Overview of the Global Financial Laws and Regulatory Framework

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FINANCIAL LAW ANDFINANCIAL LAW ANDREGULATIONSREGULATIONS

WEEK 1

Overview of the Global Financial

Laws and Regulatory Framework


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Is regulation for the financial markets reallynecessary?

Can it be self-regulated?

Introduction


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1. To discourage excessive risk taking by market intermediaries

2. To maintain adequate liquidity (liquidity is both aprecondition for investment as well as a potential source offinancial risk i.e. it can permit both rapid entry to and exit frominvestments)

3. To protect investors problems arise in relation toinformation asymmetry

4. To protect financial markets

5. To maintain trust in market credibility

6. To avoid a financial crisis

Reasons for regulations


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Prior incidents

What exactly is being discouraged? Some prior incidents:

Collapse of a major bank such as BCCI (Bank of Credit and

Commerce International )

Ponzi Schemes such as the Madoff case

Lehmann mini-bond derivatives scandal


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What kind of regulations?

Once it can be agreed that regulation is necessaryone must then ask what it should look like.

First we need to understand the nature of financialmarkets and in particular how financial assets arevalued.


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Problems with financial assets

The value of financial assets is based onfuture expectations regarding return oninvestment and liquidity

Expectations are by their very nature biasedby the predisposition of investors who react

to market movements such that they canoften be unduly optimistic or undulypessimistic


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Problems with financial assets

Financial stability helps to maintain balancedexpectations

Financial markets play an important role indetermining patterns of savings, investment andconsumption

In that respect they are just as important as themarkets for real assets if not more important


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International regulations?

It is therefore important to find a balancebetween market regulation and the need tomaintain free and competitive markets

If regulation can be organised on a nationallevel, why then do we need an international

layer of regulation?


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National parliaments can only makelegislation for their respective sovereignstates, but:

1. Finance flows across political borders fasterthan goods and most services

2. Large increases in portfolio capital flows foreign investment, M&A activity and privateequity


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3 Speculative capital flows (most FX transactions arespeculative) including hedge fund activities

4 Proceeds from criminal activities money laundering

5 Interdependence of global financial markets limits abilityof individual States to intervene


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What kind of international

regulations?

Some degree of international co-operation istherefore necessary

This is mostly achieved through internationaltreaties or organisations which require theirsignatories / members to adopt minimum

standards of local regulation or to adoptagreed patterns of behaviour by mutualagreement


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Modern history of international financial regulationreally only begins in the aftermath of World War II

During the 1920s markets were dominated byinternational speculative capital flows (hot money)as well as investment flows from the developed tothe developing world

However, much of Europe was weakened by WorldWar I

Historical perspectives


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Historical perspectives

The Wall Street of the late 1920s led to USdomestic legal market reforms and usheredin the Great Depression years of the 1930s

World War II (1939 1945) led to asignificant expansion in US industrial outputand the US emerged as a world power


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Historical perspectives As the war drew to a conclusion the victorious allies met to draw

up a framework for the new economic and political world order

The aim was to rebuild Europe and Japan, whilst building upTaiwan, South Korea, Hong Kong and other countries. At the

same time major Communist States such as the Soviet Unionand the PRC were to be contained along with their potential alliesin Latin America and Africa

In 1947 a meeting at Bretton Woods, US, finalised the creation ofthree new organisations designed to secure global financial

stability.


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International Monetary Fund

(IMF)

The International Monetary Fund (IMF) was createdby Treaty designed to avoid problems which arosefrom the use of floating FX rates in the 1920, and

the competitive FX Rate devaluations of the 1930s.It has 185 members

Member States were required to maintain official par

values for their exchange rates so as to promote FXstability


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IMF

Member currencies were fixed to the US$ and linked to the valueof gold (Gold Standard)

The IMF would provide short term loans to Members based on

their quotas to help overcome temporary balance of paymentsproblems

Changes in par value only allowed with IMF approval. Capitalcontrols were enforced

Fixed exchange rates contributed to smooth economic progress


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International Bank for Reconstructionand Development (IBRD)

The International Bank for Reconstruction andDevelopment (IBRD) or then World Bank was createdat the same time as the IMF (also by Treaty) and sharesthe same 185 Member States.

In the post World War II years it mostly provided loans torebuild Europe and Japans war damagedeconomies

It also provided guarantees for certain privateinvestment


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IBRD

During the 1950s and 1960s it played a sort oflender-of-last resort role for foreign direct investmentprojects and infrastructure loans to Asian, LatinAmerican and Middle Eastern countries

During the 1970s and 1980s (oil crisis) it helpedmany developing countries with emergency loansconditional on the implementation of structuraladjustment programmes


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GATT

The General Agreement on Tariffs and Trade(GATT) was established as the only remainingpart of the then planned International Trade

Organisation (ITO) / then World TradeOrganisation

Its aim was to reduce public barriers to trade

supported by FX stability as per the IMF treaty.


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Further IFI developments

International financial markets remained stable untilthe late 1960s by which time the relative differencesin economic growth of the Members made the fixed

system of fixed exchange rates unworkable(Problems to be discussed in next class)

In response a number ofInternational Financial

Institutes (IFI) were subsequently established.


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Basel Committee

(Basel Committee) on Banking Regulationand Supervisory Practices was establishedby a group of central bank regulators in 1974

following the collapse of several banks

Its membership includes the central bankersand regulators of the thirteen G10 countries(in practice thirteen)


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Basel Committee

Standards created by the committee are extended globallythrough IMF / World Bank conditional programmes

A number of major banks failed following the deregulation ofexchange rates

Growth in consolidation of global banking often dominated byUS banks


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Further developments

Emergence of big bulge bracket investment banks

Concentration of risk as banks have illiquid assets

and liquid liabilities (on demand deposit accounts)

Bank failure can lead to systemic risk if deposits arelost and international payment systems are

disrupted. Domino effect would result.


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Basel II

The current Basel II builds on the 1988 accord andis framed around three pillars as its standards:

1. Capital adequacy requirements based on 8% ofrisk weighted assets

2. Supervisory review of bank internal control

systems and management

3. Transparency and disclosure

The International Organisation of


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Security Commissioners(http://www.iosco.org/about/)

The International Organisation of SecurityCommissioners (IOSCO) was formally establishedin 1983

Membership comprises all security regulators andsome stock exchanges

Risk - Consolidation of brokerages and exchangesas well as close business dealings with banks
http://www.iosco.org/about/http://www.iosco.org/about/http://www.iosco.org/about/http://www.iosco.org/about/


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Security Commissioners (

http://www.iosco.org/about/) Its aims are threefold:

1. To protect investors

2. To ensure that markets are fair

3. To reduce systemic risk
http://www.iosco.org/about/http://www.iosco.org/about/


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Financial Action Task Force

The Financial Action Task Force (FATF)was created in 1989 by the G7 Summit inresponse to organised international crime

and money laundering through theinternational payment settlement systems

Its members include the G7 countries alongwith eight other countries


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International Association of

Insurance Supervisors

The International Association of Insurance

Supervisors (IAIS) was established in 1994

Members are country insurance regulators who aretypically attached to finance ministries ordepartments

Growing consolidation leads to greaterconcentration of risk


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International Association of

Insurance Supervisors

It has three aims: 1. To contribute to the improvement of supervision to

protect policy holders

2. To promote the credibility of insurance markets

3. To contribute to global financial stability

Implementation of a three pillar system similar to Basel II isplanned but unlikely to be implemented before 2011


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Financial Stability Forum

Financial Stability Forum (FSF) was created in1998 by the G7 finance ministers and central bankgovernors in response to the damage caused by the

Asia financial crisis Surprised by the inability of the existing

organisations to avoid the crisis, it was felt that aforum was necessary to address a failure of co-

ordination within the existing structure


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Financial Stability Board

After the financial crisis in 2009, FSF is reformed asFSB (Financial Stability Board) to strengthen its role.

The FSBs mandate is to assess vulnerabilities affecting the financialsystem; identify and oversee action needed to address them; promotecoordination and information exchange among authorities responsible forfinancial stability; monitor and advise on market developments and theirimplications for regulatory policy; advise on and monitor best practice inmeeting regulatory standards; undertake joint strategic reviews of the policydevelopment work of the international standards setting bodies; set

guidelines for and support the establishment of supervisory colleges;manage contingency planning for cross-border crisis management; andcollaborate with the International Monetary Fund (IMF) to conduct EarlyWarning Exercises.


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International Accounting

Standards

International Accounting Standards Board (IASB) originally setup in the 1960s to examine ways to harmonize accountingstandards

Generally met resistance from US and European standardsetters

Since 2003 listed companies in the EU are required to reportusing international accounting standards (IAS) and internationalfinancial reporting standards (IFRS)

US to decide whether or not to adopt


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OECD

The Organization for Economic Cooperation andDevelopment (OECD) was established in Paris in1961. Membership of thirty countries

Objective is to bring together the governments ofcountries committed to democracy and the marketeconomy through sustainable development

OECD Ministers released Principles of CorporateGovernance in 1999


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Hong Kong/China

Closer to home

Hong Kong Securities and Futures Commission (SFC) 1989

Hong Kong Monetary Authority (HKMA)1993

China Securities Regulatory Commission (CSRC) 1992

China Insurance Regulatory Commission (CIRC) 1998

China Banking Regulatory Commission (CBRC) 2003

Overview of the Global Financial Laws and Regulatory Framework

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