Did the Financial Crisis Generate a Fourth Pillar of Global Economic Architecture?

Global financial crises often serve as catalysts for innovations in global governance. The crisis of 2008 was no exception. An enormous amount of scholarly analysis has been devoted to the creation of the G20 leaders forum in November 2008. Much less attention has been paid to a second innovation in international governance that took place five months later: the creation of the Financial Stability Board (FSB) by the G20 leaders at their second summit meeting in April 2009. The lack of scholarly attention is surprising since the FSB's creators heralded this new institution as an innovation of major importance. US Treasury Secretary Tim Geithner described the FSB's as “in effect, a fourth pillar to the architecture of cooperation we established after the second world war” alongside the IMF, World Bank and GATT/WTO.1 Geithner's made these comments in response to a reporter's question about how the new post-crisis international financial regulations developed by the G20 would be enforced. Before the crisis, analysts often complained about the weak nature of the governance of international financial standards. In contrast to the international trade agreements, international financial standards have long been “soft law” with which compliance is entirely voluntary. They have been developed by relatively obscure international standard setting bodies with no formal power and little capacity to encourage compliance. Left to the discretion of national authorities, past compliance with international financial standards was frequently uneven at the national level.2 Geithner was suggesting that the FSB could act as a new fourth pillar of global economic governance by helping to encourage the implementation of harmonized international financial standards. This vision was captured in the FSB's charter that set out its role of “fostering a level playing field through coherent implementation across sectors and jurisdictions”.3 Has the FSB lived up to this ambitious billing in its first few years? I address this question in this short article, arguing that the FSB's creation has been much less significant for this aspect of global financial governance than Geithner suggests.4 The G20 leaders gave the FSB several mechanisms to encourage implementation of international standards. First, membership in the FSB came with an obligation to “implement international financial standards”.5 This provision was much less impressive than it appeared, however. Article 16 of the FSB's charter noted very clearly that membership in the FSB was “not intended to create any legal rights or obligations”.6 The reason was straightforward: the FSB's charter had not been ratified by any legislature and did not even have any legal standing of any kind. Indeed, the charter did not even specify any consequences of failing to comply with the new membership obligation. It simply noted that “the eligibility of Members will be reviewed periodically by the Plenary in the light of the FSB objectives”.7 The FSB's Plenary, however, employs a consensus rule, allowing any country to veto any effort to have its membership suspended. Second, compliance with international standards was to be encouraged by the fact that member countries committed to “undergo periodic peer reviews, using among other evidence IMF/World Bank public Financial Sector Assessment Program reports”.8 Since a number of FSB members (including the US, China, Indonesia and Argentina) had refused to participate in the Financial Sector Assessment Program before the crisis, this commitment was more significant.9 The promise to undergo peer reviews was also new. The FSB hoped that peer reviews would foster a “‘race to the top” in terms of adherence to international financial standards.10 Peer reviews would be conducted by the FSB's Standing Committee on Standards, drawing on a report prepared by experts from FSB members with the help of FSB staff. FSB staff would prepare a final report that would be made public after the Plenary's approval and whose recommendations were to be implemented by the reviewed member. The effectiveness of this peer review process for encouraging international standards to be implemented is questionable. For example, some critics are skeptical about how critical FSB members will be of each other. As Paul Blustein puts it, “international groupings are notorious for conducting peer reviews with kid gloves, because members know that harsh treatment toward others will invite the same on themselves….Little evidence of a proclivity for such outspokenness has surfaced in the handful of peer reviews conducted by the FSB so far.”11 It is also worth noting that the quality of the FSB's peer review depends heavily on FSB staff who are expected to play a key role in supporting the reviewers and preparing the final report. The size of the FSB secretariat is tiny, however; in mid-2013, it had 28 staff and was authorized to expand this to only forty. Compare this to the OECD or the IMF, each of which have over 2000 staff. The FSB's staff size means that it can support only relatively infrequent country peer reviews. Partly because of capacity constraints, the FSB decided in 2011 that countries would only have to undergo country peer reviews every 2-3 years after completing a FSAP assessment or a Report on the Observance of Standards and Codes (ROSC) (which summarizes countries’ compliance levels based on FSAP results).12 Since FSB members committed to undergo an FSAP only every five years, country peer reviews will only happen every half decade as well. The core weakness of peer reviews, however, is that non-compliance with their recommendations has few significant consequences. A December 2011 Handbook for FSB Peer Reviews noted the following mechanisms for encouraging compliance in jurisdictions whose implementation of recommendations was lagging: “a letter from the FSB Chair to the relevant member outlining the Plenary's concerns; a discussion by the Plenary with the reviewed jurisdiction; or publication of the Plenary's concerns on the FSB website.13 None of these is likely to be change the behavior of a government intent on ignoring the advice of a FSB peer review. When the FSB was first established, the G20 leaders did briefly contemplate more serious penalties against jurisdictions refusing to comply with international financial standards. In April 2009, they asked the FSB “to develop a toolbox of measures to promote adherence to prudential standards and cooperation with jurisdictions.”14 In March 2010, the FSB then announced an initiative under which non-complying jurisdictions (NCJs) would face “a balance of both positive and negative measures”.15 One negative measure would involve the publication of the names of non-complying jurisdictions by the end of 2010 if positive measures (such as dialogue and technical assistance) were not achieving sufficient progress. Others included possible restrictions on market access or on cross-border financial transactions. The FSB notes that these measures would be “subject to approval by the Plenary and the judgement of the FSB member jurisdictions in their implementation”.16 But it was obvious from the start that sanctions were unlikely to be applied against a FSB member since any such measure required the support of the Plenary. Moreover, under this initiative, the FSB sought to foster compliance only with some very basic international cooperation and information exchange principles embodied in three key standards that had been developed well before the crisis. The limits of the initiative became clear when the FSB released a report identifying compliance levels among 61 jursidictions in advance of the November 2011 G20 summit. Only two jurisdictions were identified as non-complying - Libya (the former regime) and Venezuela - both of which were described simply as “not engaged in dialogue with the FSB”.17 FSB members have also so far chosen not to expand this initiative. The FSB had noted in March 2010 that “the ultimate goal is to promote adherence by all countries and jurisdictions” and promised that “following completion of the first round of evaluations, the Expert Group will engage in a further round of dialogue with a different group of jurisdictions, subject to approval by the Plenary after review by the SCSI.”18 This second round of evaluations has not yet taken place. In early 2010, the FSB also suggested that the initiative might eventually be widened to apply to broader set of international standards, but this has not been done.19 Particularly important is the fact that FSB members have not extended this initiative to encourage compliance with the extensive international regulatory reforms they have backed since the crisis. To foster implementation of these post-crisis reforms, the FSB is relying on entirely on voluntary tools such as peer pressure and monitoring. This approach was very evident in November 2011 when the G20 leaders endorsed a new FSB “coordination framework for implementation monitoring”.20 Under this framework, the FSB Secretariat began to produce an annual “status report” on the progress of implementation involving four grades (or “traffic lights”). The FSB has also made more extensive efforts to encourage implementation of standards among non-members by inviting 70 non-member jurisdictions to join six new formal regional consultative groups covering the Americas, Asia, the Commonwealth of Independent States, Europe, the Middle East and North Africa, and Sub-Saharan Africa. Their role in the FSB governance structure was formalized when the charter was amended in June 2012. None of these initiatives challenge the weak soft-law governance of the international financial standards that existed before the crisis. The lack of serious change was apparent in January 2013 when FSB members gave the FSB a formal legal personality for the first time as an association under Swiss law. The Articles of Association noted once again that the FSB's activities and decisions “shall not be binding or give rise to any legal rights or obligations under the present Articles. Members can recuse themselves at any time from these activities or decision-making where such activities or decision-making are not consistent with their legal or policy frameworks”.21 Rather than “hardening” international financial law, this initiative had been designed with much more modest objectives such as the need to hire permanent staff and establish more stable funding for the FSB. The FSB is thus an extremely weak body. While the creation of the WTO in the mid-1990s helped to strengthen the governance of international trade law, the implementation of international financial standards continues to rest on voluntary commitments. Some analysts think this is a shame, arguing that compliance challenges can only be addressed effectively through a more powerful WTO-like international institution.22 But G20 policymakers have been unwilling to embrace this idea, despite the vaulted rhetoric about a new “fourth pillar” of global economic governance. The failure of the G20 leaders to depart from the soft law nature of the pre-crisis governance of international financial standards means that the challenges in enforcing implementation remain. Some of these challenges are familiar from the pre-crisis period such as competitive pressures and private sector lobbying. But the challenges have also intensified in the wake of the crisis in ways that make the failure to innovate in a substantial way even more significant. For example, because of the extensive nature of the international regulatory reforms endorsed by the G20, their implementation often requires more significant legislative initiatives than in the past. The severity of the crisis has also politicized financial regulatory issues in many countries in ways that complicate the passage of these initiatives and other implementation efforts.23 In this context, it is hardly surprising that implementation of many of the post-2008 international financial standards has been slow. Even when reforms are being put in place, the uneven nature of their implementation has often been striking. The result is an international playing field that is increasingly uneven – the very result that the FSB was supposed to prevent. At each G20 summit, the leaders continue to promise “timely, full and consistent implementation” of the agreed standards.24 But in the absence of any significant international legal constraint or fear of sanctions, they do not always fulfill these commitments. Why, then, were the G20 leaders not bolder when they created the FSB? Why did they not create a stronger body that could really have been a fourth pillar of global economic governance? In advance of the first G20 summit, some policymakers, such as then British Prime Minister Gordon Brown, did appear to favour the creation of a more powerful global regulator.25 But the idea found little support beyond a few countries such as France. Policymakers in the US and elsewhere have long been wary of accepting binding international constraints on their financial regulatory policies.26 Financial regulation plays an important strategic role in domestic political economies, a role whose importance was highlighted more clearly than ever by the crisis experience. Many policymakers are also wary of overly ambitious efforts to harmonize regulations internationally because of their belief that domestic regulatory practices must be adapted to distinct national circumstances.27 The domestic politicization of regulatory issues during the crisis only further undermined support for proposals to delegate power to an international authority. Distrust of delegating regulatory responsibilities to foreigners was also reinforced by the international dynamics around efforts to resolve and pay for failed financial institutions during the crisis. In 2008-09, the costs of bank failures and their bailouts usually fell on the host country because of failed cooperation between host and home country authorities. This experience led policymakers to favor initiatives to strengthen their country's regulatory autonomy rather than dilute it. This preference has only been reinforced by the fact that the G20 and FSB have been unable to reach meaningful international agreements for cross-border resolution of failing firms or burden-sharing of bailouts. One such initiative involves the greater use of “host country” regulation under which international banks are forced to establish separately capitalized local subsidiaries that can be regulated more exclusively by the host authority. Another is the requirement that clearing of OTC derivatives be done domestically rather than through foreign clearing houses that are beyond the control of domestic regulators and supervisors.28 The growing popularity of these kinds of policies highlights the distrust of many national regulators in the prospects for international regulatory cooperation in the wake of the crisis. This distrust, reinforced by the crisis experience itself, has encouraged regulators protect their country's interests unilaterally rather than delegate power to foreigners or any kind of global regulator. The slow and uneven implementation of many of the new international financial standards has only reinforced the case for these attempts to insulate a country's financial system from potentially poor regulatory practices and financial instability abroad. In the face of these developments, the FSB's creation looks even less important. Supporters of the FSB's creation such as Geithner argued that it would be major new player in global economic governance encouraging the implementation of new harmonized international financial standards for globally integrated markets. Instead, however, the FSB is increasingly on the sidelines watching the emergence of a more decentralized international financial order that is characterized by greater financial market and regulatory fragmentation along national lines. As a legacy of the 2008 financial crisis, it appears that nation-states (or perhaps regions in the case of the EU) are the key pillars of global economic governance in the financial regulatory realm rather than the FSB. Eric Helleiner is Faculty of Arts Chair in International Political Economy in the Department of Political Science and Balsillie School of International Affairs. He is author of The Status Quo Crisis (Oxford University Press, 2014) and The Forgotten Foundations of Bretton Woods (Cornell University Press, 2014).

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