Global financial firms are in danger of drowning in the ocean of uncertainty that floats between the rhetoric of the G-20 and the reality of international regulation.
When the finance ministers and central bankers of 19 countries and the EU meet again next month, there will be more grand statements about the importance of working together toward global financial stability and growth.
But behind the talk is contradictory action. G-20 member countries are forging ahead, without much concern for coordination. The U.S., the U.K. and the EU are all heading in different directions.
So for the financial companies that operate globally, being overseen nationally is leading critics to ask an increasingly uncomfortable set of questions:
How can systemically important institutions be effectively supervised?
Should we ring-fence or segregate operations by country?
Would it be easier to simply break them up?
Obviously, the industry needs an alternative to piecemeal oversight.
Enter Charles Dallara, who has led the Institute of International Finance since 1993 and is perhaps the only trade association executive easily mistaken for a diplomat. Dallara trots the globe, representing some 440 financial companies, including nearly all of the major ones in the U.S. and Europe.
I caught up with him this week, his first day back in the office after five weeks on the road, including some tense days as lenders' lead negotiator in the Greek-debt talks.
Before the next G-20 meeting, Dallara plans to make his case for a global regulatory coordinating council. This won't be the first time, but it may be the most urgent.
"We are approaching a crossroads here," Dallara said in the interview. "Are we prepared to put aside national and parochial tendencies … for the better interests of the global economy, or are we going to reconcile ourselves to increasingly disjointed national approaches?"
See what I mean about being mistaken for a diplomat? Dallara is no flamethrower. But he has a quiet relentlessness about him.
"Every day we wake up and see countries acting unilaterally. There needs to be a much greater willingness, in my view, of the global regulatory community to chastise such efforts."
Of course, the Dodd-Frank Act is Exhibit A in countries going it alone. After the 2008 financial crisis, Congress got to work and enacted a 2,300-page law in July 2010 that addresses everything from capital to consumer protection.
"This is a reverse way to run global regulation," Dallara said. "Europe was clearly troubled by some of what was happening in Dodd-Frank. … But it saw the law as a political inevitability rather than protest the fundamental nature of having U.S. legislation front-run global discussion, which is what it did."
What's a better approach?
"Leaders have to be mature enough to stand up to their constituents and say, 'Guys, we are going to pursue our priorities here, but we are going to do it as part of a broader global process that is consistent with our desire to promote jobs on a global basis.' " The U.S.'s reform law, Switzerland's "gold-plated" capital requirements and Europe's crackdown on executive compensation share a common thread, Dallara said.
"They tend to reflect an inability of the political leadership to get ahold of itself and say, 'How do we do this in a world dominated by a global economy and a global financial system where all of our most important firms are operating across borders?' "
In time for the G-20 meeting, the institute plans to release a study detailing the macroeconomic drag caused by excessive and disjointed regulatory changes. (September's meeting of finance ministers and central bankers sets the stage for the next G-20 summit in November when heads of state will gather in Cannes, France.) The institute's study will update one released in June 2010, which was met with some skepticism. It's not exactly news when an industry group concludes added regulation will slow economic growth and job creation. But a little more than a year later, Dallara said the evidence is tougher to explain.
"The data reinforces our case that while central bankers and policymakers alike are wondering why the recovery hasn't been stronger, they are missing the elephant right in the middle of the room, which is burdensome regulatory reform.
"It is going to be much harder this time to criticize it for being just industry self-serving."
Dallara, 63, joined the institute from what was then JPMorgan & Co., where he led the investment and commercial banking business in Eastern Europe, the Middle East, Africa and India. He split the 1980s between the Treasury Department and the International Monetary Fund. He holds several advanced degrees, including a doctorate in philosophy, is a member of the Council on Foreign Relations and may just be the Bill Rhodes of his generation.
Dallara stops short of suggesting a formal treaty to enforce coordination among regulators. "We don't need a legal environment, but we do need a system of incentives and disincentives so that if countries fail to cooperate they would be ostracized, chastised, criticized, cajoled," he said. "It's what I would call a hard form of peer pressure."
The Financial Stability Board or the Basel Committee on Banking Supervision could do the job, he said, provided their structures were drastically overhauled and their resources greatly expanded. The board is a collection of the world's central bankers and the committee is made up of global regulators. Neither group is strong enough to ensure countries toe a coordinated line, Dallara said.
"Right now the chairman of the Basel Committee and the chairman of the FSB are part-time jobs," he said. "For this to really work you need a center of gravity; you need a critical mass of full-time, committed professional leaders whose job is to frame, implement and monitor globally consistent regulation and supervision."
For Dallara, the most troubling inconsistency among regulators involves capital. The institute supports the Basel III move toward more capital and better-quality capital. But Dallara said what started as global standards are morphing into minimums as various countries tack on surcharges and press for speedier adoption.
"Why don't we let the financial institutions settle in to trying to meet their new capital requirements within the original time frame?" he asked. "What this says to me is they are willing to put their near-term financial stability goals ahead of economic recovery, and that's a bit risky."
Dallara opposes regulatory moves to flag certain institutions as systemically important. "I understand the logic behind it I think it is poorly timed and I think it is poorly framed," he said.
He also disagrees with the conventional thinking that big is risky.
"We seem to be making an assumption that systemic risk will stem from these large, complex institutions. What evidence is there in modern financial history or modern sovereign risk? The country that has shaken Europe to its foundation is Greece. No one would have designated Greece as a systemically relative sovereign if you had asked anybody three years ago. The same thing goes for Northern Rock in the U.K. … You might have gotten someone to say Lehman, but I even doubt that."
Dallara contends "our monitoring of systemic risk around institutions is fundamentally flawed."
"It's not the institutions themselves that are the source of risk. It is the dynamic interaction between institutions, markets and products that becomes the source of systemic risk. And that can be done with small institutions, with large institutions, with skinny ones, fat ones, tall ones and short ones. To me it is heading us off on the wrong track to say, 'Aha! We want to contain systemic risk, so we are going to surround these particular institutions with notably higher levels of capital.' It could produce incentives that are totally counterproductive."
In other words, as companies strive to provide a return on capital, they reach for risk.
"The loading up of extra capital requirements on these large global institutions, when they are competing against" less-regulated companies "is going to produce the wrong incentives in terms of risk positions," Dallara said.
"This is just reality. Regulators have to ask themselves what are the intended consequences and what are the unintended consequences of what they are doing."
In a recent meeting with Dallara, a senior regulatory official cited one potential unintended consequence: the end of global finance.
Dallara doesn't think the situation is quite that dire, but he is concerned. "We are in the midst of a real global effort to disintegrate our financial systems where we are each going to be protecting our own backyard at the expense of the neighborhood."
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