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Implementation of financial regulatory reforms

Work on priority post-crisis financial regulatory reform is broken down into four main components: resilience of financial institutions, solving the too-big-to-fail problem, making derivatives safer, and transforming shadow banking. This work is coordinated through the Financial Stability Board (FSB), which promotes international financial stability through information exchange and cooperation of national financial authorities and international standard-setting bodies, and by encouraging coherent implementation of policies across sectors and jurisdictions. The BCBS sets standards for prudential regulation and sound supervision of banks and provides a forum for cooperation on these matters. The International Association of Insurance Supervisors (IAIS) is the independent global insurance standard-setter. The International Organization of Securities Commissions is recognized as the global standard setter for the securities sector. The FSB assesses vulnerabilities affecting the global financial system on an ongoing basis to reduce systemic risk, and considers the regulatory, supervisory and related actions needed to address these vulnerabilities.

Reforms in global norms for financial regulation are agreed through the global standard setting bodies, and are usually subsequently endorsed by the FSB and the G20. The norms are generally targeted at countries with the most advanced financial markets, but the cluster on strengthening global economic governance described the efforts for the standard setting bodies to increase the voice and participation of developing countries. The FSB, as well as the standard-setting bodies, monitor the implementation and the effects of the agreed reforms. The second annual report to the G20 on this topic was published in August 2016; it concluded that implementation progress remains steady but uneven, and that strengthened resilience due to the reforms has stood the global financial system in good stead. The FSB will publish its next report in advance of the G20 Leaders’ Summit in July 2017. Each report includes in-depth analysis of the effects of the reforms. As outlined below, there are differences of opinion among Task Force members as to how successful the agreed reforms will be at addressing systemic risks.

Resilience of financial institutions

Banks continue to build capital and liquidity buffers to meet the new Basel III capital adequacy standards. All large internationally active banks report meeting the fully phased-in minimum risk based capital and leverage ratio requirements. Additionally, 80% of these banks report meeting or exceeding the fully phased-in minimum liquidity requirements.

However, there are questions to whether these capital adequacy rules are sufficient to reduce systemic risks. UNCTAD argues that while Basel III requires banks to maintain higher capital adequacy ratios compared with Basel II, its risk-weighting methodology still allows banks to maintain very high leverage ratios.  This is because the regulations allow the banks’ own evaluations or credit rating agencies’ assessments for calculating their risk-weighted assets and therefore the level of capital they need to cope with unexpected losses.

Addressing too-big-to-fail institutions

A key focus for regulators following the financial crisis has been to reduce the systemic risks and the associated moral hazard problem created by large financial institutions that are considered “too-big-to-fail”. The systemically important financial institution (SIFI) framework seeks to address this, first by identifying firms and then using a range of policy tools to reduce the chance of these firms failing and also to ensure that if they fail effective recovery and resolution regimes are in place which do not lead to the bail-outs that occurred following the financial crisis. The list of global systemically important banks (G-SIBs) and global systemically important insurers (G-SIFIs) are published annually by the FSB in consultation with the respective standard setting bodies and national authorities, on the basis of assessment methodologies developed by the standard setting bodies and annual updated information provided by financial institutions in the respective assessment samples. The latest lists were published in November 2016.

SIFIs and G-SIFIs are subject to policy measures in the form of additional loss absorbency requirements, resolution requirements and more intensive supervision. In particular, should individual SIFIs need to be wound up, the FSB has adopted Key Attributes of Effective Resolution Regimes for Financial Institutions as an international standard for resolution of financial institutions that could be systemic in failure, including a particular focus on policies to enable effective cross-border resolution, as these institutions typically operate in multiple countries. The FSB carries out annual monitoring of the progress made by FSB member jurisdictions in aligning national resolution regimes for all financial sectors with this international standard.

The latest progress report was published in August 2016 and concluded that while the development of policies to address the risks posed by too-big-to-fail banks is largely complete, there is still some work necessary to implement those policies. In particular, only a subset of the jurisdictions have implemented bank resolution regimes with comprehensive powers that are broadly in line with the FSB principles. Substantial work remains in achieving effective resolution regimes and operationalizing plans for systemically important institutions. The focus is now shifting from banks toward resolution of systemic insurance companies and central counterparties where the progress has been slower.

Derivatives reform

The FSB is coordinating policy reforms on over-the-counter (OTC) derivatives markets and publishes regular progress reports on implementation of those reforms, most recently in August 2016. Implementation of over-the-counter (OTC) derivatives reforms is well underway, but progress remains uneven. Margin requirements are behind schedule and platform trading frameworks are relatively undeveloped in many jurisdictions. The availability and use of trade repositories (TRs) continues to expand, but significant work is still needed to ensure trade reporting is effective.

The FSB together with IOSCO has engaged with regulators in emerging markets (for example through a dedicated workshop on OTC derivatives reforms held in Singapore in October 2016, which was attended by 40 authorities from a range of advanced economy and emerging market jurisdictions) to consider the impact of the reforms on their markets, since the derivatives markets in these jurisdictions tend to be less developed.

Shadow banking

The FSB has defined shadow banking as “credit intermediation involving entities and activities (fully or partly) outside the regular banking system”, or non-bank credit intermediation in short. In the Addis Agenda, Member States acknowledged the importance of robust risk-based regulatory frameworks for all financial intermediation. Further information on this commitment can be found in the relevant section in the action area on private business and finance.

Additionally, the FSB is implementing a policy framework aimed at transforming shadow banking into resilient market-based finance. As part of this work, the FSB conducts an annual monitoring exercise covering global trends and risks of the shadow banking system. It provides a quantitative assessment of the activities of shadow banking in 26 jurisdictions. Implementation of the agreed reforms for shadow banking remains at a relatively early stage and more work is needed by the FSB and jurisdictions to assess and respond to potential financial stability risks in this area. Implementation of policies to reduce the run risk of money market funds (MMFs) is ongoing. Progress remains mixed across FSB jurisdictions in implementing IOSCO’s recommendations on incentive alignment approaches for securitisation.

Work in this area includes policy tools to address risks from securities lending and repurchase agreements. As part of the effort to transform shadow banking into resilient market-based finance, the FSB has agreed policy recommendations to address structural vulnerabilities associated with asset management activities. The recommendations cover issues such as liquidity mismatch between fund investments and redemption terms, and leverage within investment funds.