Speech by SEC Commissioner:
"The Role of International Regulatory Cooperation and Coordination in Promoting Efficient Capital Markets"
Commissioner Kathleen L. Casey
U.S. Securities and Exchange Commission
Instituto Bruno Leoni
June 12, 2010
Thank you, Alberto [Mingardi].
It is such a pleasure to join you and be part of this year's program. Last year, I was only able to participate in a portion of the program, but had such a wonderful experience that I was committed to returning this year — no matter how challenging the logistics or short the visit.
Before I begin, I need to make the standard disclaimer that my remarks today represent my own views, and not necessarily those of the SEC or my fellow Commissioners.
This morning's discussion topic is quite timely and relevant given the enhanced focus on and significance of international cooperation and coordination in light of the recent global financial crisis, and I am eager to share some of my perspectives as a securities market regulator.
As with previous financial crises, the demonstrated interconnectedness of markets and contagion effects around the world have resulted in calls to international action by world political leaders. Coordinated international responses have been sought to identified weaknesses or deficiencies in financial regulation and regulatory oversight. This new imperative to seek global solutions and to support the development and enforcement of international standards raises important considerations and questions about the appropriate or optimum role of international cooperation and coordination in our global marketplace.
The ongoing dialogue among financial regulators worldwide is important, and well-considered international efforts have the potential to reduce the risk of a similar series of events in the future, and to improve the resilience of the global financial system. In addition, continued and expanded international cooperation in information sharing and enforcement should serve to enhance investor confidence.
International regulatory coordination is not an end to be sought for its own sake, however. Instead, its value is measured by the extent to which the policies endorsed or adopted promote fair, efficient and transparent capital markets and support capital formation while minimizing the costs and burdens of regulations associated with promoting these goals.
Thus, it is imperative to recognize not only the potential benefits, but also the limitations and potential costs of coordination in international financial regulation.
Recent and Ongoing Coordination and Cooperation
Of course, efforts at international financial regulatory coordination and cooperation are not new. For financial regulators, international cooperation and coordination has long been critically important to effectively achieving their mission. Capital flows know no geographic boundaries. Market actors and entities operate globally, market conduct and activity crosses borders and investors seek foreign investment opportunities.
Thus, national regulators, like the SEC, need cooperative relationships and coordination with other jurisdictions if they are to be effective in regulating and overseeing their markets.
But, in the past decade, most notably after the passage of the Sarbanes Oxley Act of 2002 (SOX), there has been a step increase in efforts to expand and deepen dialogue between various financial market regulators in order to minimize cross border frictions and externalities as well as seek to identify emerging regulatory issues and seek more harmonized standards or common approaches to regulation.
In 2002, prior to passage of SOX, the EU-U.S. Dialogue on Financial Market Regulation (Dialogue) was created as a forum in which to discuss issues surrounding cross-border regulation. Dialogue participants included the U.S. Treasury Department, the SEC, the Federal Reserve Board, and representatives of the European Commission's Internal Markets.
Following the passage of SOX, however, as the SEC began the task of writing rules required under that Act, the Dialogue provided an invaluable forum to discuss cross-border issues associated with implementation of SOX. In particular, the forum facilitated discussion of potential conflicts between potential U.S. regulations under SOX and European countries' laws and regulations, as well as ways in which the objectives of SOX could be accomplished under home country laws and regulations.
Largely due to the Dialogue, the SEC incorporated accommodations into our rules — including changes to the requirements for a board's audit committee financial expert, exceptions to certain stock exchange listing requirements for foreign private issuers, and carve-outs from restrictions on the use of non-GAAP financial measures — designed to prevent foreign private issuers from expending management, financial and intellectual resources attempting to comply with conflicting rules.
This Dialogue continues to play an important role today as the United States and EU grapple with fundamental reforms in key areas of regulation such as credit rating agencies, hedge funds, short selling, OTC derivatives and accounting convergence.
But the Dialogue is only part of a much broader engagement on issues such as these, which now occurs at many levels, both bilaterally and multilaterally.
Other Arrangements — Formal Dialogues
The SEC, like many other regulators, also looks to bilateral MoUs and other arrangements with foreign counterparts in order to facilitate information sharing and cooperation regarding oversight of market participants that operate across borders.
These arrangements complement the use of formal bilateral and multilateral dialogues with counterparts to facilitate identification and discussion of common issues of regulatory concern and enhance enforcement cooperation.
I travelled here yesterday directly from Montreal, Canada, where I attended the International Organization of Securities Commissions (IOSCO) Annual Conference. IOSCO is the leading international policy forum for securities markets regulators, including CONSOB and the SEC, that regulate over 95% of the world's securities markets. For well over a decade, IOSCO has promoted and supported international cooperation in securities regulation.
In 1998 IOSCO adopted its Objectives and Principles of Securities Regulation (Principles) which laid out a set of international regulatory benchmarks for all securities markets in support of:
The protection of investors;
Ensuring that markets are fair, efficient and transparent; and
The reduction of systemic risk.
In 2002, the SEC joined with other IOSCO members in adopting a multilateral memorandum of understanding (MMoU) to facilitate cross-border enforcement and exchange of information among international securities regulators. Since that time, 96 percent of IOSCO's 115 members have met the requirements to become signatories to this MMoU or in the process of seeking legislative changes to do so.
IOSCO has prioritized the effective implementation of the Principles and of the MMoU, identifying them as the "primary instruments in facilitating cross-border cooperation, reducing global systemic risk, protecting investors and ensuring fair and efficient securities markets."
At our meeting earlier this week, IOSCO published a revision of its Principles to incorporate eight new principles based on the lessons learned from the crisis and the subsequent changes in regulation intended to strengthen the global regulatory system.
More important than the objectives and perspectives themselves, however, is the consensus developed by IOSCO members around and in support of these objectives and Principles, and their commitment to adherence with them.
And, of course, IOSCO's work and adherence to its Principles has taken on even greater relevance and importance with the new backing provided by the FSB and G-20 Leaders.
Benefits of Regulatory Cooperation and Coordination
These various bilateral and multilateral efforts have yielded significant benefits to the global financial system. In particular, they promote the fundamental objectives of securities regulation: investor protection; the promotion of fair, efficient and transparent markets; and the reduction of systemic risk.
These arrangements promote these objectives in several ways:
by facilitating enforcement of securities laws;
by supporting regulators' evaluation and consideration of regulations and the adoption of high quality regulations; and
by enhancing regulatory consistency and certainty for international market participants.
Perhaps the most obvious manifestation of international cooperation is information sharing and cooperation that enables enforcement of a nation's securities laws across borders. Technological advances have facilitated the movement of capital across borders and increased investment opportunities for investors.
However, these same advances also have enhanced the ability of securities laws violators to transfer assets abroad or base fraudulent activities outside their home countries' borders in an effort to avoid detection and prosecution. As a consequence, securities regulators and other law enforcement and governmental agencies may find that their domestic enforcement abilities are insufficient to combat cross-border securities fraud. Strong international cooperation is vital to the quick, effective and appropriate resolution of international enforcement investigations.
Supporting Analysis of Regulations and Adoption of High Quality Regulations
Certainly, some of the most significant work done by IOSCO and other international fora and organizations, such as the Financial Stability Forum (now the Financial Stability Board), the G-20, the Basel Committee on Bank Supervision and others, is dedicated to considering appropriate regulations, standards and guidelines for international financial markets and the global economy.
Historically, these organizations have tended to outline principles that individual national regulators may choose to adopt, as they see fit, in the manner in which they deem appropriate.
A benefit of these cooperative efforts for national regulators is that, to the extent that they choose to implement these principles in accordance with their governing law, the underlying analysis of a broad array of experts worldwide significantly enhances the transparency and credibility of the resulting laws or regulations.
Another benefit, particularly for nations with developing economies, is the ability to leverage off of the experiences of other national regulators by adopting high-quality regulations consistent with the regulatory principles developed by IOSCO and others.
Promoting Regulatory Consistency and Certainty for Participants
Additionally, when national regulators cooperate to develop regulatory principles upon which they agree, it is more likely that they will adopt broadly consistent regulations, even if the particular manner of implementing these regulatory principles may differ from one country to another.
Moreover, to the extent that different approaches to regulation may result in regulatory differences, the problem of conflicting regulations can be mitigated or eliminated in many cases through bilateral and multilateral dialogues.
A tremendous benefit of this process to market participants is regulatory certainty in cross-border transactions, as regulations based upon broadly agreed principles will tend to result in consistent treatment of participants' actions. Regulatory certainty, in turn, reduces compliance costs and other frictions associated with cross-border transactions, resulting in greater efficiency in our global markets.
Changing Views of Cooperation and Coordination After Financial Crisis
There can be no doubt that financial events in one country have the potential to affect many others, as the recent financial crisis illustrated, and thus financial regulations in one country likewise can affect other countries.
As a result, since the onset of the financial crisis, there has been a new focus on increasing implementation by national financial regulators of international standards. This focus has included international political pressure on countries to adopt, or to conform their regulations to, these standards.
In April 2009, the G-20 Leaders issued a Declaration on Strengthening the Financial System (Declaration), in which member countries agreed to substantive legal and regulatory actions in relation to, among others:
regulation of systemically important institutions, markets and instruments; and
compensation principles at significant financial institutions.
In addition, in the Declaration the G-20 Leaders singled out "non-cooperative jurisdictions" and "call[ed] on all jurisdictions to adhere to the international standards in the prudential, tax, and [anti-money laundering and combating the financing of terrorism] areas."
In response to this call, the Financial Stability Board's Standing Committee on Standards Implementation launched "an initiative to encourage the adherence of all countries and jurisdictions to international financial standards, including by identifying non-cooperative jurisdictions and assisting them to improve their adherence," with a focus, initially, on "adherence to international cooperation and information exchange standards in the financial regulatory and supervisory area."
Relatedly, the G-20 Leaders called for "strengthen[ed] objective peer reviews, based on existing processes, including through the [IMF's Financial Sector Assessment Program (FSAP)]."
An FSAP assessment is an in-depth analysis of a country's financial system focusing on, among other things, the stability of a country's financial sector. One aspect of this analysis is to "rate the quality of bank, insurance, and financial market supervision against accepted international standards." While the program is voluntary, the IMF has noted that it believes this is a weakness of the program.
Under the new focus on implementation and compliance by the G-20, FSB and respective standard setters, FSAPs have taken on new meaning and importance. As a result, greater attention by national jurisdictions will be given before agreeing to principles and standards that may viewed as largely aspirational, rather than operational.
Further, this emphasis may promote a trend toward greater detail or specificity in international standards in order to obtain the clarity that jurisdictions will demand if they know that they will later be assessed against them. And this will likely make consensus on principles and standards even more difficult to achieve.
Limitations of Regulatory Coordination
This necessarily raises the question of how realistic, achievable and desirable efforts to impose a set of common standards or regulations on individual nations really is, and what can be accomplished through international cooperation and coordination of financial regulation.
There are real practical limitations on the ability of international bodies to effectively impose or require the adoption of specific regulations by individual nations, and there are strong prudential considerations that counsel against such an approach.
First, the credibility of financial regulations imposed on individual nations by their international peers is subject to substantial doubt to the extent that those regulations are promulgated without the consent or input of the affected nations and market participants. The credibility of a regulatory regime depends on the legitimacy of the regulator, the accountability of the officials responsible for adopting the regulations and the transparency of the process by which the regulations are adopted.
The legitimacy of any regulation depends on the authority of the regulator to promulgate it. International bodies derive legitimacy, however, only from their membership. They have no ability to promulgate regulations with the force of law in any nation. Instead, they depend on their member regulators to adopt regulations in accordance with governing law.
International bodies also are not accountable to the regulatees affected by the rules they seek to impose. As with their legitimacy, their accountability derives from that of their members or, in some cases, that of their "political masters" such as the G-20 Leaders.
While, in many cases, regulatory principles developed by international bodies are characterized by transparency, this is not universally the case. I alluded earlier to IOSCO's work. IOSCO publishes its papers and recommendations for public comment before they are finalized — a process that includes an opportunity for market participants and member nations to review and comment meaningfully on the draft report.
The pronouncements of some international bodies, however, are not subject to such a process. Moreover, the processes of even the most transparent international bodies in many cases would not comply with the regulatory processes required to promulgate regulations in individual nations.
Without legitimacy, accountability and transparency, regulations are likely to encounter resistance from the affected nations and market participants, as they may have little confidence in the process by which the regulations were adopted and little or no perceived stake in the success of the regulations.
Practical and Cultural Concerns
In addition, there are important practical and cultural differences in national markets that dictate flexible approaches to achieving regulatory principles and outcomes.
In considering new regulations, national regulators must evaluate their own individual markets, including not only the prevailing political views of and traditions with respect to the appropriate scope and role of regulation, but also the legal framework in which the regulations must fit.
This framework includes the business models and structures of affected entities, specific constraints on regulatory authority such as the Administrative Procedures Act and Paperwork Reduction Act (which requires cost/benefit analysis of rules) in the United States and privacy law concerns common in the European Union, the interaction with existing (and potentially conflicting) laws and regulations and the differences between a civil law and common law tradition.
Benefits of Competition
Furthermore, such a uniform set of regulations would deprive the global markets and economy of the benefits of international competition. These benefits derive from the notion that poor regulatory decisions — either over-regulation or under-regulation — and bureaucratic inefficiency will be punished through the capital markets, whereas more effective regulation will be rewarded.
In addition, a uniform set of regulations would deprive regulators of the "laboratory" effect, whereby regulators can assess the merits of regulatory approaches undertaken by other countries and adopt those approaches that best satisfy their unique mix of culture, legal environment and other considerations.
Some have argued that it is exactly this type of international competition that must be eradicated through international consistency of regulation — that regulation should be used to "level the playing field" among nations and avoid a "race to the bottom" or the least regulated markets, where arbitrage opportunities exist.
This approach raises a threshold question, however — what does a "level playing field" mean? Invariably, each nation will have its own ideas as to what is "fair," based on its own national interests.
It is not unusual to find that "level playing field" arguments are often grounded in protectionist policies and trade disputes. Furthermore, we have seen this in practice as lawmakers and regulators have responded in varying ways to the crisis on how to regulate credit rating agencies, hedge funds and short selling. The bottom line is that their decisions are necessarily driven by domestic political considerations and national interest.
Of course, significant cross border issues and costs are raised by widely differing regimes that affect global actors and activities. For many market participants, absent bilateral or multilateral efforts to minimize these differences, they must comply with all of these varying regulatory requirements if they wish to operate or do business in those jurisdictions. It remains to be seen how capital and market participants will respond to these differences, and whether we have a new paradigm where the most "stringent" regulatory regime essentially sets the standard.
In conclusion, there is undoubtedly an important role for international cooperation and coordination in financial regulation, and the past decade saw significant successes in this area. In my view from a market regulator's perspective, these initiatives were successful because:
they were based on the fundamental objectives of securities regulation, which are common to all financial regulation — investor protection; the promotion of fair, efficient and transparent markets; and the reduction of systemic risk — rather than larger political goals;
they were characterized by broadly accepted regulatory principles, rather than detailed regulatory mandates; and
they benefitted from the credibility that comes from the legitimacy, accountability and transparency derived from the regulators that participated in these efforts.
As policymakers consider internationally coordinated financial regulation in the wake of the recent crisis, it is essential that they bear these principles in mind and that they are cognizant of the limitations of international action.
Thank you once again for inviting me to speak today, and I look forward to what I expect will be a fascinating discussion with the panel.