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Governance of Global Financial Markets

Governance of Global Financial Markets The Law, the Economics, the Politics

Author: Emilios Avgouleas
Publisher: Cambridge University Press
ISBN: 9780521762663
Published In: April 2012
Format: Hardback , 500 pages
Jurisdiction: International ? Disclaimer:
Countri(es) stated herein are used as reference only

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The recent financial crisis proved that pre-existing arrangements for the governance of global markets were flawed. With reform underway in the USA, the EU and elsewhere, Emilios Avgouleas explores some of the questions associated with building an effective governance system and analyses the evolution of existing structures. By critiquing the soft law structures dominating international financial regulation and examining the roles of financial innovation and the neo-liberal policies in the expansion of global financial markets, he offers a new epistemological reading of the causes of the global financial crisis. Requisite reforms leave serious gaps in cross-border supervision, in the resolution of global financial institutions and in the monitoring of risk originating in the shadow banking sector. To close these gaps and safeguard the stability of the international financial system, an evolutionary governance system is proposed that will also enhance the welfare role of global financial markets.

• Provides a clear overview of current regulatory reforms in the EU, the USA and at the global level

• Analyses current EU, US and international reforms (Basle III, FSB Standards) dealing with systemic risk, too-big-to-fail institutions, capital and liquidity regulation, bank resolution, OTC derivatives and credit rating agencies

• Conceptual analysis of the evolution of governance structures for international finance and of the legal, economic and political developments that shaped them gives the reader an understanding of the different bodies and economic and political rationales that underpin and shape international financial regulation

Foreword	xiii
Preface	xv
List of abbreviations	xx
1 Introduction	1
1 The autumn of 2008	1
2 Why the GFC was not prevented?	2
3 Why is finance so important?	4
3.1 Overview	4
3.2 Should finance be regulated?	6
5 Whither governance of global financial markets?	12
5.1 The book’s subject matter	12
5.2 Towards a new governance model	12
6 Book structure	15
Part I Financial markets and financial crises	19
2 Financial markets and financial crises	21
1 Introduction	21
2 The important functions of the financial system	23
2.1 How financial systems foster economic growth	23
2.2 Mobilization, pooling of savings and ease of exchange	24
2.3 Information production, facilitation of investor (saver) monitoring and capital allocation	26
2.4 Risk management and risk reduction	27
2.5 Corporate governance	29
2.6 Evidence of the strong link between developed financial systems and economic growth	30
2.7 FSD, availability of finance and poverty alleviation	32
3 Evolution of global markets and financial innovation	35
3.1 Complex instruments and international financial markets	35
3.2 The different classes of derivatives contracts	36
3.3 Securitization and structured finance	40
3.4 Credit derivatives	47
3.5 Shadow banking	51
4 Efficient markets, inefficient markets, adaptive markets	54
4.1 Introductory remarks	54
4.2 Efficient Markets Hypothesis versus Behavioural Finance	57
4.3 Other puzzles	61
4.4 Adaptive markets	62
5 The neo-liberal consensus policies and the growth of global financial markets	64
5.1 The Jackson Hole Consensus	64
5.2 Deregulation	67
5.3 Washington Consensus policies	70
6 Financial markets and financial crises	72
6.1 The Asian Crisis	72
6.2 The Global Financial Crisis	74
6.3 Are financial markets inherently unstable?	79
7 Summary of findings	88
3 The causes of the Global Financial Crisis	89
1 Introduction	89
2 Macro-causes	92
2.1 Global trade imbalances and lax monetary policies	92
2.2 The flawed use of financial innovation	96
2.3 Failed government policies	106
2.4 Neo-liberal economic doctrine and deregulation	110
2.5 Irrational exuberance and other behavioural causes	121
3 Micro-causes: the issue of misaligned incentives	126
3.1 Executive compensation and corporate governance failures	126
3.2 The ‘originate-to-distribute’ model	129
3.3 The flawed information content and use of credit ratings	130
4 Flawed regulations	133
4.1 Capital and investor protection regulations	133
4.2 ‘Too-big-to-fail’ institutions and lack of cross-border special resolution regimes	134
5 Market failure, regulatory failure and the financial revolution	136
5.1 An alternative explanation of market and regulatory failure?	136
5.2 Complexity, emergence and the GFC	142
5.3 The role of insider rent-seeking	146
5.4 A knowledge revolution	150
6 Concluding remarks	154
Part II The evolution of governance structures for international finance	155
4 The evolution of global financial governance and development of International Financial Regulation	157
1 Introduction	157
2 The Bretton Woods and post-Bretton Woods phase	159
2.1 Introductory remarks	159
2.2 Monetary stability – financial stability and the IMF	162
2.3 The origins of TRNs and of standard setting	165
2.4 The most important TRNs of the post-Bretton Woods period	168
2.5 Reconstruction, development and the World Bank	179
2.6 Trade liberalization and financial services: from the ITO to the WTO	182
3 Intermediate phase: a ‘New International Financial Architecture’ (1998–2008)	185
3.1 An overview of the NIFA	185
3.2 The evolution of standard setting bodies and financial standards during NIFA	189
3.3 Implementation – monitoring and the FSAP surveys	199
3.4 A critique of NIFA	203
4 The emerging architecture	204
4.1 Introductory remarks	204
4.2 The emergence of the G-20	205
4.3 The IMF	206
4.4 From the FSF to the FSB	207
4.5 The supervisory colleges	209
5 Summary and concluding remarks	210
5 The ‘softness’ of soft law and global financial governance	213
1 Introduction	213
2 What is international financial regulation?	217
2.1 Regulation rationales	217
2.2 The advantages of soft law and TRNs in the context of global financial governance	221
2.3 Soft law shortcomings	225
2.4 The issue of legitimacy	232
3 Can soft law financial governance meet the challenges? Lessons from the GFC	236
3.1 Introductory remarks	236
3.2 The flaws of the Basel capital framework	237
3.3 Regulatory arbitrage through asset transformation, credit ratings and other follies	238
3.4 The systemic implications of neglecting liquidity	240
3.5 Flawed risk models and procyclicality	243
4 Supervisory failures, cross-border crisis management and ‘too-big-to-fail’ institutions	246
4.1 Overview of the issue	246
4.2 A closer look at the Kaupthing, Fortis and Dexia cases	249
4.3 Lack of cross-border resolution regimes and ‘too-big-to-fail’ institutions	252
5 What should be done?	256
Part III Regulatory reform and a new governance model for global financial markets	259
6 Regulatory and supervisory reform: US, EU, BCBS	261
1 Introduction	261
1.1 Overview	261
1.2 Summary of reforms	262
2 Critical aspects of the Dodd–Frank Act	272
2.1 Supervision of SIFIs and systemic risk oversight under the Dodd–Frank Act	272
2.2. Regulation of derivatives markets under the Dodd–Frank Act	280
2.3 Registration of hedge fund advisers	288
3 Regulatory and supervisory reform in the EU	289
3.1 The first attempt to reform EU financial regulation	289
3.2 The European system of financial supervision	302
4 The new Basel capital and liquidity framework	321
4.1 Minimum capital requirements and composition of capital	321
4.2 Capital buffers	324
4.3 Containing leverage	330
4.4 Liquidity ratios	332
4.5 Risk management and supervision	341
4.6 Evaluation of Basel III	344
7 Global reform of the ‘too-big-to-fail’ institution and the new resolution regimes in the US and the EU	348
1 Introduction	348
2 FSB principles for the supervision of SIFIs	351
3 Targeting bank size and speculative banking activities	352
3.1 The Volcker Rule	352
3.2 Ban on proprietary trading	354
3.3 Limited sponsoring or investing in private equity and hedge funds	356
3.4 The regime for non-bank financial companies	358
3.5 UK proposals on the structure of the banking industry	359
4 Increased capital requirements for SIFIs and G-SIFIs	360
4.1 Contingent capital instruments	360
4.2 Capital surcharges	368
5 BCBS-FSB principles on cross-border SIFI resolution	370
5.1 What is the problem?	370
5.2 BCBS, FSB and IMF recommendations on cross-border resolution	373
6 The Dodd–Frank Act resolution regime for SIFIs	381
6.1 Enhanced supervision and failure prevention	381
6.2 Orderly Liquidation Authority	384
6.3 Evaluation	393
7 The proposed EU crisis management and resolution framework	394
7.1 General principles	394
7.2 Preparation, early intervention and prevention	396
7.3 Recovery plans and group recovery plans	401
7.4 Resolution plans	403
7.5 Early intervention powers	407
7.6 Resolution powers and tools	409
7.7 Financing resolution	422
7.8 Evaluation of the EU resolution regime	424
8 Summary and conclusions	425
8 An evolutionary model for global financial governance	429
1 Introductory remarks	429
1.1 Overview	429
1.2 Summary of the proposal	432
2 The proposed global regulatory framework	435
2.1 General principles: the importance of shared values	435
2.2 The global macro-prudential supervisor	440
2.3 A global micro-prudential authority	442
2.4 Global financial policy, regulation and risk knowledge authority	447
2.5 A global resolution authority	451
2.6 Other advantages of the proposed governance system	454
3 Conclusion	457
Index	460

Emilios Avgouleas
University of Edinburgh

'Certainly far too much of the thinking underpinning the regulatory reforms since the crisis has been an extension of the thinking that delivered us the crisis - people are still thinking within the same box. Professor Avgouleas has stepped out of this box, and dared to think larger thoughts, and propose more fundamental reforms, that actually seek to address the seminal change from a system of national financial systems to one truly globalized financial system … With a fuse burning in the Eurozone that could ignite a far larger crisis than the GFC, nothing could be more urgent than the G20 resolving to make at least some of the ideas in this book a reality.' Ross Buckley, University of New South Wales