The world after the G20 Summit in Seoul

Progress on financial reforms was made in Seoul but diverging national approaches are in evidence.

The focus of the recent G20 summit was on trade imbalances and exchange rates, and understandably so. Achieving a balance of macro-economic and financial regulatory reform is essential to the ultimate goal of greater global financial stability.

Post Seoul: where are we now?

While the signing-off for the Basel III proposals was a major step forward, there remains significant scope for divergence. Many of the finer details have yet to be agreed, and its implementation is likely to differ.

There are already clear signs of different countries applying different standards. Perhaps this was inevitable.

Further progress is needed on the core aspects of the reform package, such as the treatment of ‘systemically important financial institutions’ (SIFIs), if a more level playing field is to be achieved.

Capital and liquidity standards

By endorsing the Basel III capital and liquidity framework, the G20 has made a significant step forward in strengthening global standards.

They include substantially higher minimum requirements for the highest quality capital (equity and retained earnings), the proposed counter-cyclical capital buffer, a maximum leverage ratio, and proposed new minimum liquidity ratios for a stock of high quality liquid assets and for a more robust funding structure.

However, the long transitional periods for the new standards may unintentionally allow fractures to occur in international consistency, as markets and some regulators will press firms for more rapid implementation.

Uncertainty for SIFIs

The Basel Committee did not meet the G20 deadline to put forward detailed proposals on additional regulatory requirements for SIFIs.

Moreover, in setting out the broad policy framework for addressing SIFIs, the Financial Stability Board now refers to higher capital requirements applying ‘initially and in particular’ to Global SIFIs, thereby creating for the first time a distinction between global and domestic SIFIs.

This introduces uncertainty for large global banks and could result in an unlevel playing field for globally active SIFIs competing in national markets with predominantly local SIFIs.

Remuneration

The G20 reaffirmed the importance of fully implementing the FSB’s Principles on Compensation. The FSB conducted its first peer group review in March 2010 of how countries have implemented these principles and will undertake a follow-up review in 2011.

Standardising derivatives

Market reform recommendations on the central clearing and trade reporting of OTC derivatives were welcomed, and the G20 stressed the importance of internationally consistent implementation.
But, with so many details on the scope and reach of new rules still to emerge from separate US and EU approaches, this will likely continue to be an area of policy divergence.

Credit ratings

The Basel Committee had been expected to report by October 2010 on reducing the reliance on credit ratings within the regulatory capital framework.

This has been delayed, but the G20 welcomed the FSB’s more general recommendations to reduce references to credit rating assessments in laws and regulations, and to generate a clear expectation that banks, institutional investors and other market participants do not rely solely or mechanistically on credit ratings.

Accounting standards

On the convergence of accounting standards, the G20 encouraged the IASB and FASB to continue their efforts to achieve greater convergence in financial instrument accounting standards by the end of 2011.

To date, many countries have converted their accounting rules to IFRS, but there is still much work ahead for US-GAAP and IFRS convergence and even in areas in which there has been convergence, subtle differences still exist.

The international community needs to maintain and increase momentum as the new standards emerge.

Supervisory scrutiny

There have been welcoming moves towards increased supervisory intensity and effectiveness, although this is another important area of increasing divergence between countries and regions.

Many supervisors are clearly driving forward both their capacity and their determination to apply more intensive and assertive supervision of regulated firms. This may lead to inconsistent national supervisory approaches across a wide range of areas – not just on capital and liquidity but potentially also on corporate governance, remuneration, risk management and systems and controls.

Implications for financial institutions

While the G20 may be successful in agreeing on an agenda, it is unlikely to ensure a level playing field in regulation and to avoid fragmentation of markets and regulatory arbitrage.

There is every indication that financial institutions will continue to face differing national requirements and the complexity and implementation challenges that will bring.

Institutions or jurisdictions disadvantaged by the increasingly un-level playing field may call for a renewed focus and effort to address this lack of coordination ahead of the next G20 summit.