What mechanisms have emerged to regulate the global financial system? Who are the key players? How well do international standards and codes of conduct meet the needs of poor and emerging economies? These issues are addressed in a working paper from the International Monetary Fund (IMF), produced by the Financial Sector Operations and Policy Department and the Cofinancing and Project Finance Group, Legal Vice Presidency.
Financial globalisation has brought a shift in the balance of power from governments to markets. It has proved hard to formulate a new discipline for an international financial system. The approach that has emerged is the adoption of international codes of conducts and standards, an innovative and constructive effort. The approach combines the key features of previous successful episodes of regulatory harmonisation and represents, with all its limitations, a structured approach to the problems raised by the globalisation of capital markets.
The key feature of the new approach has been the substitution of the traditional top-down process with a new process where only a minimum number of common rules are defined. Further harmonisation is left to market forces. The three key principles are minimum harmonisation, mutual recognition and reputationally-induced discipline.
- From the 1970s onwards, ‘non- governmental’ sector initiatives have often taken the lead in setting the pace for and even forcing government interventions in the financial area.
- The example of Euromarket and American Depositors Receipts show that markets have the capacity to spread existing standards across jurisdictions, and to develop contractual and regulatory standards through arbitrage and competition.
- Market mechanisms also have had some success in developing and enforcing financial standards through reputational discipline. Adherence to norms is by the threat of loss of reputation or public censure.
- International codes of conduct are often adopted as law and regulation at national level. Implementation of national law may prove difficult. International codes of conduct do not always transfer well to different legal and cultural systems. Regulatory systems have high costs for small countries.
- Standards are often developed by exclusive groups – they are therefore unlikely to meet the problems and issues of those who are not representative. But building agreements between an inclusive and representative group is a time consuming process.
The standards and codes approach plays an important role in reducing the risk of instability related to weak regulations. However, the ultimate success of this approach will lie in the capacity to provide operational content:
- A refinement of standards and codes is needed to accommodate different legal traditions and to deal with the needs of financial systems of different size and complexity.
- For small developing countries, the costs of financial regulation may require different regulatory structures than those prevailing in larger economies.
- A clearer definition of the role played by different standards in promoting economic growth and financial stability would help to set priorities among different regulatory reforms and improve the effectiveness of standards and codes.
- International standards and codes could be made more effective through a macro-prudential approach. This approach looks at ways to limit costs to the economy caused by financial shocks.
