  Lamfalussy follow-up future structure of
  supervision.
• Adoption of the Resolution on 9 October of 2008.

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5. Enhancement of liquidity risk management

• International level
• Basel Committee on Banking Supervision (BCBS)
• Action
• Basel Committee published on 25 September of
  2008 the Principles for Sound Liquidity Risk
  Management and Supervision.
• The 17 Principles focus on
• the governance of liquidity risk management,
• the measurement and management of liquidity risk,
• the public disclosure of information on liquidity
  risk management framework and liquidity position
  of each credit institution, and
• the role of supervisory authorities.

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5. Enhancement of liquidity risk management
(cont.)

• European level
• Committee of European Banking Supervisors (CEBS)
• Action
• On 18 September of 2008 CEBS published its
  Advice in response to the European Commissions
  Call for Technical Advice on Liquidity Risk
  Management. The Advice is divided into four main
  parts
• nature and definition of liquidity and liquidity
  risk,
• recent changes in the liquidity risk environment
  and factors that influence negatively the
  liquidity,
• liquidity risk management practices of financial
  institutions, and
• the main challenges for the supervision of
  liquidity risk management.

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6. Review of deposit guarantee schemes (cont.)

• European level
• European Commission
• Action
• 15 October of 2008 Publication of EU
  Commissions Proposal for a Directive amending
  Directive 94/19/EC on Deposit Guarantee Schemes.
• The main changes proposed are as follows
• Member States are required to increase the
  coverage level for deposits to at least 50,000
  and by 31.12.2009 to at least 100,000
• Co-insurance (i.e. where the depositor bears part
  of the losses) is abandoned
• Establishment of the obligation for deposit
  guarantee schemes to be in a position to pay duly
  verified claims by depositors in respect of
  unavailable deposits within three days (currently
  the respective time period is three months and
  can be extended twice)
• Amendments by the European Parliament

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6. Review of deposit guarantee schemes (cont.)

• European level
• European Forum of Deposit Insurers (EFDI)
• Action
• EFDI is elaborating and will send to the
  European Commission in the first half of 2009
  five reports on a number of self-regulatory
  initiatives that could be undertaken for the
  improvement of the function of deposit guarantee
  schemes at a cross-border level within the EU.
  These reports concern
• the scope of the current definition of deposits,
• the exchange of information between deposit
  guarantee schemes,
• best practices concerning the improvement of
  consumer information on deposit guarantee
  schemes,
• the deadline for payment of claims by depositors,
  and
• risk based elements.

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7. Ensuring adequate valuation of financial
instruments

• International level
• International Organization of Securities
  Commission (IOSCO)
• Action
• On 29 May of 2008, IOSCO announced that its
  Technical Committees Standing Committee on
  Multinational Disclosure and Accounting will
  consider whether additional guidance and
  disclosure related to measurement at fair value
  would be valuable in meeting the needs of
  investors.
• No specified timeframe.

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7. Ensuring adequate valuation of financial
instruments (cont.)

• International level
• International Accounting Standards Board (IASB)
• Actions
• IASB issued for consultation a new standard for
  special purpose vehicles and related risk
  disclosures for off-balance sheet entities (SIC
  12),
• Review of IFRS 7 and IAS 39 (October 2008),
• Issuance of a new IFRS on fair value measurement
  guidance. IASB aims to issue an exposure draft in
  mid-2009 and the project plan envisages that an
  IFRS on fair value measurement guidance will be
  published in 2010.
• The objective of the above actions is to enhance
  the regulatory framework on accounting,
  disclosure and audit guidance for valuations.

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7. Ensuring adequate valuation of financial
instruments (cont.)

• European level
• European Commission
• Action
• Commission Regulation (EC) No 1004/2008 of 15
  October 2008 amending Regulation (EC) No
  1725/2003 adopting certain international
  accounting standards in accordance with
  Regulation (EC) No 1606/2002 of the European
  Parliament and of the Council as regards
  International Accounting Standard (IAS) 39 and
  International Financial Reporting Standard (IFRS)
  7.

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7. Ensuring adequate valuation of financial
instruments (cont.)

• European level
• Committee of European Securities Regulators
  (CESR)
• Action
• On 10 July of 2008, CESR published for
  consultation a statement on fair value
  measurement and related disclosures of financial
  instruments in illiquid markets. The statement
  focuses on the identification of active and non
  active markets and the use of valuation
  techniques. CESR published the final document on
  3 October of 2008.
• European level
• Committee of European Banking Supervisors (CEBS)
• Action
• On 18 June of 2008, CEBS published a Report on
  issues relating to the valuation of complex and
  illiquid financial instruments.

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7. Ensuring adequate valuation of financial
instruments (cont.)

• European EU level
• EU Industry Roundtable on Securitization
  Transparency
• Action
• In order to establish rigorous valuation
  processes and robust valuation disclosures at
  financial institutions level, it has been
  decided that work should be done in three
  strands
• the establishment of valuation processes,
• the maintenance of sound governance and control
  practices associated with those processes, and
• the enhancement of the quality of
  valuation-related disclosures.
• gtTo that direction EU Industry Roundtable on
  Securitization Transparency is preparing a paper
  on Investor Credit Assessment and Valuation
  Principles.

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8. Review of the role of Credit Rating Agencies

• International level
• International Organization of Securities
  Commission (IOSCO)
• Actions
• IOSCO issued on 28 May of 2008 the revised Code
  of Conduct Fundamentals for Credit Rating
  Agencies.
• IOSCO issued in September of 2008 a Report
  concerning the methods of monitoring the
  compliance of credit rating agencies with the
  Code of Conduct Fundamentals for Credit Rating
  Agencies.

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8. Review of the role of Credit Rating Agencies
(cont.)

• European level
• European Commission
• Action
• Publication on 12 November of 2008 of the EU
  Commissions Proposal for a Regulation on Credit
  Rating Agencies
• European level
• Committee of European Securities Regulators
  (CESR)
• Action
• Publication on 20 May of 2008 of its Advice on
  the role of credit rating agencies in structured
  finance

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9. Enhancement of transparency in financial
markets and securitization process

• International level
• Basel Committee on Banking Supervision (BCBS)
• Action
• BCBS will issue by 2009 further guidance to
  strengthen disclosure requirements under Pillar 3
  of Basel II framework.
• European level
• Committee of European Banking Supervisors
  (CEBS)
• Action
• CEBS published in June and in October of 2008
  two Reports with the findings of an assessment
  of 22 large banks transparency with regard to
  the activities and instruments affected by the
  recent financial crisis.

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9. Enhancement of transparency in financial
markets and securitization process (cont.)

• European level (cont.)
• European Industry (EBF, LIBA, ESBG, EACB and
  EAPBFA) has published at the end of 2008 a set of
  Good Practice Guidelines for Pillar 3
  Disclosures, in order to promote sound,
  consistent and appropriate granular
  implementation of the securitization related CRD
  disclosure requirements.
• European Banking Federation published on 24
  September of 2008 a Report on the Alignment of
  Pillar 3 Disclosures, which is an industry
  contribution to enhance transparency.

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9. Enhancement of transparency in financial
markets and securitization process (cont.)

• European level (cont.)
• Market Data Reports
• Under the aegis of the EU Industry Roundtable on
  Securitization Transparency, the European
  industry, in order to assist policymakers in
  their monitoring and assessing of trends in the
  primary and secondary securitization market, is
  working on a set of Reports
• Securitization Data Report-Primary Market (SDR).
  The SDR will be produced quarterly, with monthly
  supplements on spread and price data. It is
  available on the European Securitization Forum
  (ESF) and the Securities Industry and Financial
  Markets Association (SIFMA) websites. On 25 June
  of 2008, Roundtable trade associations
  responsible for the SDR (i.e. ESF, SIFMA, ICMA
  and CMSA) published the first issue.
• Secondary Market Holdings Report (SMHR). The SMHR
  will be produced quarterly. Data will be
  collected for the following financial
  instruments CDOs, Commercial Mortgage-Backed
  Securities, Residential Mortgage-Backed
  Securities, ABS Credit Cards, ABS Equipment
  Lease, ABS Auto, ABS Consumer Loans, ABS Student
  Loans. The SMHR will only be shared with
  officials from regulatory and supervision
  authorities. The first SMHR has been published on
  30 June of 2008.

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C. The global financial regulatory/supervisory
structure
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D. The European financial regulatory/supervisory
structure