Michael Foot Managing Director,
UK Financial Services Authority at the Guernsey Financial Service Commission Seminar on "International Co-operation and Exchange of Information." 5 June 2003.

  1. One consequence of being part of a single regulator is that it is easier to see close-up the rather different ways in which international regulatory co-operation within each of (I) banking, (II) securities and (III) insurance has evolved over the last two decades. Of course, in any such evaluation the reviewer is probably biased towards the model with which he/she is most familiar (though I have subjected what follows to review by UK regulators from all 3 backgrounds). But the differences are striking. For the first part of this talk, I would therefore like to:
  • sketch out these differences
  • discuss whether the differences are fading as we progress and
  • ask what are the best features of each that might eventually be incorporated in a "best of class" model.
  1. International co-operation between banking regulators was "first out of the block" – no doubt necessitated by the relatively early growth of large global banks who wanted where possible to operate through a branch network. Problems for any of these banks could spell difficulties for many individual countries and indeed at the extreme pose a systemic threat to the soundness of the system. [Witness for example the failure of Herstatt Bank in 1974, when the dangers of cross-border foreign exchange settlement first came all too painfully alive.]
  2. I was not involved personally in the creation of the Basel Committee and the efforts that led to Basel1. But I have been assured that, without the determination of the top regulators at just 2 institutions, the Federal Reserve of New York and the Bank of England, progress would have been many years slower than it in fact turned out to be – even with the stimulus provided by Herstatt.
  3. Over the following years, he value of both the direct personal and institutional links between the various G10 banking regulators was tested and proved as periodic banking crises came and went. But some other "facts of life" also began to emerge and three of these are important for present purposes:
  • A) The pace of evolution of financial markets is so great that no sooner has a definitive statement come from the authorities than the regulator is "left behind", either by some new regulatory arbitrage or by a further evolution of the market. The choice in these circumstances is between a regulatory approach that sticks to high principle and one in which detailed interpretation and revision continues almost daily. The first requires a huge amount of trust between fellow regulators if it is to work, as each tries to apply these high principles to "their" firms. The second risks being way behind the game because details are "hard-wired" into the system and take ages to change. The choice of where to go in this matrix of principle and detail is, I think, the hardest one that any international regulatory grouping faces.
  • B) The original Basel Committee model had the merit of bringing together the most sophisticated banking regulators and letting them crack on at their own pace. But, as time has gone by, the 2 weaknesses of this approach have become increasingly obvious. First, if the Basel Committee wants co-operation from outside its ranks, then the regulators not on this Committee must have a means by which they are genuinely involved in the discussion and formulation of policy to which they are being invited to sign up. Second, the growth of sophisticated banking markets outside the original G10 has made the need to involve the newer players on an equal footing much more pressing than the first reason alone would have suggested. To its credit, the Basel Committee has moved quite some way to try and involve a widening circle of other banking regulators.
  • C) If regulators are going to produce anything that it is worth their industries having, and it is to be done by extensive co-operation and discussion with the industry itself, then nothing is going to emerge quickly. Basel2 (which will be at least 8 years from first steps to implementation in any single country) is proof enough of this. But there will be many occasions where international regulatory action has to move much more quickly than that. Collective action by regulators is rarely likely to be quick and the question of the speed with which international regulators should be able to move at need is one to which I will return.
  1. The challenges for the securities regulators (in IOSCO) and insurance (IAIS) have been similar but have been tackled somewhat differently. In particular, from the outset both organisations have had a much more inclusive membership than did Basel. This model too has its weaknesses. It seems to be harder (though by no means impossible) to get significant detailed initiatives pushed through and also to raise the money needed for an adequate secretariat, if this means a share has to be found by emerging market countries . To illustrate this last point I would guess that, despite a late burst by both IOSCO and IAIS, expenditure by the banking regulators on their secretariat must still be at least the sum of the other 2 put together. While more money is not necessarily money well spent, it is still the case that a respectably sized secretariat is a necessary if not sufficient condition for real progress in advancing international standards in the area.
  2. The other difficulty – I think especially for the IAIS but modestly so perhaps for IOSCO too - has been the very different nature and focus of the US regulators (who in the case of Basel I argued played a seminal part in launching the Committee). The SEC is a Federal regulator like the Federal Reserve but, historically, it seems to have been slower than its banking colleagues to internationalise. Also (because of the view it has long taken on consolidated supervision) it has been less willing to take an "all-in" view of the financial groups it deals with. Instead, it has stuck with the broker-dealers it was there originally to regulate.
  3. In the case of insurance, the position has been much more difficult because there was not and is not a Federal regulator of insurance. And, while I would be the last to want to get involved in the long-running debate between Federal and States’ rights, it is without doubt the case that the existence of 50 State bodies, many of which have a purely domestic orientation, has seriously delayed the development of international standard setting in insurance.
  4. Despite these constraints, there have been some real IOSCO successes in recent years, and IAIS is also now making better progress with a substantial volume of work occasioned by the difficulties that the insurance industry (both life and non-life) is facing globally. I will touch on a few of these when I speak.


    Who guards the guardians?

  5. I think that all but the most blinkered regulators want to "know how they are doing" relative to their peers in other countries. And, of course, for very good reasons, we all want assurance that those other regulators on whom we rely are "doing the job" they are supposed to be doing. At last, with the work of bodies like FATF and now the IMF FSAP programmes, we are starting to get some answers to this pertinent question.
  6. First efforts among traditional regulators to review the work of their colleagues did not bear immediate fruit. In 1994, the Bank of England (then the UK’s banking regulator) urged G10 colleagues to join in what it called peer group review, a process based very much on what the large firms of auditors were doing at that time to try to ensure consistency of standards in their own businesses. There was one test case, when the Dutch and Spanish regulators reviewed the work of the Bank of England. But there was no second volunteer.
  7. Fortunately, the much later development of the IMF FSAP programme has given us progress on another front, and – to judge by the thoroughness with which the UK’s own programme was conducted – we should all be able to gain some comfort as the Fund moves towards completing the first round of its endeavours. (And, almost as importantly, as the IMF reverts in subsequent Article IV Consultations, we need to find out what has happened to its detailed recommendations to members for further progress.)
  8. I suppose I may be slightly biased, as the Fund’s summary for the UK was pretty favourable (though not surprisingly it noted that standards needed to be good, given the importance to world stability of the international business passing through London). And I would not claim the process was without stress. The resource cost of dealing with the Fund is substantial – in the case of the FSA alone around US$ 500,000. And the Fund is at the cutting edge of a number of complex issues, where there can be no certainty that any of us have chosen the "right answer". [Notably, in the case of the UK, perhaps the hardest single issue was how to model the interconnections between the UK’s international and domestic financial sectors, to see if and under what circumstances problems in the one could spill over into the other. With the help of 12 major British and non-British banks operating out of the UK, we eventually managed this to mutual satisfaction; but it is no easy task.]
  9. And we have to recall that, while the Fund team can and do press hard on issues such as deviations from the various (Basel, IOSCO and other) standards and look extremely closely at the workings of the key payment and settlement systems, there is only so much that they can do. They cannot and do not pretend to tell us how well a regulator will handle a particular difficult situation when the chips are down, when political pressure might be applied, or when there are major judgements to be made, the accuracy of which may look very different with hindsight.
  10. Nevertheless, and I shall be interested to hear from our hosts here how they have found the exercise, the IMF FSAP programme is, to my mind, one of the potentially most important advances we have had in the last few years, in the field of improving international regulatory co-operation. It should help to tease out where the remaining key weaknesses in the global financial system really are; and, hopefully, help also to arm local regulators with better arguments for political help in framing changes in legislation and/or extra resources where these are needed.


    Co-operation in individual cases.

  11. As with peer group performance, it can be hard to measure the extent of co-operation that actually occurs between regulators though I suspect everyone would agree that should be an important feature of any international regulatory arrangement.
  12. Of course we all of us have little pieces of paper called MOUs and I am often asked how many Memoranda of Understanding the FSA has outstanding with other regulators. The honest answer is that I had never tried to find out until I had to prepare this speech. The answer turns out to be that the FSA "inherited" around 150 from its predecessor organisations of which about two-thirds can fairly be called "active" and there is a small but important pipeline of agreements under negotiation.
  13. I think, however, it is important to dwell for a moment on what the existence of an MOU does and doesn’t mean. I accept that there can be real value in having a bilateral MOU with another regulator, where there is – or is likely to be – the need for practical co-operation. The existence of such a document means that there has been at least some due diligence done on both sides about each other’s system and that the results have been broadly satisfactory. It often means that it will be easier to pass regulatory information without challenge. It generally means that (typically annually and even if there seems little to discuss) the regulators from the two sides get together, and discuss the performance of each other’s economy and of their major financial institutions. Over time, regulators can and do start to build up the personal relationships that really make a difference when a difficult live case comes along.
  14. I can also see value in at least some of the multilateral arrangments around, such as the IOSCO Multilateral MOU. And I have long been an enthusiastic supporter of the arrangements within the EU under the Second Banking Co-ordination Directive, not least for the clarity which 2BCD brings to which regulator is responsible for what.
  15. But – and it is an important "but" – the existence of an MOU does not of itself eliminate problems if problems there are. An MOU will not be legally binding. It does strongly depend upon mutual trust and, if that is absent, the existence of a piece of paper means little. Of itself, it also does nothing to remind each set of regulators (especially away from the annual cycle of meetings) that the piece of business they are dealing with may have some operational importance for a regulatory colleague abroad and to follow up to see if it does. And, finally, the existence of an MOU doesn’t alter the frequent reality that there can be real and unavoidable tension between the home and host supervisor when problems become acute. I can cite one very encouraging example from my own dealing with Guernsey – namely the handling of the Barings crisis in 1995 – and will cover that briefly when I speak. But there will also be those in the room who will have bad experiences to share as well.
  16. Progress in international co-operation does seem to vary considerably between particular areas of endeavour. My colleagues who deal with financial crime cases In areas with which I have less personal involvement tell me that there has been some very real progress here and that, where the spirit is willing, a lot can be done. The sad events of 9/11 and subsequently have had the effect of reminding us all of the need for such co-operation and that each of the parties involved has potentially something to gain from a positive outcome.
  17. However, in the one area of financial crime in which I am personally interested – the sharing of information about possible market abuse across borders – I fear we are still at a very early stage. Despite a lot of good will, the payoff so far for a great deal of work appears to be rather limited. But in the various international and regional fora whose existence now dominates our collective diaries, there are ways of talking through how we can do better. And it is also a comforting fact (though there is still further to go) that a Darwinian process of natural selection of financial centres seems to be hard at work. Perhaps the analogy is not quite right, because the regulators are playing an active role in the evolution process. But it does seem to me incontrovertible that the number of dubious centres – while still far from zero – is certainly smaller than it was 3 years ago.


    Handling a crisis

  18. It would not be normal for a regulator to finish on too positive a note, so let me end by sharing with you a concern which I flagged at the very beginning of this talk. That is the question of whether or not our elaborate international infrastructure even now (despite the creation of the Financial Stability Forum and all the other ways in which Ministries of Finance, Central banks and Regulators come together) has the ability and will to proactively identify potential financial storms early enough.
  19. I have to admit that:
  • the international system has coped pretty well with a profound series of economic and financial shocks over the last few years
  • many financial institutions seem to have learned how to handle and diversify their risks far better than was the case in the recession of the early 1990s.
  • there is also some excellent analysis these days, amid the mountain of the bland communiques written weeks or days before the meeting to which they relate, for those who want to scan the horizon.
  1. I also think that some of the international worries of which we hear are overdone and I recognise too that – with the best will in the world – some problems will always catch us unawares. But, over 15 years ago, Gerry Corrigan – then President of the New York Fed – noted that the large banks and large securities houses were linked in ways that "create operational, liquidity and credit interdependencies that stagger the imagination". Fifteen years on, our imaginations may have expanded but so too – sometimes it seems almost exponentially – has our financial universe. International regulatory co-operation will function best where we have at least some warning of the squalls to come. As of now, I for one, would be willing to go on investing in better storm prediction to accompany the storm mitigation.

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