Increasing Transparency at the Financial Stability Board and Basel Committee

Shortly after President Trump took office, Congressman Patrick McHenry (R-NC) sent a sharply worded letter to Janet Yellen demanding that the Federal Reserve immediately cease participation in international financial regulation forums such as the Financial Stability Board (FSB), The Basel Committee on Banking and Supervision (BCBS), and the International Association of Insurance Supervisors (IAIS). McHenry believes it is improper for the Fed to engage with these “global bureaucrats in foreign lands” until President Trump has had a chance to review “past agreements that unfairly penalized the American financial system in areas as varied as bank capitol, insurance, derivatives, systemic risk, and asset management.”

McHenry’s letter is the latest in a long list of criticisms leveled against the BCBS, FSB, IAIS and other international groups by Republican lawmakers. At a hearing of the House Monetary Policy and Trade Subcommittee held last September, Bill Huizenga (R-MI) characterized the FSB as a “shadow regulatory agency using backdoor channels to determine a one size fits all approach to applying European standards on American financial institutions.” To many conservatives, these transnational regulatory networks are unaccountable to elected officials, lacking in transparency, and unresponsive to the concerns of the financial industry and general public.

Criticism of these groups is in some ways an inevitable consequence of their organizational design. For any international standard-setting body, there is typically a tradeoff between accountability and effectiveness, and between responsiveness and industry capture. Regardless of where the standard-setting body lies on these two spectrums, criticism will follow. If the BCBS and FSB were deemed to be too accommodative of concerns expressed by the financial industry, Democratic lawmakers would surely be up in arms.

This does not mean that Republican’s complaints should be ignored. Rather, to the extent possible, international standard-setting bodies and their member institutions should try earnestly to address these complaints if doing so doesn’t diminish regulatory effectiveness. However, my experience interacting with the FSB and BCBS, while working at the Federal Reserve Bank of New York, taught me that these institutions are not very receptive to change. Something as simple as updating their websites and releasing meeting minutes would go a long way towards improving transparency and reducing suspicions, without sacrificing their core mission of promoting financial stability.

These changes would likely be too little too late for the Trump administration, which has embraced a platform of economic nationalism that cares little for historical norms and international institutions. This is unfortunate, because it is precisely now – when the collective memory of the financial crisis has begun to fade – that adherence to, and support for, globally agreed upon strict regulatory standards is so important. And if these standards are relaxed or ignored, the FSB’s and BCBS’ obstinance will be partly to blame.

The Basel Committee on Banking Supervision (BCBS) and the International Association of Insurance Supervision (IAIS)

The failures of Herstatt Bank in Germany and Franklin National in the U.S. in 1974, awakened banking regulators to the contagion risks posed by internationally active banks operating in an increasingly interconnected world economy. Shortly thereafter, the central bank Governors of the Group of Ten countries established the BCBS to be the “primary global standard setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters.” The cooperation that ensued gave birth to Basel I in 1988, resulting for the first time in internationally agreed upon minimum capital standards, which were revised, and expanded, with the release of Basel II in 2004 and Basel III in 2010. The IAIS was established in 1994 to serve essentially the same function as the BCBS but in regards to insurance supervision.

The BCBS and IAIS are characterized by scholars as “soft-law” bodies, meaning “they lack legal personality, issue largely non-binding standards, and permit significant variations in implementation across jurisdictions.”[1]  Thus, these organizations are effective only if their member states are willing to adopt and implement the agreed upon standards in their own jurisdictions.

It is easy to see why international cooperation is so critical when it comes to financial regulation. Without it, sophisticated global banks would simply base their operations in the jurisdiction with the least stringent standards. This would lead to other countries reducing their standards so as to prevent their domestic banks from relocating to the less restrictive jurisdiction, thereby taking jobs and tax revenue with them. A race to the bottom ensues, until unrestrained mega banks inevitably take on too much risk and implode, taking the global economy down with them.

Criticism of Soft-Law Bodies

The organizational structure of soft-law bodies often invites suspicion and criticism. In his paper, “Who’s in Charge of Global Finance,” Michael Barr notes that early on, the BCBS and IAIS were criticized for “technocratic cultures that were unresponsive to domestic constituencies; for organizational secretiveness and lack of transparency; for limited memberships that excluded many less-developed nations and reinforced the economic hegemony of developed Western nations; for distorting domestic policy; and for privileging industry insiders and experts over average global citizens in their decision-making processes.”[2]

The IAIS responded to this criticism by expanding their membership to incorporate non-western countries, which many have argued limited its effectiveness. The BCBS did not expand its membership, but they did increase their outreach to developing nations by forming regional consultative groups (RCGs). In addition, beginning with Basel II, the BCBS began to put out substantive proposals for public notice and comment, a process which continues to this day. Also beginning with Basel II, the BCBS began conducting Quantitative Impact Studies (QIS). The purpose of each QIS is to gather the necessary data from financial institutions to gauge the impact of proposed capital, liquidity, or other requirements on the financial system. The BCBS typically releases a public summary of the data and uses the results to modify the final standards.

The Financial Stability Board (FSB)

The Financial Stability Forum (FSF) was established by the G-7 after the Asian financial crisis in the late 1990’s. Its purpose was to bring greater coordination to the work of transnational financial regulatory networks like the BCBS and IAIS.[3]  However, the FSF shared many of the same soft-law properties as the standard-setting bodies it was tasked with overseeing, and it was largely ineffective in getting member countries to adopt best practices for prudential financial regulation.

The FSF’s ineffectiveness was laid bare by the onset of the financial crisis in 2008. Shortly thereafter, the G-20 assumed responsibility for the crisis response and agenda-setting for international economic policy going forward. The FSF was rechristened the Financial Stability Board (FSB) and its agenda was made clear at the G-20 Pittsburgh summit in 2009: strengthen bank capital, restrain executive compensation, improve transparency in the over-the-counter derivatives market, and develop strategies for unwinding failed systemically important financial institutions.

In addition to coordinating the work of international standard-setting bodies – same as the FSF – the FSB’s charter calls on the organization to “develop and promote the implementation of effective regulatory, supervisory and other financial sector policies.”  The FSB attempts to accomplish this by:

• Independently assessing financial sector vulnerabilities and the adequacy of existing regulations to address them;
• Reviewing the work of international standard-setting bodies;
• Enforcing global compliance with international financial standards by conducting peer reviews; and
• Publicity reporting on which jurisdictions are non-compliant with internationally agreed upon standards.

Republican Criticism

Despite the decisive steps taken by G-20 leaders to endow the FSB with formal decision-making authority, it is important to note that its decisions are still non-binding; countries are free to ignore any of the FSB’s standards. However, many Republicans, and even some Democrats, feel as though U.S. regulators treat the FSB’s pronouncements as binding; taking the global standards and introducing them in the U.S. as is, without any consideration for the impact on U.S. banks and economic growth.

To support their argument, they point to the FSB’s designation of Prudential and MetLife as global systemically important insurers (G-SIIs) in July of 2013, and the Financial Stability Oversight Council’s (FSOC) subsequent decision to classify these institutions as non-bank systemically important financial institutions (SIFIs) in September of 2013 for Prudential and December of 2014 for MetLife. Critics contend that the FSOC’s decision was based solely off of the FSB’s designation of these firms as G-SIIs, and was not based upon any type of independent analysis. Roy Woodall, the FSOC’s independent member with insurance expertise, certainly believes this to be the case. Writing in his dissent to MetLife’s SIFI designation, Woodall states: “Despite subsequent assertions by some of the Council’s members that the FSB and Council processes are separate and distinct, they are in my mind very much interconnected and not dissimilar.”

Many conservatives also decry what they believe to be the secretive nature of international standard-setting bodies. They have even gone so far as to introduce legislation designed to shed more light on the internal deliberations of at least one of these bodies. Last year, the House passed the Transparent Insurance Standards Act out of concerns that the IAIS may develop insurance capital standards that are unfavorable to U.S. insurers. One of the bill’s provisions requires the Secretary of the Treasury, and Chair of the Federal Reserve Board, to provide a semi-annual “description of the efforts by the Secretary and the Board to increase transparency and accountability at the Financial Stability Board with respect to insurance proposals and the International Association of Insurance Supervisors, including efforts to provide additional public access to working groups and committees of the International Association of Insurance Supervisors.”

My Experience

I had the opportunity to interact with the BCBS and FSB while working at the New York Fed.[4] Essentially, my responsibilities entailed keeping tabs on what was being discussed within these organizations and summarizing this information for higher-ups. I quickly discovered this task would not be as simple as I originally envisaged. These are sprawling organizations, with dozens of committees and subcommittees, as well as unclear memberships and mandates.

Take for instance the FSB. If you go to their website, they provide a fairly concise organization structural, with descriptions and membership lists for four main standing committees that report into the FSB’s Steering Committee. However, the reality is that there are dozens of other committees within the FSB that are nowhere to be found on their website.

The workings of the BCBS are even murkier, with their website displaying only a fraction of their total number of committees. For the committees that are displayed, a list of members is not even provided.[5] Most of these unnamed committees will have at least one representative from the U.S., who will periodically travel to Switzerland on the taxpayers’ dime to attend committee meetings.

Part of the challenge in my old role at the New York Fed was trying to figure out who within our organization participated on all these committees. Some of the committees had been around for years, while many more were created in the aftermath of the financial crisis and quickly staffed. In some instances, people ended up on a committee because one of their co-workers who was on another committee would recommend them to the new committee’s chair, who would then extend an initiation to that person directly, unbeknownst to anyone in our central office. This process was extremely problematic, as it hindered centralized coordination of our staff’s committee participation, and prevented us from instilling any kind of message discipline into New York Fed committee members.

Other U.S. regulatory agencies also participate on international committees, and often times one committee will have two or more members from the U.S., each one representing a different regulatory agency. The FSB’s Standing Committee on Supervisory and Regulatory Cooperation for instance, has members from the Federal Reserve, Department of the Treasury, and the Securities and Exchange Commission. There are no guarantees that these individuals will share the same view on every topic that comes before the committee. In fact, there is a long history of regulatory agencies in the U.S. disagreeing with each other on significant issues. Thus, the U.S. may not be speaking with one voice on some of the most critical issues being debated by international standard-setting bodies; issues that ultimately will affect U.S. financial institutions and the U.S. economy.

Recommendations

This lack of transparency and coordination serves no one, and only fuels the arguments of those who claim the FSB and BCBS are too secretive and unresponsive to the public’s concerns. One simple recommendation is for international standard-setting bodies to provide a complete listing of all their committees on their website, along with each committee’s charter and the names of committee members.

It is hard to see how this information could negatively impact the workings of any committee. On the contrary, a complete listing of all committees and committee members would actually assist standard-setting bodies and their member organizations, who for the first time would be able to holistically assess the organizations they are a part of and contribute to. The BCBS for instance, could use the information to determine their committee structure has grown too unruly and decide to streamline their decision making process. U.S. regulators could use the information to assess employee contributions to international committees and whether that’s the best use of their staff’s time and energies. U.S. agencies could also use the information to better coordinate with each other ahead of critical committee meetings.

Other scholars have offered more substantive recommendations to increase transparency within international standard-setting bodies, particularly the FSB. Eric Helleiner recommends the FSB “make public all meeting schedules, agendas, attendees, and minutes of meetings of the Plenary and RCGs.” Michael Barr believes the FSB should formally adopt notice-and-comment procedures for rule-making, and that national finance ministries and regulators who participate in FSB deliberations should seek public input before they agree on global standards.[6]

These recommendations, if enacted, would provide the financial industry with a greater ability to influence the international rulemaking process. This is not necessarily a bad thing, provided that their influence does not result in watered-down standards incapable of constraining excessive risk-taking. Greater industry input could actually enhance the credibility of the global rulemaking process, and lessen the resistance of domestic policymakers opposed to international cooperation on financial regulatory standards.

Conclusion

Even if the above recommendations are enacted, Republican opposition to U.S. participation in the FSB, BCBS, and IAIS is unlikely to dissipate entirely. Frankly, I find many of their complaints baseless; driven more by political opportunism than facts. Rather than the Europeans using the FSB and BCBS to foist their standards upon the U.S., as many Republicans claim, it has clearly been U.S. regulators pushing the FSB and BCBS to adopt more stringent standards, oftentimes to the chagrin of the Europeans. The Europeans fierce resistance to the BCBS’ proposed changes to the methodology for calculating risk-weighted assets is a case in point. Furthermore, U.S. regulators have, in many instances, implemented more stringent standards than what was agreed upon at the international level and implemented in Europe. Such is the case for capital and liquidity standards.

But there is some validity to the claims that international standard-setting bodies like the FSB, BCBS, and IAIS are too secretive and lacking in transparency. This perception is partly due to their intentional design and soft-law characteristics, and partly due to their inbred penchant for secrecy. Based upon my experience, the FSB and BCBS would benefit from some simple changes that would provide the public, and policymakers, greater visibility into how these institutions are structured and how they make decisions.

These changes wouldn’t silence all of their critics, but it would disarm the arguments of some of the more conspiratorially minded. However, the White House is now occupied by a man known for his embrace of conspiracy theories, and the U.S. appears set to play a much more limited role in international fora going forward. This may lead to a rollback of post-crisis rules and regulations, and if it does, the FSB and BCBS will bear some responsibility.

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[1] “Who’s in Charge of Global Finance?” Geo. J. Int’l L. 45, no. 4 (2014): 982

[2] Id.

[3] As well as the International Organization of Securities Commissions (IOSCO) and the International Accounting Standards Board (IASB).

[4] I worked at the Federal Reserve Bank of New York from July 2011 to August 2016

[5] Only the chairs of committees are displayed on the website

[6] Barr, supra note 1, at 1024