A New World Financial Order: G-20 Leaders Discuss International Regulation

On Thursday, the world leaders from the 20 most powerful countries (G-20) will gather in Pittsburgh, PA to discuss the matters affecting their respective countries. On the top of every leader’s list is financial regulation. Many are concerned that despite the harsh realities of failing economies, concrete reforms are likely to remain a distant prospect, primarily because the G-20 has no law-making power. EU Ambassador to the United States John Bruton stated that "G-20s don't make the detailed decisions ... But they can create the conditions…. for reforms.” However, any real reform will have to be drafted, adopted, and implemented by national authorities not the G-20.

President Obama and the leaders of Britain, Germany and France are expected to try to reignite the fervor of a year ago to regain momentum for international financial reform by raising the sensitive issue of executive compensation. There is recommendation that executive bonuses should be linked to the long-term performance of investment decisions and the financial condition of banks’ balance sheets to discourage short-term risk taking. Ambassador Bruton stated that “[t]here is a high level of anger in Europe about the fact that the remuneration packages have been designed to emphasize short-term returns." G-20 leaders will also recommend comprehensive regulation of the over-the-counter (OTC) derivatives markets, hedge funds, credit rating agencies and debt securitization.

When Lehman Brothers collapsed in September 2008, freezing world capital markets, the G-20 leaders were galvanized around one single point-- tighter financial regulation. Now its been a year later, economies are stabilizing with the help of their respective governments, markets are rebounding – in the U.S. the Dow Jones industrial average, is up approximately 50 percent since February – there is a light at the end of the tunnel (and it is not the proverbial train). The G-20 leaders have less of an impetus to “create the conditions” for international financial regulation reform.

The reality is to introduce tough new capital requirements for banks, at this time, may actually harm banks’ balance sheets because governments want banks to lend more to help spur economic recovery. Stephen Green, chairman of the British Bankers' Association and HSBC bank, wrote in a letter to British Prime Minister Gordon Brown that "[t]he simple fact remains that financial institutions cannot take steps to further increase the amount of capital they hold and at the same time lend that capital to businesses and consumers."

Debates on details and timing for reform are growing heated. The Financial Stability Board (FSB), the G-20's policy coordinating arm, last week cited "challenges in maintaining an appropriate balance and pace of regulatory reform." Europe is suspicious about a U.S. push for banks to adopt a leverage ratio. There is a worry in Europe that adopting a leverage ratio that goes beyond being just a "backstop" to Basel II would undermine the Basel rules. There is still no consensus on how to define a leverage ratio or what assets should be included.

Many nations have already pledged to take new steps to strengthen regulation of the global financial system. However, the continental Europeans and the United States have stressed different elements of reform. The European Union is pushing for restrictions on bankers' pay in order to eliminate what they see as perverse incentives that encouraged irresponsible risk-taking. The United States has put more emphasis on forcing banks to raise the quality and quantity of capital they have on hand to cover potential losses in an effort to better protect taxpayers from having to pay for banks' mistakes. Joe Engelhard, policy analyst at investment research firm Capital Alpha Partners stated that the G-20 might produce a consensus on capital standards, but it will take much longer to settle on "the exact levels of the new capital and leverage ratios and even longer to agree to the new liquidity regime."

The G-20 members are working on a framework for regulatory reform with firmer deadlines. Ultimately, though, it is up to national legislatures to follow through. The U.S. Congress is working on a proposal to overhaul financial regulation.

Lydie Nadia Cabrera Pierre-Louis
St. Thomas University School of Law