Select Committee on Treasury Sixth Report

5  International action


140. A number of initiatives have already been established at the international level to analyse the underlying causes of the market turbulence since mid-2007. The G7 has asked the Financial Stability Forum, which was established in 1999 and, is tasked with promoting international financial stability and consists of national authorities responsible for financial stability in significant financial centres, to examine the causes of the recent market turbulence, with a focus on events in the markets for structured products. The Financial Stability Forum working group presented an initial report on its work programme to the G7 in October 2007 and intends to prepare a draft report to the G7 in February 2008 with a final report to be presented to the G7 in April 2008. The working group has also said that it intends to examine the authorities' capacity to respond to episodes of market turbulence, relating to the tools and instruments available to central banks and supervisors in times of distress and coordination between them at the national and international level.[195]

141. Similar work on the causes of the recent market turbulence and appropriate policy responses is also under way in the European Union (EU). On 19 October 2007, the Prime Minister, Chancellor Merkel of Germany and President Sarkozy of France issued a joint declaration regarding recent financial market developments. The joint declaration stated that "as a key global financial marketplace, the European Union should have a strong role in developing the global response to these events". The Economic and Financial Affairs Council (Ecofin) has announced a programme of work on the recent market turbulence, which European Union leaders are to discuss at the Spring European Council.[196]

142. The Government, in its January 2008 discussion paper on financial stability and depositor protection, stated that there was considerable international consensus on the key issues raised by recent events and that, broadly speaking, work by the Financial Stability Forum and the EU was focussing on:

  • Effective prudential risk management within banks and other financial institutions, including liquidity, market and credit risk management practices;
  • Accounting and valuation procedures for complex structured products;
  • The role of credit rating agencies in structured finance; and
  • Prudential regulation of financial institutions, particularly in relation to their exposure to off-balance sheet vehicles.[197]

We have already discussed the issue of effective prudential risk management within banks and other financial institutions in our Report on Northern Rock.[198] We discuss international initiatives on the other issues being considered by the Financial Stability Forum and European Union as well as other international actors in this chapter.

The importance of action at the international level

143. The UK Government, in its January 2008 discussion paper on financial stability, has stressed that, in addition to reform in the UK, it is important that the international community responds in a coordinated way to recent events. The Chancellor reiterated the importance of taking appropriate action at the international level when he gave evidence to us. The Chancellor told us that:

The Forum for Financial Stability is looking at this, it is also being looked at the European Union level, I will be discussing it with my French, German and Italian counterparts next week and, when the Financial Stability Forum reports at the G7 in Japan in February, I hope we will have proposals in front of us not just in relation to the off-shore SIVs but also in relation to credit rating, in relation to early warning systems, a whole range of matters which need to be looked at and which, frankly, we can deal with to some extent here in the United Kingdom but we actually need international co-operation.[199]

144. We also asked the Chancellor of the Exchequer about progress on action at the international level. The Chancellor explained that because "so many countries are affected by these problems … there is a political momentum which I think is very helpful".[200] He added that one of the Government's priorities was to strengthen the role of the IMF in relation to these international problems.[201]

145. Sir John Gieve also stressed the importance of action at the international level, agreeing with the Chancellor that the response to the turmoil "has to be done on an international basis, because these are international instruments". He explained that the Bank of England was "working through Basle, where the director of financial stability in the Bank is leading the work on liquidity, and in the Financial Stability Forum, where I and Callum McCarthy are involved, to try and get an international policy consensus on how to address these issues".[202] Angela Knight, Chief Executive of the British Bankers' Association, told us that there are already a number of organisations and institutions in place and that "the best way to make those sorts of global institutions work properly is for countries which have big financial centres such as ourselves to fully engage with global standards". Ms Knight went on to say that:

You can never be sure that everybody is going to abide by global standards because in the end it has got to be locally administered, but the big centres are the ones that have the people, they have the products, they have the broad range of services and have of course the self-interest of getting the global standards right. That is the sort of engagement which I sincerely hope we continue to make.[203]

Global financial institutions and the role of the IMF

146. One of the British Government's key concerns has been to call for a stronger role for the IMF in maintaining the stability of the international economy. The Chancellor of the Exchequer in a speech in October 2007 said that:

We now need new responsibilities for the International Monetary Fund and the Financial Stability Forum—first set up after the Asian financial crisis ten years ago—working together as the international community's early warning system. The Fund should use its surveillance system to identify global economic and financial risks, and we need a stronger role for the Forum in tackling them.

The Chancellor went on to say that this stronger role for the IMF "should include better communication between nations and sharing best practice … and leading coordinated regulatory responses to risks to prevent problems before they occur".[204] European leaders reaffirmed their commitment to reforming global institutions in their joint communiqué at the recent London summit on the global economy. The communiqué, signed by the Prime Minister, the President of the European Commission, Chancellor Merkel of Germany, Prime Minister Prodi of Italy, and President Sarkozy of France, stated that:

the recent market turmoil has also highlighted the need for reform to ensure that global institutions can meet the challenges of the 21st century. We need a better early warning system for the global economy and we need to ensure that its warnings have the force and authority to ensure that they are acted upon.[205]

147. We support the Chancellor's approach to seek to make the IMF the international community's early warning system, identifying global economic and financial risks, acting to identify problems before they occur. In our Report of 2006 on Globalisation: the role of the IMF we supported proposals that "the IMF should focus more on crisis prevention as well as on crisis resolution, and … there should be a new focus on surveillance". We note, however, that whilst the IMF should play a leading role in identifying global economic and financial risks, it lacks the necessary policy instruments to enforce action by market participants. Yet the international turbulence of since mid-2007 has served to emphasise just how great the challenge facing the global financial community is in improving their response to financial problems. We support a greater role for the Financial Stability Forum sharing information and coordinating the global response to such shocks.

International work on credit rating agency reform

148. The market turbulence since August 2007 has prompted widespread calls for reform of the credit rating agencies. Areas of concern include over-reliance by investors on credit rating agencies, potential 'conflicts of interest' and the methods used by rating agencies. Witnesses to our inquiry, including the Chancellor of the Exchequer, were clear that reforms to the way credit ratings agencies operate were necessary. The Chancellor told us that "the way in which credit agencies operate is something that I think we need to look at," going on to say it was an issue that needed to be considered internationally.[206]

149. Indeed, there are already several examinations at international level on the role of the ratings agencies in the current crisis and possible ways forward. Both the Financial Stability Forum and Ecofin are examining the role of the credit rating agencies as part of their work analysing the recent disturbances in financial markets and, in addition, the International Organisation of Securities Commissions (IOSCO), is conducting a review of the securities markets dimension and the processes whereby ratings are determined.

150. As part of its review, IOSCO will examine whether there is a case for building on its existing international code of conduct for credit rating agencies to ensure the code's applicability for structured finance products. The IOSCO 'Code of Conduct Fundamentals for Credit Rating Agencies' was introduced in December 2004 to "promote investor protection by safeguarding the integrity of the rating process".[207] The existing code has been described as a market-driven oversight framework for the ratings agencies whereby the agencies develop their own proprietary code of conduct aligned on a "comply or explain" basis with the key provisions developed by IOSCO. The Governor of the Bank of England stressed that an international solution was required on credit rating agencies because "these are international ratings of internationally traded instruments" and therefore "we have to take our partners with us".[208] Mr Sants explained to us in October 2007 that the FSA was playing a key role in examining the role of credit rating agencies through "a working group within IOSCO, which is the main securities global co-ordinating agency … They have a code of practice and it was agreed in the IOSCO fora that we would be looking again at that code of practice to see what lessons could be learnt from recent events".[209]

151. We discuss issues such as investor over-reliance on credit rating agencies, potential conflicts of interests and the methods used by credit rating agencies in greater detail in subsequent chapters, as well as possible reforms.

International work on prudential regulation of financial institutions in relation to their exposure to off-balance sheet vehicles

152. The Financial Stability Forum and EU are also assessing the implications of recent events for the prudential regulation of financial institutions, particularly in relation to their exposure to off-balance sheet vehicles. The issue of off-balance sheet funding has emerged as an important issue because, during the recent market turbulence, contractual obligations of banks to off-balance sheet vehicles in the form of contingent liquidity facilities, or even non-contractual reputational considerations, has required banks to provide funding for and/or reabsorb the assets backing these structures at a time of severe stress in the market.

153. The focus of international work will be on the Capital Requirements Directive (CRD)/Basel II, which includes a dedicated framework for assessing the regulatory capital that needs to be held in relation to securitisations. The Government has said the authorities will work on with their counterparts in the Financial Stability Forum and EU on these matters. One key issue for consideration is whether there remain incentives under the CRD/Basel II framework for banks to minimise their regulatory capital requirements by holding assets in structured investment vehicles and other funding vehicles and, if so, whether that might reduce the total amount of regulatory capital in the financial system to below the level that the authorities consider desirable.[210] We support the Government's efforts to promote a review of the Capital Requirements Directive/Basel II framework, and in particular to ensure that that framework does not provide perverse incentives to banks to reduce capital adequacy.

Accounting and valuation of structured products

154. A third priority area for international action identified by the Financial Stability Forum and the European Union surrounds the accounting and valuation of structured products. These initiatives are, in part, designed to tackle the difficulties which emerged during the recent period of market turbulence in valuing complex financial products and which helped exacerbate uncertainty about losses in the banking sector.[211]

195   FSF Working Group on market and institutional resilience, Preliminary report to the G7 Finance Ministers and Central Bank Governors, 15 October 2007 Back

196   Joint Declaration of Chancellor Merkel, President Sarkozy and Prime Minister Brown regarding recent financial market developments, Lisbon, 19 October 2007 Back

197   Financial stability and depositor protection: strengthening the framework, HM Treasury, Bank of England and Financial Services Authority January 2008, p 24 Back

198   HC (2007-08) 56-I Back

199   Q 1852 Back

200   Q 1858 Back

201   Q 1863 Back

202   Q 1695 Back

203   Q 1604 Back

204   Speech by the Chancellor of the Exchequer, Reuters, Canary Wharf, 1 October 2007 Back

205   Joint communiqué on the global economy, 29 January 2008 (available at  Back

206   Q 806 Back

207   Code of Conduct Fundamentals for Credit Ratings Agencies, The Technical Committee of the International Organization of Securities Commissions, December 2004, p 4 Back

208   Q 1701 Back

209   Q 299 Back

210   Financial stability and depositor protection: strengthening the framework, HM Treasury, Bank of England and Financial Services Authority January 2008, pp 34-35 Back

211   Ibid., pp 28-29


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