Monday, January 26, 2009

Group of 30 Issues Sweeping Report on Financial Reform

On January 15, the Group of Thirty (G30), a private, nonprofit, international body made up of senior representatives of the private and public sectors and academia, released a report entitled Financial Reform: A Framework for Financial Stability.  The stated purpose of the report is "to help inform the needed debate among policymakers and the international financial community" on these issues:
  1. The policy issues related to redefining the scope and boundaries of prudential regulation;

  2. Reforming the structure of prudential regulation, including the role of central banks, the implications for the workings of “lender-of-last-resort” facilities and other elements of the official “safety net,” and the need for greater international coordination;

  3. Improving governance, risk management, regulatory policies, and accounting practices and standards; and

  4. Improvements in transparency and financial infrastructure arrangements.

The report recommends a sweeping and coordinated global restructuring of the legislative and regulatory framework governing the financial services industry; however, the focus of most of the recommendations rests on the United States.  Given that one of the report's key authors is Paul Volker, chairman of the Group of 30's board of trustees, former Chairman of the Federal Reserve, and current adviser to President Obama, this report is likely to be taken very seriously by the President and Congress as they consider reforms to the regulation of the financial services industry.  The report's core recommendations are:

1.  Gaps and weaknesses in the coverage of prudential regulation and supervision must be eliminated.  All systemically significant financial institutions, regardless of type, must be subject to an appropriate degree of prudential oversight.

  • In all countries, the supervision of the activities of all banks should be consolidated under one prudential regulator, with a focus on the largest and most complex.

  • Large, systematically important banks should have close supervision, be prohibited from engaging in high-risk activities, and should be restricted from sponsoring and managing commingled private pools of capital (i.e., hedge funds and private equity funds). These banks should also retain a meaningful part of the credit risk of collective debt instruments they package and sell.

  • Consolidated, national-level prudential regulators should be established to regulate financial institutions not organized as bank holding companies, like investment banks, broker-dealers, and large internationally active insurance companies.

  • Money market mutual funds offering bank-like services should be required to reorganize as special purpose banks, and regulated in the same manner as banks.  Money market mutual funds not reorganizing as special purpose banks should offer only conservative investments with relatively modest returns and low risk, be prohibited from using amortized cost pricing, and should have a floating NAV rather than one that is pegged at $1.00 per share. 

  • Hedge fund managers and managers of other large private pools of capital should be subject to a national prudential regulator with the authority to require registration, periodic reports and public disclosure and to establish appropriate standards for capital, liquidity, and risk management for large and systematically significant funds.  The recommendation stresses that the regulatory framework should be applied on an globally consistent basis.

  • The role of GSEs like Fannie Mae an Feddie Mac should be based on a clear separation of the private sector functions of risk intermediation from the governmental roles of insurance and guarantees of credit risk.  The degree of public support for Fannie Mae and Freddie Mac should be expressly defined.  Purely governmental entities providing support for the mortgage market through market purchases should have explicit statutory backing and financial support.

2.  The quality and effectiveness of prudential regulation and supervision must be improved.
  • Regulatory structures should be reevaluatied to eliminate overlaps and gaps in coverage.

  • The role of central banks should be to promote and maintain financial stability and, in most countries, take a strong role in prudential regulation. 

  • The authority of central banks to provide lending in extreme emergency situations should be maintained, and expanded to include non-bank institutions.

  • Central banks support should be limited to forms that do no not involve high-risk assets.  That kind of support is more appropriately made by directly accountable government entities and agencies.

  • International coordination of national regulatory authorities an finance ministries should be enhanced to:
(1) better oversee international banks,

(2) move beyond coordination of regulations and standards to better enforcement,

(3) close regulatory gaps and raise standards related to offshore banking centers, and

(4) develop mechanisms for joint consideration of global systemic risks.

3.  Institutional policies and standards must be strengthened, with particular emphasis on standards for governance, risk management, capital, and liquidity. 

  • Regulatory standards for governance and risk management should be strengthened with emphasis on boards’ oversight of compensation and risk management policies to balance risk taking with long-term health of the company and the interests of shareholders.

  • Steps should be taken to adjust international capitalization standards to protect against firms' tendencies to be take excessive risks during boom times.

  • Fair value accounting principles and standards should be revised to deal with distressed market situations and suddenly illiquid securities.  Principles based standards should be developed that better reflect the business model of financial institutions, and accounting standard setters should coordinate with regulators to ensure sound operation of financial institutions.  

4.  Financial markets and products must be made more transparent, with better aligned risk and prudential incentives. The infrastructure supporting these markets must be made much more robust and resistant to potential failures of even large financial institutions.

  • Derivatives, SIVs, and other securitized financial products should be regulated in the same ways as publicly traded stocks and bonds are regulated, and a formal system of regulation and trading of credit default swaps and similar products should be established and consistently applied internationally.

  • Credit rating organizations should be regulated in a consistent manner, globally, and the "issuer pays" system should be modified.

  • An early warning system for bank closures, market freezes, and corrective actions should be established.  

A forward by Paul Volker and Jacob Frenkel, as well as a description of the report and a fuller explanation of the report's recommendations is available at:

The full text of "Financial Reform: A Framework for Financial Stability" is available for purchase at: