The Structure of Financial Supervision Approaches and Challenges in a Global Marketplace

Home , Group of Thirty, Jaime Caruana, National Bank of Poland, Qatar Central Bank

The structure of Financial Supervision Approaches and Challenges in a Global Marketplace

30 Group of Thirty All members of the Study Group served in their personal capacities. The views expressed in this report do not necessarily reflect the views or polices of their respective institutions, nor does publication of the report by the Group of Thirty imply an endorsement of the views expressed herein.

Copies of this report are available for $95 from:

The Group of Thirty 1726 M Street, N.W., Suite 200 Washington, D.C. 20036 Tel: (202) 331-2472 Fax: (202) 785-9423

www.group30.org email:[email protected] The structure of Financial Supervision Approaches and Challenges in a Global Marketplace

30 Group of Thirty Washington, DC 2008

Contents

Foreword...... 7

Acknowledgments...... 9

Financial Regulatory Systems Working Group...... 10

Executive Summary ...... 11

Part I: Analysis...... 17

Introduction...... 18 Background...... 19 The Policy Goals of Regulation...... 21 A. Safety and Soundness of Financial Institutions...... 22 B. Mitigation of Systemic Risk...... 22 C. Fairness and Efficiency of Markets...... 22 D. Protection of Customers and Investors...... 23 The Four Approaches to Financial Supervision...... 23 1. The Institutional Approach...... 24 2. The Functional Approach...... 24 3. The Integrated Approach...... 24 4. The Twin Peaks Approach...... 24 Selected Examples of Each Model of Financial Supervision ...... 24 The Institutional Approach—China and Mexico...... 24 China...... 25 Mexico...... 26 The Functional Approach—Italy and France...... 26 Italy...... 26 France...... 27 The Integrated Approach—The United Kingdom and Germany...... 28 The United Kingdom...... 28 Germany...... 29 The Twin Peaks Approach—Australia and the Netherlands...... 30 Australia...... 31 The Netherlands...... 31 The Exception—The U.S. Model...... 32

An Assessment of the Four Supervisory Approaches...... 33 The Institutional Approach...... 34 The Functional Approach...... 34 The Integrated Approach...... 36 The Twin Peaks Approach...... 37 The Role of the Central Bank...... 39 The Role of Deposit Insurance...... 42 Domestic Coordination Issues among Supervisors...... 43 Cross-Border Coordination Issues...... 46 Lessons Learned from Recent Experiences...... 49 Twelve Principal Concluding Observations...... 50 A Final Comment...... 51

Part II: Profiles...... 53

The Institutional Approach...... 55 China...... 57 Hong Kong...... 65 Mexico...... 75 The Functional Approach...... 83 Brazil...... 85 France ...... 95 Italy ...... 105 Spain...... 115 The Integrated Approach...... 123 Canada...... 125 Germany...... 137 Japan...... 145 Qatar...... 153 Singapore...... 161 Switzerland...... 169 The United Kingdom...... 175 The Twin Peaks Approach...... 185 Australia...... 187 The Netherlands...... 197 The Exception—The United States...... 205 Financial Crisis Management Mechanisms—The European Union...... 227

Membership in International Financial Institutions...... 233

Appendix: Supporting Institutions...... 237

Group of Thirty Members...... 241

Group of Thirty Publications since 1990...... 245

Figures Figure 1. The Financial Services System Regulatory Structure, China...... 61

Figure 2. The Financial Services System Regulatory Structure, Hong Kong...... 71

Figure 3. The Financial Services System Regulatory Structure, Mexico...... 80

Figure 4. The Financial Services System Regulatory Structure, Brazil...... 91

Figure 5. The Financial Services System Regulatory Structure, France...... 101

Figure 6. The Financial Services System Regulatory Structure, Italy...... 110

Figure 7. The Financial Services System Regulatory Structure, Spain...... 120

Figure 8. The Financial Services System Regulatory Structure, Canada...... 132

Figure 9. The Financial Services System Regulatory Structure, Germany...... 143

Figure 10. The Financial Services System Regulatory Structure, Japan...... 150

Figure 11. The Financial Services System Regulatory Structure, Qatar...... 158

Figure 12. The Financial Services System Regulatory Structure, Singapore...... 165

Figure 13. The Financial Services System Regulatory Structure, Switzerland...... 173

Figure 14. The Financial Services System Regulatory Structure, the United Kingdom...... 179

Figure 15. The Financial Services System Regulatory Structure, Australia...... 193

Figure 16. The Financial Services System Regulatory Structure, the Netherlands...... 201

Figure 17. The Financial Services System Regulatory Structure, the United States...... 218

foreword

In July 2007, the Group of Thirty decided to launch a review of various national supervisory and regulatory approaches and place them within the context of the changing global financial system. The study set out to look at the changes evident in the financial markets and the evolution of the national supervisory architecture at a time when central banks and supervisory agencies have been seeking to improve their supervisory processes in light of the blurring of lines between different financial sectors and businesses. The review of 17 major national supervisory systems has confirmed that while dealing with similar problems and challenges, such systems are fashioned through a process that includes a myriad of political, cultural, economic, and financial influences. Despite the many differences from country to country and market to market, the central bankers, supervisors, and government ministries are charged with overseeing financial institutions and dealing with threats to the stability of the financial system. Our review of supervisory structures has drawn out their commonalities and differences, and the challenges faced by those selecting one approach or another. The Group of Thirty is pleased to present this broad review to the supervisory and regulatory community. It is hoped that this assessment of the various regulatory systems will be of interest to policymakers, and that a consistent presentation of structural details of various systems will help illuminate differences in financial supervisory structures for analysts, journalists, and the officials directly concerned.

Paul A. Volcker Jacob A. Frenkel Chairman of the Trustees Chairman The Group of Thirty The Group of Thirty

Acknowledgments

The Group of Thirty would like to pay tribute to those whose time, talent, and energy have driven this project forward. First, we would like to thank the members of the working group, who committed their time and intellect to bringing this project to fruition. Special recognition must go to the many supervisory institutions and individuals that provided their views and input during the interviews and the research process. Without their support and collective input the review would not have been possible. Documentary research is useful, but it is no substitute for the personal impressions of senior central bankers, supervisors, and regulators. A full list of the institutions that aided this project is provided in the appendix. Crafting a cohesive report reflective of many national perspectives and touching a broad array of difficult supervisory and regulatory approaches requires considerable knowledge of the issues and is never easy, but the task was achieved through the hard work and careful prose of Annette Nazareth, who served as Rapporteur of the report. The Group of Thirty thanks Annette for her efforts. We also acknowledge the efforts of Alastair Clark for his assistance in the early stages of the study. We would also like to thank Don Ogilvie and Rich Spillenkothen of Deloitte & Touche LLP and the Deloitte Center for Banking Solutions and their team, including especially Julia Kirby and Jeanne-marie Smith for their commitment and contributions to the project. Deloitte & Touche provided assistance in reviewing the 17 national supervisory systems and in documenting the results for use in the report. Thanks to our editor, Diane Stamm, and our designers, Sarah McPhie and Katie Bur- gess, for their dedicated efforts and flexibility when working on this project. Finally, the coordination of this project, the many aspects of report production, and the allocation and organization of different responsibilities had their logistical center at the offices of the Group of Thirty. This project could not have been completed without the efforts of Stuart Mackintosh, Sviatlana Francis, and Nicole Firment of the Group of Thirty.

Financial Regulatory Systems Working Group

Chairman Vice Chairman Paul A. Volcker Roger W. Ferguson, Jr. Former Chairman, Board of TIAA-CREF Governors of the Federal Reserve System

Members Jacob A. Frenkel Richard Debs American International Group, Inc. Morgan Stanley & Co.

Geoffrey Bell Arminio Fraga Neto Geoffrey Bell & Company Gavea Investimentos

E. Gerald Corrigan Gerd Häusler Goldman Sachs & Co. Lazard International

Andrew Crockett John Heimann JPMorgan Chase International Financial Stability Institute

Jacques de Larosière Stuart P.M. Mackintosh BNP Paribas Group of Thirty

Observers Jaime Caruana Don Ogilvie International Monetary Fund Deloitte Center for Banking Solutions

Terrence Checki Richard Spillenkothen Federal Reserve Bank of New York Deloitte & Touche LLP

Daniel Hofmann Zurich Financial Services

Rapporteur Annette Nazareth

10 Executive Summary The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Executive Summary

The Group of Thirty (G30) commenced a or jurisdictions. They also call for careful 17-jurisdiction review of financial regula- assessment of their approaches to financial tory approaches in July 2007, prior to the crisis management, and the extent to current market turmoil that has impacted which current structures (national and many countries around the globe.1 We international) are effective in dealing with began the project at a time when the the collapse of a systemically important efficiency and efficacy of financial regula- global financial institution. tion and supervision were being actively The G30 report reviews the financial discussed and debated. Today, those issues regulatory approaches of 17 jurisdictions are even more salient and important in order to illustrate the implications of for national and international financial adopting one or another of the four prin- supervisors and policymakers as they seek ciple models of supervisory oversight. The to restore financial stability. This report review comprises documentary research, is being published during a period of supplemented with interviews of central extensive global focus on the benefits bank governors and supervisors in each and challenges of various supervisory jurisdiction, and includes a cross-section approaches. We hope it will contribute to of developed economies and emerging the international dialogue on the key mat- markets. The study demonstrates the com- ter of supervisory architecture. monality of the challenges faced by supervi- The last 25 years have been a period of sors around the globe, and illuminates the enormous transformation in the financial many different structural solutions adopted services sector. The marketplace has by supervisors addressing these common seen a marked shift from domestic firms challenges within their own particular eco- engaged in distinct banking, securities, and nomic, political, and cultural contexts. insurance businesses to more integrated financial services conglomerates offering The Four Approaches to Supervision a broad range of financial products across The report assesses the four approaches to the globe. These fundamental changes in financial supervision currently employed the nature of the financial service markets across the globe (Institutional, Functional, around the world have exposed the short- Integrated, and Twin Peaks; see table on comings of financial regulatory models, the following page). It describes the key some of which have not been adapted to design issues of each supervisory model, the changes in business structures. These illustrates how each has been implemented developments require central banks, in practice, and assesses the strengths and supervisors, and finance ministries to assess weaknesses of each approach. the efficacy of the particular supervisory structures in place in their home countries

1 The jurisdictions reviewed are Australia, Brazil, Canada, China, France, Germany, Hong Kong, Italy, Japan, Mexico, the Netherlands, Qatar, Singapore, Spain, Switzerland, the United Kingdom, and the United States.

12 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Executive Summary

Institutional The Institutional Approach is one in which a firm’s legal status (for Approach example, a bank, broker-dealer, or insurance company) determines which regulator is tasked with overseeing its activity from both a safety and soundness and a business conduct perspective.

Functional The Functional Approach is one in which supervisory oversight is de- Approach termined by the business that is being transacted by the entity, without regard to its legal status. Each type of business may have its own functional regulator.

Integrated The Integrated Approach is one in which a single universal regulator Approach conducts both safety and soundness oversight and conduct-of-business regulation for all the sectors of financial services business.

Twin Peaks The Twin Peaks approach, a form of regulation by objective, is one in Approach which there is a separation of regulatory functions between two regulators: one that performs the safety and soundness supervision function and the other that focuses on conduct-of-business regulation.

We found that all policymakers and In general, no one model has proven regulators interviewed underscored the unambiguously superior in achieving all critical importance of regulatory frame- the objectives of regulation. Strong leader- works accommodating and keeping pace ship and qualified administrators can offset with dramatic changes and innovation in to some degree the impediments and defi- financial markets. As financial markets and ciencies that may stem from suboptimal institutions evolve, so too must the regula- regulatory structures, but at some point tory systems that oversee them. regulatory regimes need to be updated Of course, the design of national super- and modernized to accommodate financial visory architecture rarely, if ever, takes evolution, market realities, and global place with policymakers proceeding from integration. a blank slate. Instead, regulatory structures The report finds a number of structural evolve as a result of particular national and design trends evident in the jurisdic- debates, events, and economic crises that tions studied. may prompt a reappraisal of existing frameworks, much like what can be seen to The Institutional Approach be unfolding in the United Kingdom and The traditional or Institutional Approach the United States. to supervision is perhaps the model under Many of the jurisdictions that the G30 the most strain, given the changes in finan- studied have modified or restructured cial markets and players, and the blurring financial regulatory systems within the last of product lines across sectors. Agencies 15 years, and a majority are currently in the using the Institutional Approach to super- process of further restructuring or actively vision can overcome its shortcomings via debating the need for significant changes various coordination mechanisms, but the to modernize their systems. structure is suboptimal, given the evolution

13 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Executive Summary

of the markets we have witnessed. The a single entity responsible for all sectors jurisdictions reviewed that use the Institu- of the financial industry. The jurisdictional Approach are China, Hong Kong, tions reviewed that use this approach are and Mexico. Canada, Germany, Japan, Qatar, Singapore, Switzerland, and the United Kingdom. The Functional Approach The Functional Approach to supervision The Twin Peaks Approach remains quite common and appears to There is a growing interest in and support work well, so long as coordination among for “regulation by objective” of the Twin agencies is achieved and maintained. How- Peaks Approach to supervision. The Twin ever, there is a general awareness that this Peaks Approach is designed to garner may be a somewhat suboptimal structure. many of the benefits and efficiencies of the Because of this, a number of jurisdictions Integrated Approach, while at the same are moving away from the Functional time addressing the inherent conflicts that Approach toward twin peaks or integrated may arise from time to time between the systems. The jurisdictions reviewed that objectives of safety and soundness regula- use the Functional Approach are Brazil, tion and consumer protection and trans- France, Italy, and Spain. parency. When prudential concerns appear to conflict with consumer protection issues, The Integrated Approach the prudential supervisor in the twin peaks The report finds some support for the use system may give precedence to safety and of an Integrated Approach to supervision. soundness mandates, because these are This approach can be effective and effi- closely intertwined with financial stability. cient in smaller markets, where oversight The Twin Peaks Approach may help to of the broad spectrum of financial services force a resolution to this conflict. The can be successfully conducted by one regu- two jurisdictions that use the Twin Peaks lator. It has also been adopted in larger, Approach are Australia and the Nether- complex markets where it is viewed as a lands. A number of other jurisdictions are flexible and streamlined approach to regu- engaged in debates over adopting this type lation. The Integrated Approach has the of approach. These include France, Italy, advantage of a unified focus on regulation Spain, and the United States. and supervision without confusion or conflict over jurisdictional lines that can occur The Exception—The United States under both the Institutional and Func- As much as any jurisdiction reviewed, the tional Approaches. While the Integrated United States is a prime example of the Approach has the effect of eliminating the role that historical precedent, politics, redundancies that occur under the Institu- and culture have played in the regulatory tional and Functional Approaches, some structure. The current structure is quite observers believe it may create the risk of a complex and has come under increased single point of regulatory failure. The chal- scrutiny. The U.S. structure is functional lenges of coordination among supervisors with institutional aspects, with the added in times of disturbance appear to be evi- complexity of a number of state-level agen- dent even under the Integrated Approach, cies and actors. Historically, it had been in which regulation is consolidated into viewed as generally effective in meeting the

14 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Executive Summary

various goals of financial supervision. But in the agencies. Such structures aimed at today structural reform is more likely to be facilitating coordination and information on the policymaking calendar, in large part sharing are important, but many of them because of weaknesses exposed during the have yet to be tested by the collapse of a 2007–2008 credit crunch and related finan- systemically important financial institution. cial institution failures. The March 2008 U.S. Treasury “Blueprint of a Modernized The Role of the Central Bank Financial Regulatory Structure” recognizes Irrespective of the structure of supervi- the current weaknesses and advocates a sion, central banks emphasize the critical modified Twin Peaks Approach as a long- importance of having information about term goal. and a direct relationship with large, systemically important financial institutions. The Importance of Domestic Supervisors typically stress the importance Coordination and Communication of communication and coordination with Whatever the approach to financial the central bank and the bank’s involve- supervision of a particular jurisdiction, any ment in crisis management, in particular. system must strive to have effective coordi- Some jurisdictions retain a prudential nation among supervisory agencies, central supervisory function for the central bank banks, and finance ministries. (for example, Brazil, France, Hong Kong, Agencies should seek to maintain good Italy, Singapore, Spain, the Netherlands, contacts and interaction at the operational and the United States), while others do not levels and the principal level. Coordination (for example, Australia, Canada, China, and communication can and do create Japan, Mexico, Qatar, Switzerland, and the challenges, even in jurisdictions that have United Kingdom). an integrated regulator, although, other Regardless of the particular structure things being equal, the challenges are adopted, if information-sharing and often greater when there are a larger num- decision-making linkages between the ber of regulatory agencies. central bank and other agencies are To facilitate coordination, most inadequate, this can have a serious jurisdictions create special coordinating negative impact on coordination in times bodies. Such a coordinating body, often of financial crisis, precisely when effective called a Financial Stability Committee, collaboration is most required. can comprise the heads or senior officials of the regulatory agencies, the central The Importance of Deposit bank, and the finance ministry. This type Protection Schemes of institution can prove useful in normal Many of those interviewed stressed the times, and especially important during importance of an effective, transparent, times of crisis, when the linkages and lines and efficient deposit protection scheme of communication already in place can be as a part of a modern financial regulatory activated without delay. This type of struc- architecture. For supervisors grappling ture is often underpinned by Memoranda with maintaining confidence in the of Understanding (MOUs) among various financial system, a well-understood deposit agencies and can be supplemented by protection scheme is an important part cross-membership of boards by principals of a national supervisory and regulatory

15 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace

structure. All systems reviewed in the G30 lished along institutional lines (banking, report either have a deposit protection securities, insurance), and as such cannot scheme in place or are planning to imple- fully reflect the changing nature of the ment one. Any regime must be structured global financial services marketplace. in such a way as to ensure that depositors’ In part to deal with that eventuality, a funds can be accessed promptly. In the majority of supervisors recognize the value absence of confidence that they will have of supervisory colleges for systemically ready access to their funds, depositors will important global financial institutions as have a strong incentive to join a bank run fora to build linkages among agencies in and withdraw their deposits. normal times, and which play a critically important role in periods of crisis. Many The Structure of International supervisors also believe that flexibility in Cooperation the procedures and operations of these A number of supervisors interviewed colleges is critical to their success going expressed concern that the international forward. architecture of supervisory coordination and communication has not kept up with Conclusion the changes in the nature and structure of Substantive issues of the design and perfor- the global financial marketplace. Supervi- mance of financial markets are important sors worry that the current ad hoc inter- when considering supervisory and regula- national coordination system may not be tory reforms. Central bankers, supervisors, able to handle the failure of a systemically and ministries of finance must ensure that important global financial firm and the important public policy goals continue to concomitant tremors such an event would be achieved in a dynamic global market- send around the world. place as supervisors look to update and The current international coordinating alter the regulatory architecture. We hope bodies involved in encouraging common the G30 review of the financial supervisory standards and the exchanges of informa- approaches of 17 selected jurisdictions tion cannot be expected to act as the entity helps extend the general understanding of for managing emerging financial crises, the complex issues at stake when deciding although they can and do provide an to adopt one approach or another and important analytical resource ex post facto. when considering administrative reforms. These organizations are generally estab-

16 Part I: analysis The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

Introduction This report assesses the four basic As financial market turmoil spreads models of financial supervision currently across the globe, regulators, supervisors, employed across the globe (Institutional, policymakers, and the public at large have Functional, Integrated, and Twin Peaks been questioning the effectiveness of Approaches). After a background discus- financial supervision and whether changes sion that provides historical context in to existing supervisory models are needed. terms of market developments and institu- Such a reassessment process is not a new tional changes over the last two decades, phenomenon. History has shown that we describe in detail key design issues of financial market disruptions have often each supervisory model and illustrate how been followed by regulatory reforms. Some each has been implemented in practice. of these reforms were incremental, with We assess the strengths and weaknesses targeted changes made to existing over- of each supervisory approach. We then sight regimes. Others, however, involved analyze and discuss how coordination and wholesale adoption of very different cooperation among relevant governmental regulatory approaches. All reforms shared bodies are achieved domestically under a common goal: to regulate and supervise each supervisory approach. Special atten- the financial markets and institutions in an tion is directed to the role of the central optimal manner. Even in the absence of a bank and the procedures in place for financial crisis or market failure, handling financial crises. Further, we exam- general concerns over the costs ine methods for international regulatory History has shown and burdens of regulation, and cooperation and coordination. Finally, we structural inefficiencies and their briefly make concluding observations and that financial market potential impact on competi- consider other challenges beyond regula- disruptions have often tion, have similarly called into tory structure that may warrant further been followed by question the advantages and policy consideration. disadvantages of various financial The financial regulatory approaches of regulatory reforms. supervisory models.2 The Group 17 selected jurisdictions are examined to of Thirty is publishing this illustrate the implications of adopting one Report during a period of exten- of the four principle models of regulatory sive global focus on the benefits and chal- oversight.4 These jurisdictions include a lenges of various supervisory approaches cross-section of developed economies and in order to contribute to the international emerging markets. The second part of this dialogue on this very important issue.3 Report contains a summary, or “profile,”

2 “Sustaining New York’s and the U.S.’ Global Financial Services Leadership,” McKinsey & Co., January 2007 (www.nyc.gov/html/om/pdf/ny_report_final.pdf). “Commission on the Regulation of U.S. Capital Markets in the 21st Century – Report and Recommen- dations,” U.S. Chamber of Commerce, March 2007 (http://www.uschamber.com/publications/reports/ 0703capmarketscomm.htm); and “The Competitive Position of the U.S. Public Equity Market,” Committee on Capital Markets Research, De- cember 2007 (www.capmktsreg.org/pdfs/The_Competitive_Position_of_the_US_Public_Equity_Market.pdf). 3 References to regulation and supervision will be used interchangeably in this report since most oversight bodies have the authority to both regulate and supervise. Regulation generally refers to the issuance of rules by an authoritative body, while supervision refers to the oversight of an entity through the application of rules. 4 The jurisdictions reviewed were Australia, Brazil, Canada, China, France, Germany, Hong Kong, Italy, Japan, Mexico, the Netherlands, Qatar, Singapore, Spain, Switzerland, the United Kingdom, and the United States.

18 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

of the financial regulatory structure for financial services conglomerates offering each jurisdiction. Each profile provides a broad range of financial products across a general description of and a historical the globe. The traditional demarcations background to the current regulatory sys- among the products and services offered tem in the jurisdiction. It also cites notable by banks, insurance companies, and nonstatutory elements of the financial reg- securities firms have substantially blurred, ulatory system and describes the regulatory as each has sought to maximize profits structure, enforcement procedures, the through business expansion and financial framework for coordination, international innovation. The days when banks primarily considerations, and current structural regu- took deposits and made loans, investment latory issues. Information contained in the banking firms engaged in a narrow range profiles was derived from interviews with of securities businesses such as the relevant authorities in each jurisdiction underwriting, brokerage and and from other internationally recognized trading, and advisory work, and The traditional organizations such as the World Bank, the insurance companies only issued demarcations among International Monetary Fund (IMF), the property and casualty or life Bank for International Settlements (BIS), policies are long past. Today, each the products and the International Organization of Securi- of these sectors engages in new services offered by ties Commissions (IOSCO), the Interna- businesses that offer complex banks, insurance tional Association of Insurance Supervisors and sophisticated products, many (IAIS), and the Financial Stability Forum notable for their high degree of companies, and (FSF). imbedded leverage and often securities firms have The Group of Thirty conducted inter- demonstrating characteristics of substantially blurred. views with key officials in the relevant juris- insurance, banking, and securities dictions, and with practitioners, regulated offerings. This financial innova- parties, and those who may have been tion enhanced the profitability involved historically in the development of the financial sector for a period of of the current regulatory arrangements. time, but it has also created significant These interviews provided invaluable challenges in managing the risks of these insights into how the regulatory system cutting-edge products. has been implemented in practice and the Derivatives are one example of a product perceived strengths and weaknesses of each type that has clearly altered the financial model. landscape over the past 25 years. Year-end 1989 figures compiled by the International Background Swap Dealers Association (ISDA) indicate The past 25 years have been a period of that transactions in interest rate swaps, cur- enormous transformation in the financial rency swaps, and interest rate options were services sector. The marketplace has $2.474 trillion in notional value. By year- seen a marked shift from domestic firms end 2007, this figure was $382.3 trillion.5 engaged in distinct banking, securities, and Banks and securities firms are the primary insurance businesses to more integrated dealers in these markets.

5 ISDA Market Review (available at www.isda.org/statistics/pdf/ISDA-Market-Review-historical-data.pdf).

19 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

There has also been explosive growth outside of the traditional banking system. in the credit default swaps market. When This has made the task of supervising ISDA first began surveying this activity credit market activity more difficult for at year-end 2001, the total outstanding regulators, particularly in jurisdictions that notional amount of credit default swaps bifurcate banking and securities oversight. was $918.9 billion. By year-end 2007, it was A number of large, systemically impor- $62.2 trillion—a growth of nearly 37 per- tant institutions have emerged in many cent in the second half of 2007 alone.6 national markets during this period. Securitization products, which are Indeed, these entities are sufficiently large structured to finance assets such as mort- and integral to the marketplace to raise gages, credit card receivables, and auto “too big to fail” or even “too intercon- loans, became enormous businesses for nected to fail” concerns among regulators. financial services firms during this period. For example, in 2007 the consolidated Asset-backed securitizations, mortgage- assets of seven of the largest U.S. banks and backed securitizations, collateralized loan securities firms each exceeded $750 billion, obligations, collateralized debt obligations, and the two U.S.-government sponsored and other structured products came to rep- mortgage giants, Fannie Mae and Freddie resent an ever-larger portion of the credit Mac, had consolidated assets exceeding business. Particularly over the past several $882 billion and $794 billion, respectively.7 years, when interest rates were relatively In the second quarter of 2008, 24 global low, the securitization business fueled the banks and investment banks each reported market by providing increasingly esoteric total assets exceeding $1 trillion.8 products that satisfied the aggressive Today there are also a number of major appetite for higher-yielding securities. market participants that are unregulated. Unfortunately, it is now apparent that there Private equity firms and hedge funds repre- were serious flaws in the creation of some sent an increasing percentage of financial of these products, including inadequate markets activity, but they have generally mortgage underwriting practices and not been subject to direct supervisory over- insufficient historical data, contributing to sight. While conceptually the participation overly optimistic financial modeling used of these new entrants has benefitted the by the firms that structured these products, marketplace by fostering pricing efficien- and by the credit rating agencies that cies and risk dispersion, the relative opacity rated them. It also appears that increased of their activities raises concerns. For the reliance was placed on credit rating agen- most part, regulatory oversight of these cies and that independent credit analysis entities has been indirect, via the oversight by many market participants was severely of regulatory counterparts with which they wanting. Since most of the origination and conduct their business. distribution of these debt products was As indicated, many financial products through investment banks, a material por- today have elements of banking, insur- tion of credit market activity now occurs ance, and securities products. Yet in many

6 Ibid. 7 SEC Form 10-K for fiscal year ended 2007 for Goldman Sachs, Merrill Lynch, Bank of America, Citigroup, JPMorgan Chase, Wachovia, Fannie Mae, and Freddie Mac (available at www.sec.gov/edgar/searchedgar/ webusers/htm). 8 Balance Sheet charts, Bloomberg, Second quarter, 2008.

20 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

jurisdictions these entities are subject problems in the financial system continue to disparate regulation that reflects the to be highly contagious today. The fact that distinct business models of a bygone era. recent disruption in the collateralized debt Several jurisdictions that have reformed obligation market due to subprime mort- their regulatory structures have done so gage issues in the United States has had in order to better reflect this new business cross-border consequences in Germany, for reality. Those that have not done so seek example, provides ample proof of to manage the challenges of jurisdictional this exposure. overlaps and regulatory arbitrages caused These developments have Systemic problems in by the historical disparities in regulatory exposed the shortcomings of the financial system approaches. financial regulatory models, some continue to be highly There has also been explosive growth of which have not been updated in the globalization of the financial ser- to reflect new business realities. contagious today. vices sector over the last two decades as They also highlight the impor- technology has enabled a virtually border- tance of information sharing less marketplace. While some regulatory and international cooperation impediments still exist, on the whole the by regulators, because financial crises ability to transact business across borders is can circle the globe with alarming speed. relatively seamless. By 2007, for example, Ultimately, these developments also point three major U.S. investment banks derived to the need for convergence to high-qual- nearly 50 percent of their net revenues ity, internationally recognized regulatory from offshore activity.9 Large global finan- standards, including international account- cial institutions play a significant role in ing standards, for example. In such an many national markets. interconnected financial landscape, key Foreign securities holdings by U.S. protections must be generally accepted investors nearly doubled from $3.1 trillion and implemented in all major market cen- to $6.0 trillion between 2003 and 2006, evi- ters. To do otherwise would risk business dencing a marked increase in cross-border migration to less-regulated jurisdictions, activity.10 Indeed, today nearly two-thirds of ultimately posing a threat to the stability of all American investors have investments in the financial system. non-U.S. companies.10 While these statistics highlight the global nature of trading and The Policy Goals of Regulation investment and the interconnectedness It is commonly understood that financial of the markets, they also auger growing regulation should be designed to achieve opportunities for contagion, because a certain key policy goals, including: (a) problem in one part of the globe can safety and soundness of financial institu- easily make its way to another. Systemic tions, (b) mitigation of systemic risk,

9 See SEC Form 10-K for fiscal year ended 2007 for Goldman Sachs, Lehman Brothers, and Morgan Stanley (available at www.sec.gov/edgar/searchedgar/webusers.htm). 10 “Report on U.S. Portfolio Holdings of Foreign Securities as of December 31, 2006,” by Department of the Treasury, the Federal Reserve Bank of New York, and the Board of Governors of the Federal Reserve System, November 2007 (www.ustreas.gov/tic/shc2006r.pdf). 11 “Equity Ownership in America,” by the Investment Company Institute and Securities Industry Association (now the Securities Industry and Financial Markets Association [SIFMA], 2005, page 23) (www.sifma.org/ research/reviews/Reviews.html).

21 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

(c) fairness and efficiency of markets, and soundness of the institution being one and (d) the protection of customers and means of furthering that goal. Safety and investors. These broad goals, while clearly soundness regulation involves a mixture important, do not take into account an of proscriptive rules and more prudential additional factor that has come to be review and appraisal, with an emphasis on regarded as critical in any well-function- persuasion rather than through enforce- ing regulatory system; namely, minimum ment action involving fines, penalties, or regulatory burden through efficiency and other sanctions. cost-effectiveness. It is fair to say that each of the four models of financial supervision B. Mitigation of Systemic Risk is designed to achieve the policy goals of An overarching goal of financial supervi- regulation, albeit in different ways. The sion is to monitor the overall functioning differences in the models may be more of the financial system as a whole and to acute when viewed through the prism of mitigate systemic risk. For some regulators, regulatory burden, that is, efficiency and this goal is statutorily mandated; for others, cost-effectiveness. it is implicitly understood and adopted. Each of the four policy goals is This would seem to be the most incontro- described in greater detail below. vertible goal, and the most challenging to achieve. Financial systems cannot function A. Safety and Soundness of Financial.. . effectively without confidence in the Institutions markets and financial institutions. A major Effective regulation should be designed disruption to the financial system can to promote the safety and soundness of reduce confidence in the ability of markets individual financial institutions. Regulatory to function, impair the availability of credit oversight that focuses on the and equity, and adversely impact real eco- solvency of institutions and the nomic activity. Effective regulation protection of customer assets Systemic risk generally refers to impair- is critical to a well-functioning ment of the overall functioning of the should be designed to financial system. Traditionally, system caused by the breakdown of one or promote the safety and banks and insurance companies more of the key market components. Sys- soundness of individual have been regulated through temically important players would include, a combination of rules and among others, large, multinational banks, financial institutions. prudential examinations and hedge funds, securities firms, and insur- supervision. Protection of an ance companies. In addition, there are institution and its capital base systemically important markets and infra- was of paramount concern. For securities structures, in particular, the payments and firms, at least in jurisdictions such as the clearance and settlement systems. United States, the regulatory approach has involved more rules-based enforcement, C. Fairness and Efficiency of Markets with prescriptive rules relating to capital Well-functioning markets are character- requirements, customer protection, and ized by efficient pricing, which is achieved business conduct. The primary focus of through market rules concerning the wide securities regulators traditionally has been availability of pricing information and on customer protection, with the safety prohibitions against insider trading and

22 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

anticompetitive behavior. They require focus from safety and soundness oversight. transparency of all material information to Its emphasis is on transparency, disclosure, investors. Regulatory schemes further these suitability, and investor protection. It is goals by mandating disclosure of key infor- designed to ensure fair dealing. Such mation, whether it is about business and standards have been widely adopted in financial performance, about the prices securities regulation for several decades. at which securities are bought or sold, or The sale of risk products to individuals other key information that is important to traditionally was viewed as an appropriate investors. Disclosure permits market partici- area for substantive conduct regulation. pants to make optimal decisions with com- Classic examples of business conduct rules plete information. These transparency goals include conflict-of-interest rules, advertis- may conflict with the interests of a particu- ing restrictions, and suitability standards. lar institution at any point in time, and Some observers claim that business thus they may be contrary to other goals of conduct rules per se were less common regulation, such as maintenance of safety in the banking sector, although fiduciary and soundness and market continuity. For principles applied. As banks have ventured example, a financial institution that is expe- further from their original business models riencing liquidity issues may want to keep and have become more active purveyors of that information private in order to mini- risk-based products and services, particu- mize speculation that could disrupt efforts larly to retail customers, banking regulators to work out its problems. At the same time, are applying business conduct restrictions investors in the institution would want the more broadly. most timely and accurate information in order to make an investment decision. They The Four Approaches also have an expectation that the market to Financial Supervision prices for an institution’s stock reflect the While no two jurisdictions regulate finan- disclosure of all material information. cial institutions and markets in exactly the These divergent considerations may lead to same manner, the current models disparate responses by different regulators of financial supervision adopted and locations. worldwide can, as already noted, …each jurisdiction be divided into four categories: D. Protection of Customers and Investors (a) the Institutional Approach, reflects, among Financial regulation is also designed to (b) the Functional Approach, (c) other things, its protect customers and investors through the Integrated Approach, and unique history, business conduct rules. Particularly in cases (d) the Twin Peaks Approach. where transparency requirements alone No “pure” example of any model politics, culture, are insufficient, investors are protected may actually exist, and blurring size, economic by rules that mandate fair treatment and between approaches is prevalent. development… high standards of business conduct by The specific way in which regula- intermediaries. Conduct-of-business rules tion and supervision has been ultimately lead to greater confidence in the structured in each jurisdiction financial system and therefore potentially reflects, among other things, its unique greater market participation. Business history, politics, culture, size, economic conduct regulation has a quite different development, and local business structure.

23 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

Likewise, the effectiveness of the model and business conduct regulation. The in any particular jurisdiction may be influ- challenge for the Functional Approach is enced by uniquely local factors, so that no that activities must fall into categories clear single model may be optimal on a “one size enough for the regulator to oversee. fits all” basis for all jurisdictions. 3. The Integrated Approach 1. The Institutional Approach Under the Integrated Approach, there is The Institutional Approach is one of the a single universal regulator that conducts classical forms of financial regulatory over- both safety and soundness oversight and sight. It is a legal-entity-driven approach. conduct-of-business regulation for all the The firm’s legal status (for example, an sectors of the financial services business. entity registered as a bank, a broker-dealer, This model has gained increased popular- or an insurance company) essentially ity over the past decade. It is sometimes determines which regulator is tasked with referred to as the “FSA model” because the overseeing its activity both from a safety most visible and complete manifestation is and soundness and a business conduct the Financial Services Authority (FSA) in perspective. This legal status also deter- the United Kingdom. mines the scope of the entity’s permissible business activities, although generally there 4. The Twin Peaks Approach has been a tendency for the regulators The Twin Peaks Approach is based on to reinterpret and expand the scope of the principle of regulation by objective permissible activities, and therefore the and refers to a separation of regulatory scope of activities under their jurisdiction, functions between two regulators: one that when requested to do so by the firms. Thus, performs the safety and soundness supervi- over time, entities with different legal status sion function and the other that focuses have been permitted to engage in the same on conduct-of- business regulation. Under or comparable activity and be subject to this approach, there is also generally a split disparate regulation by different regulators. between wholesale and retail activity and oversight of retail activity by the conduct- 2. The Functional Approach of-business regulator. This is also viewed by Under the Functional Approach, supervi- some as supervision by objective. sory oversight is determined by the business that is being transacted by the entity, Selected Examples of Each without regard to its legal status. Each type Model of Financial Supervision of business may have its own functional Selected jurisdictions from those we regulator. For example, under a “pure” reviewed are highlighted here to illustrate Functional Approach, if a single entity examples of each of the four models of were engaged in multiple businesses that financial supervision. included banking, securities, and insurance activities, each of those distinct lines The Institutional Approach—. of business would be overseen by a sepa- China and Mexico rate, “functional” regulator. The functional It is often difficult to clearly distinguish regulator would be responsible for both those jurisdictions that employ an Insti- safety and soundness oversight of the entity tutional Approach from those that have

24 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

implemented a Functional Approach. This Commission (CBRC), whose responsibili- lack of clarity is understandable if one ties include banks, financial asset manage- considers that when an institution is per- ment companies, trust and investment mitted by its regulators to expand into new companies, and other depositary financial business lines within an existing entity, the institutions. Its responsibilities include Institutional and Functional Approaches approving new banking institutions, for- become difficult to distinguish. Indeed, the mulating prudential rules and regulations, terms were sometimes used interchange- and conducting examinations. ably by officials when describing the same The People’s Bank of China’s role is national models. Nevertheless, two jurisdic- now limited to formulating and imple- tions highlighted in the profiles that may menting monetary policies and maintain- best illustrate the Institutional Approach ing financial stability. It nevertheless are China and Mexico. retains a role in policy formulation. Specifi- cally, the Governor of the People’s Bank of China China is a member of the State Council of China operates under an Institutional China, the government’s executive body. Approach, with some elements of func- As such, he has considerable continuing tional supervision. While most jurisdictions influence over the general direction of that have implemented reforms in the financial reforms, particularly when the past 25 years have tended to move toward issues are debated by and decided on by an Integrated Approach or a Twin Peaks the State Council. Approach, China did not. Under the Given the evolution of financial markets, previous regulatory structure, all financial the Institutional Approach in China is fac- supervision was consolidated within the ing the need to accommodate marketplace People’s Bank of China, which is China’s changes as the financial services industry central bank. Through a series of reforms becomes increasingly integrated and the over the past 25 years, China has moved to lines between traditional banking, securi- an Institutional Approach, where the bank- ties, and insurance businesses become ing, securities, and insurance sectors are blurred. Through holding companies, supervised by separate agencies. banks and other institutions have begun to Since 1998, the China Securities Regula- offer products outside their traditional areas tory Commission (CSRC) has been the of activity, thus creating issues of supervisory agency responsible for supervising and prerogative. For example, questions arise regulating the securities and futures sec- when an insurance company offers a tradi- tor. It is responsible for listed companies, tional banking product. Should the product securities firms, and markets. It focuses on be regulated by the CIRC or the CBRC? protecting medium and small investors. Issues such as this arise with increasing fre- Also in 1998, the China Insurance Regula- quency as the product and services offered tory Commission (CIRC) was formed to by banks, securities firms, and insurance oversee the insurance industry. In 2003, companies become more similar. This puts the primary responsibility for supervision greater pressure on supervisors to coordi- and regulation of the banking sector was nate before they act. The Chinese authori- moved from the People’s Bank of China to ties believe that their efforts at coordination the new China Banking Regulatory generally have been successful.

25 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

Mexico The Bank of Mexico, the central bank, Mexico is another jurisdiction whose does not directly regulate or supervise regulatory structure employs primarily financial entities, although it may propose an Institutional Approach. The Mexicans regulation if it views existing regulation as refer to their structure of regulation and insufficient. The Bank of Mexico has four supervision as a “silo” approach. Three main objectives: to provide the country’s government agencies are in charge of regu- economy with domestic currency; to pro- lation and supervision of financial entities: mote price stability; and to promote the the National Banking and Securities sound development of the financial system Commission (CNBV), the National Insur- and the proper functioning of the payment ance and Bond Companies Commission systems. It is the lender of last resort. (CNSF), and the National Commission for The regulatory structure within Mexico the Retirement Savings System (CONSAR). has been a subject of debate since the There is no consolidated supervision and mid-1990s. Even after the merger of the no lead supervisor of financial groups. securities and the banking commissions, Another government agency, the National consideration was given to merging all Commission for the Protection of Financial existing supervisory commissions. There Services Users (CONDUSEF), is in charge was also a recognition that a specialized of consumer protection, and the Deposit body was needed to focus on consumer Insurance Agency (IPAB) administers protection in the financial services arena. deposit insurance. Debates over reforms to the regulatory CNBV is the principal supervisory entity. structure in Mexico are centered more on It regulates both banking institutions and improving the efficiency of the existing brokerage firms. In 1995, the predeces- model, and increasing the population’s sor banking and securities commissions access to a broad range of financial were merged due to the realization that services. most banking institutions and brokerage In addition to China and Mexico, Hong firms operated under common holding Kong’s12 regulatory model is also best companies within newly formed financial described as the Institutional Approach. groups. CNBV’s main objectives are safety and soundness regulation and supervision The Functional Approach—Italy and France of all financial intermediaries (except Two jurisdictions that perhaps best illus- for insurance, bond companies, and pen- trate the Functional Approach to financial sion funds). It also regulates securities regulatory oversight are Italy and France. and exchange-traded derivatives. CNBV’s Board of Governors has representatives of Italy other arms of the government, including In Italy, financial regulation is organized members from the Ministry of Finance, the along functional lines. Financial services Bank of Mexico, CNSF, and CONSAR. activities are divided among four main

12 On July 1, 1997, Hong Kong became a Special Administrative Region of the People’s Republic of China (HKSAR). In this profile, HKSAR refers to Hong Kong.

26 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

activities: banking, investment services, also required to perform all activities nec- asset management, and insurance. Each essary to promote consumer protection. industry has its own supervisor, legal frame- The Finance Code mandates that the pri- work, and rules. mary purpose of insurance supervision is The Bank of Italy, the central bank, both the sound and prudent management has a monetary policy role as part of the of the insurance and reinsurance business European System of Central Banks, and has and the integrity of the insurance market supervisory and regulatory authority over and consumer protection. Thus, ISVAP Italian banks. It is a prudential regulator is a functional regulator of the insurance whose focus is on the safety and soundness sector with both safety and soundness and of the institutions subject to its jurisdic- conduct-of-business mandates. tion. In addition to its banking supervision Since 2004, there has been significant responsibilities, the Bank of Italy focuses on debate in Italy regarding the need for the stability of the financial system. It has a further structural reform of the supervisory statutory mandate to ensure overall stability, oversight model. Some of the proposals efficiency, and competitiveness of the finan- have been aimed at reducing the number cial system. The Bank of Italy has rulemak- of supervisory authorities in the hope ing authority and enforcement powers. of designing a more efficient regulatory The Companies and Stock Exchange model. Specifically, the debate has focused Commission (CONSOB) is the public on whether the number of supervisors authority responsible for regulating the should be reduced to two—the Bank of securities markets and the provision of Italy and CONSOB—with a reallocation of investment services. Its mandate includes: the responsibilities of the other financial (a) transparency of and reviewing business regulators. Such reform, were it to be practices by securities market participants; adopted, would move Italy closer to a Twin (b) disclosure of complete and accurate Peaks Approach to regulatory oversight. information to the investing public by listed companies; (c) accuracy of prospec- France tuses related to share and security offerings France also has a regulatory oversight to the investing public; and (d) compliance model that can best be described as a Func- with regulation by auditors. CONSOB also tional Approach, although, like Italy, there conducts investigations related to insider is some allocation of functions that closely trading and market manipulation. To resembles the Twin Peaks Approach. the extent CONSOB’s focus is principally Financial services oversight was conduct-of-business oriented, this aspect reformed in France in 2003 with the goal of Italy’s approach to financial oversight of improving efficiency of the regulatory incorporates elements of the Twin Peaks system. The framework for financial super- Approach. vision was reorganized and substantially The supervisor of the insurance sector simplified at that time, although it still has in Italy is the Insurance Industry Regula- many more functional regulatory bodies tory Authority (ISVAP). ISVAP is respon- than many other jurisdictions. sible for regulating and monitoring the Prudential supervision of both banks activities of insurance intermediaries. It is and investment firms is the responsibility

27 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

of the Banking Commission, which is In addition to Italy and France, other chaired by the Governor of the Bank of jurisdictions we reviewed that employ a ver- France and is located within the central sion of the Functional Approach include bank. The division of labor between the Brazil, Spain, and, to some extent, the Banking Commission and the Financial United States. Markets Authority (AMF) resembles that of the Bank of Italy and the CONSOB in The Integrated Approach—The United Italy, in that the prudential oversight and Kingdom and Germany conduct-of-business responsibilities are split between the banking supervisor and The United Kingdom the securities supervisor, respectively. A jurisdiction that exhibits the key facets of The Committee of Credit Institutions the Integrated Approach to regulation is and Investment Firms (CECEI), also the United Kingdom (U.K.). The impetus chaired by the Governor of the Bank of for the move to the Integrated Approach France, is responsible for the authorization was the recognition that major financial of credit institutions and investment firms, firms had developed into more integrated while the AMF is in charge of the authori- full-service businesses in the U.K. and zation of unit trusts and investment funds. elsewhere in the 1990s. The historical, The Financial Markets Authority (AMF) more fragmented, or “siloed,” approach to was established in 2003 to protect the inter- regulation was viewed as suboptimal. Thus, ests of small investors and promote the in 1997, major reform of financial services smooth functioning of financial markets. regulation was put into effect in the U.K. The AMF monitors securities transac- with the creation of a unified regulator, the tions and collective investment products Financial Services Authority (FSA). to ensure compliance with disclosure The FSA regulates and supervises almost obligations to the investing public. A rep- all financial services businesses in the U.K., resentative of the central bank, the Bank of including banking, securities, and insur- France, sits on the AMF board. ance, on a prudential basis and as regards Insurance activities in France are conduct-of-business activities. It has four supervised by a separate insurance regula- main statutory objectives: to maintain tor, the Insurance and Mutual Societies market confidence, to promote public Supervisory Authority (ACAM). Licensing awareness on financial matters, to protect for insurance companies is separated from consumers, and to reduce financial crime. ACAM in a manner similar to the CECEI Thus, the FSA is responsible for both safety and is performed by the Committee on and soundness of financial institutions and Insurance Companies. To enhance coop- conduct-of-business regulation. It is often eration between the Banking Commission cited by regulated entities as a model of and ACAM, it is statutorily required that an efficient and effective regulator, not the Chairman of ACAM be a member of only because of its streamlined model of the Banking Commission, and the Gover- regulation, but also because it adheres to nor of the Bank of France, as Chairman of a series of “principles of good regulation,” the Banking Commission, is a member of which center on efficiency and economy, ACAM. the role of management, proportionality,

28 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

innovation, the international character of approach has been generally endorsed financial services, and competition.13 This and reconfirmed by the government, with overlay of pragmatic business principles, in some targeted legislative changes proposed addition to the traditional goals of regula- to address particular areas, including the tion, has been a distinguishing feature of deposit insurance scheme, the special the U.K. regulatory approach. resolution regime, and the clarity of roles The FSA also has broad investigatory, of the Tripartite Authorities (Her Majesty’s enforcement, and prosecutorial powers. Treasury, Bank of England, and FSA) The main area of financial regulation fall- within the Tripartite Agreement. Other ing outside the FSA’s purview is corporate observers have been more critical, sug- reporting and governance, which is the gesting that the Integrated Approach and responsibility of the Financial Reporting Tripartite Agreement, in particular, failed Council (FRC). Also, since 1968, takeover to ensure a fast-enough reaction to the bids in the U.K. are overseen by the Take- liquidity crisis and the related Northern over Panel. Rock bank collapse in the U.K. At the time of the 1997 regulatory reforms, the Bank of England was made Germany independent in the conduct of monetary Germany also employs an Integrated policy. It was decided, however, that allow- Approach to supervisory oversight, ing the bank to retain its direct banking although with several distinct differences supervisory role would unduly concentrate from the U.K. approach. power in the Bank of England. Concerns Prior to 2002, Germany operated under were raised regarding potential conflicts an Institutional Approach to regulation, of interest and priorities between the with separate federal supervisors for bank- monetary and regulatory functions and ing, securities, and insurance. Regulators the disparate staffing requirements for in each state (Land) supervised the stock the monetary and regulatory roles. The exchanges. In 2001, the government initi- Bank of England contributes to financial ated a reform of the German central bank stability through its market operations, its (the Bundesbank). The government also oversight of the payments system, and its reconsidered the institutional nature of access to market intelligence. In the U.K., financial supervision in light of changes in Her Majesty’s Treasury is responsible for the financial markets. Integration of the determining the statutory framework for financial sector had blurred the boundaries financial regulation and for determining among the financial services activities and whether lender-of-last-resort authority resulted in overlapping products, services, should be used. and supervisory functions. A single, inte- Recent events such as the run on North- grated supervisor was created—the Federal ern Rock bank prompted a reappraisal of Financial Supervisory Authority (BaFin). the Integrated Approach in the U.K. The The central bank nevertheless retained

13 www.fsa.gov.uk/Pages/About/Aims/Principles/index.shtml.

29 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

a number of important supervisory func- Supervision of the individual stock tions, and thus BaFin coordinates its super- exchanges in Germany is the responsibility visory functions with the central bank. of the stock exchange supervision authori- BaFin supervises all three traditional ties of the Länder. They supervise the financial businesses—banking, securities, orderly conduct of trading on exchanges, and insurance—and aims to ensure the including monitoring the pricing process. safety and soundness of these institutions. They are also responsible for the registra- BaFin’s insurance supervision aims to safe- tion of electronic trading systems and the guard insured parties. Through its market supervision of exchange-like trading systems. supervision, BaFin enforces standards of BaFin coordinates with the stock exchange professional conduct, which aim to pre- supervisory authorities in representing the serve investors’ trust in the financial mar- regulators at the international level. kets. BaFin also has an investor protection There continue to be internal debates in role and seeks to prevent unauthorized Germany over refinements to the supervi- activities. sory approach and the relative responsibili- In addition to its traditional central ties of BaFin and the central bank. It is bank roles, the Bundesbank exercises noteworthy that the central bank’s involve- some banking supervisory functions. Since ment in banking supervision, and particu- there appears to be some overlap in the larly in operational aspects, contrasts with supervisory responsibilities of the central the U.K. The central bank continues to bank and BaFin, an MOU defines their play a role in banking supervision, which respective roles in normal day-to-day super- is one of its primary areas of expertise. It vision to avoid duplication of work. Under is not involved in insurance or securities the MOU, the central bank is allocated supervision, however. Thus, Germany’s most of the operational tasks in banking supervisory structure remains somewhat supervision. It also plays a role in crisis bifurcated and does not represent a “pure” management. It advises the federal govern- Integrated Approach. ment on economic policy issues of major In addition to the U.K. and Germany, importance. other jurisdictions featured in the profiles In contrast to the U.K., insurance that use the Integrated Approach to finan- supervision in Germany is split between cial supervision include Japan, Qatar, and the federal government and the states. Singapore. Switzerland will adopt the Inte- BaFin supervises private insurance entities grated Approach as of January 1, 2009. operating in Germany that are of material economic significance, and competitive The Twin Peaks Approach—Australia and public-law insurance institutions that oper- the Netherlands ate across the borders of any Land. Each of In recent years there has been a discern- the Länder’s supervisory authority gener- able increase in interest in the Twin Peaks ally applies to those insurance entities Approach to regulatory supervision and whose activities are limited to particular regulation by objective. Two examples of state and private insurance entities of lesser the implementation of that approach are material economic significance. Australia and the Netherlands.

30 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

Australia The Netherlands Since 1997, following a review of its system The Netherlands adopted a Twin Peaks of financial services regulation, Australia Approach to financial services regulation. has organized its oversight responsibilities Unlike Australia, in the Netherlands the under a Twin Peaks Approach that sepa- central bank (DNB) also serves as the rates prudential regulatory oversight from prudential and systemic risk supervisor of conduct-of-business regulation. all financial services, including banking, The Australian Prudential Regulatory insurance, pension funds, and securities. Authority (APRA) regulates deposit-taking The Netherlands Authority for the institutions, which include banks, building Financial Markets (AFM) is responsible societies, credit unions, and insurance com- for all conduct-of-business supervision. Its panies and large superannuation (retire- overall objective is to promote transpar- ment pension) funds. It is independent of ent markets and processes and to protect the central bank and is a prudential regula- the consumer. The work of the agency tor that focuses on the safety and sound- is guided by three further objectives: to ness of the entities it supervises. APRA is promote access to the market; to ensure responsible for dealing with institutions the efficient, fair, and orderly operation of that are unable to meet their obligations, the market; and to guarantee confidence and it does this in close cooperation with in the market. Both the DNB and the AFM the Reserve Bank of Australia (RBA), the have enforcement authority. Australian central bank, which is available Until the late 1990s, the Netherlands to provide liquidity support if necessary. employed the Institutional Approach to APRA also has a statutory duty to promote financial supervision. Regulators were financial system stability in Australia. divided along the traditional lines of The Australian Securities and Invest- banking, insurance, and securities. This ments Commission (ASIC) is the business model was abandoned in favor of a Twin conduct regulator responsible for market Peaks Approach due to the consolidation integrity and consumer protection across of the Netherlands financial sector into the financial system in Australia. It regu- one dominated by companies conducting lates companies, financial markets, finan- business across multiple product lines, cial services organizations, and market pro- and the development of complex financial fessionals. It is not a prudential supervisor. products that have cross-sector elements. It issues guidelines, preferred practices, In the Netherlands, the Ministry of regulatory guidelines, and codes of con- Finance serves as the lender of last resort in duct. It also has enforcement powers. the event of a potential financial institution The RBA has responsibility for finan- failure. The DNB would take the lead in cial stability, interest rates, and payment crisis management. Under current arrange- systems. It is responsible for ensuring that ments, the AFM would not play an official licensed clearance and settlement facilities role in crisis arrangements, although it may for securities and derivatives conduct their be included in a future MOU. affairs in a manner consistent with finan- In addition to Australia and the Neth- cial stability. erlands, the other jurisdiction we reviewed

31 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

that is expected to adopt a Twin Peaks and investment banking were separated Approach in the near future is Spain. by the Glass-Steagall Act. The Securities and Exchange Commission (SEC) was The Exception—The U.S. Model established to regulate the U.S. securities Given the size and significance of the markets, and the Federal Deposit Insur- U.S. market, any description of financial ance Commission (FDIC) was put in place supervision would be incomplete without to insure deposits and discourage bank some mention of the U.S. model of regula- runs. Predecessors to the Office of Thrift tion. Perhaps as much as any jurisdiction Supervision (OTS) and the Commodity reviewed, the United States is a prime Futures Trading Commission (CFTC) example of the role that historical prec- were established to regulate home loan edent, politics, and culture have played in banks, thrift institutions, and commodity the regulatory structure. U.S. regulation exchange activities. of financial institutions took its present The Financial Modernization Act of 1999, form in the Great Depression of the 1930s, also known as the Gramm-Leach-Bliley Act and the structure established at that time (GLBA), repealed provisions of the Glass- largely reflected the siloed structure of the Steagall Act that restricted the ability of businesses at that time. While the current bank holding companies to affiliate with structure is quite complex and has come securities firms and insurance companies. under increased scrutiny in recent years, GLBA substantially modernized the U.S. for the most part it has been viewed as financial services industry, but it made only effective in meeting the various goals of incremental changes to financial services financial supervision, including promoting regulation. As a result, U.S. financial con- safety and soundness of individual financial glomerates can now operate in virtually all institutions, market integrity, investor and areas of financial services, but the regula- customer protection, and financial stability. tory structure remains largely institutional. The model can best be described as a Func- Attempts to address functional regulation tional Approach, with some institutional under GLBA, whereby the regulator that elements. is responsible for the activity will supervise One unique aspect of the U.S. system that activity, were minimally successful, is its dual nature. Since the earliest days because the provisions of the Act were of the government, banks have had the subject to numerous exceptions that were choice of state or federal charters, with highly negotiated in the legislative process choice being viewed as an important and immensely difficult to implement. source of innovation. With the creation Indeed, the implementing rules concern- of the Federal Reserve in 1913, state-char- ing the functional regulation of securities tered institutions that were members of activities of banks took several years to the Federal Reserve came under federal negotiate among the relevant banking and supervision. securities supervisors. The events of the stock market crash Ultimately, banking and securities activi- of 1929 and the Great Depression of the ties are regulated at both the state and 1930s resulted in a supervisory oversight federal levels by multiple regulators. Insur- structure that has lasted for decades. ance, on the other hand, is regulated at Among other things, commercial banking the state level and futures principally at the

32 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

federal level. Five federal agencies oversee pragmatic approaches such as cooperation banking and thrift activities (the Federal and information sharing with other rel- Reserve Board, the Office of the Comptrol- evant supervisors to address any perceived ler of the Currency, the Federal Deposit structural inefficiencies in their regulatory Insurance Corporation, the Office of models. Those that are in the process of Thrift Supervision, and the National Credit implementing reforms, such as Union Administration), and state and fed- Spain and Switzerland, were opti- eral banking agencies jointly oversee state- mistic that impending changes chartered banking institutions and thrifts. to their regulatory models would The United States and Banking regulators employ a prudential not only improve their ability to the United Kingdom regulatory approach, while the Securities regulate effectively, but would currently stand apart and Exchange Commission (SEC) is gener- also do so in a more streamlined, for the intensity of ally more enforcement oriented. efficient, and effective manner. Several recent studies have focused on The United States and the their ongoing efforts the inefficiencies of the U.S. regulatory sys- United Kingdom currently stand to reassess the tem and have recommended reforms. Each apart for the intensity of their effectiveness of their study has referenced the potential negative ongoing efforts to reassess the impact that this duplicative regulatory effectiveness of their regulatory regulatory approaches. structure and the costs associated with it approaches. This is due in no may be having on U.S. competitiveness.14 small part to the severity of the The recent rescues of the investment bank financial problems, stresses, and Bear Stearns and the government-spon- market phenomena that have occurred sored enterprises Fannie Mae and Freddie in both jurisdictions—the winding down Mac, have also spurred a vigorous public and sale of Bear Stearns, the government dialogue on the structure and effectiveness efforts to reinforce market confidence of financial regulation in the United States. in the mortgage giants Fannie Mae and Freddie Mac in the U.S., and the run on An Assessment of the Four Northern Rock in the U.K. Supervisory Approaches In its report entitled “Blueprint of a Regardless of the approach to financial Modernized Financial Regulatory Struc- supervision adopted in a particular ture,”15 issued in March 2008, the U.S. location, all regulators we interviewed Treasury proposes a major restructuring of expressed confidence in their ability to financial supervision toward a regulation satisfy their statutory mandates and meet by objectives approach, in some ways simi- the goals of regulation under their existing lar to the Twin Peaks Approach to supervi- regulatory structure. Most have developed sion and regulation. In the U.K., both the

14 “Sustaining New York’s and the U.S.’ Global Financial Services Leadership,” McKinsey & Co., January 2007 (www.nyc.gov/html/om/pdf/ny_report_final.pdf). “Commission on the Regulation of U.S. Capital Markets in the 21st Century – Report and Recommen- dations,” U.S. Chamber of Commerce, March 2007 (http://www.uschamber.com/publications/reports/ 0703capmarketscomm.htm); “The Competitive Position of the U.S. Public Equity Market,” Committee on Capital Markets Research, De- cember 2007 (www.capmktsreg.org/pdfs/The_Competitive_Position_of_the_US_Public_Equity_Market.pdf). 15 www.treas.gov/press/releases/reports/Blueprint.pdf.

33 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

financial supervisors and the Parliament legally authorized and overseen as banks, appear to support targeted changes to insurance companies, or securities firms, the existing Integrated Approach. In both the separate institutional regulators may jurisdictions, the benefits and disadvan- regulate the activity differently. This differ- tages of other regulatory approaches have ent regulatory treatment may take the form been actively debated. of different capital treatment or customer Ultimately, of course, the success of any protection rules, for example. regulatory approach must be measured In practical terms, the Institutional by the ability of regulators to achieve the Approach may be the most difficult to policy goals of regulation in real world maintain given how much financial services contexts rather than by simply tallying firms and products have evolved from their theoretical pros and cons. Arguably, there institutional labels—banking, insurance, is no single optimal approach for all juris- and securities. As regulators expand the dictions, because each has its own unique scope of business that is permissible in issues. That said, there is merit in consider- a regulated legal entity, that activity will ing the benefits and disadvantages of each likely overlap with the regulatory purview approach in order to assist those who seek of another supervisor. At its most extreme, to make informed decisions on possible this can result in regulators overseeing vir- reforms. tually identical conduct under potentially different rules. In practice, it has in at least The Institutional Approach some cases moved the regulators to adopt The Institutional Approach to supervision some functional elements of supervision is under some stress due to significant where there are clear overlaps in product changes in financial services offerings. This appears to be occurring, for business models. The Institu- example, in China. As cross-sector business The Institutional tional Approach is based on a has expanded in China, questions of super- Approach is based on business model that, to a large visory prerogative have arisen. Agencies are a business model that, extent, no longer exists. Many working to strengthen the coordination large financial firms are involved among their activities involving cross-sector to a large extent, no in a cross-section of products products in order to reach agreement on longer exists. and services rather than in the regulatory actions before approvals are monoline activities of the past. granted. Indeed, they tend to operate The Institutional Approach potentially along business lines without regard to legal suffers from not having a single regulator status of the entities in which the activity is with a 360-degree overview of a regulated technically situated or recorded for regula- entity’s business or of the market as a tory purposes. whole. It also suffers from not having a The Institutional Approach suffers from single regulator that can mandate actions potential inconsistency in the applica- designed to mitigate systemic risk. tion of rules and regulations by disparate regulators and the challenges associated The Functional Approach with interagency coordination. Because The Functional Approach to financial the same or economically similar activity supervision involves regulating activities may be conducted by entities that are across functional, as opposed to legal

34 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

entity, lines. The clear benefit of a Func- Another disadvantage of the Functional tional Approach to supervision is that, at Approach is that it forces financial institu- least in theory, a single, technically expert tions to deal with multiple regulators, regulator will apply consistent rules to which is often more costly in the same activity regardless of the entity terms of time and effort. There in which it is conducted. Regulatory is a tendency for multiple regula- arbitrage, which can occur when multiple tors to duplicate efforts to some The clear benefit of a regulators interpret and enforce the degree. In rare instances, supervi- Functional Approach same, or perhaps even inconsistent, rules sors may take disparate regulatory to supervision is that, in different ways, is avoided under this positions relative to the same at least in theory, a approach. As an acknowledged expert activity, putting the regulated agency, the regulator may be better able to institution in an untenable situa- single, technically expert attract and retain highly qualified subject tion. Multiple regulatory agencies regulator will apply matter experts who can interpret and apply must expend much time and consistent rules. applicable rules to the same functions effort coordinating and commu- across different legal entities. nicating among themselves. One of the major challenges of func- As multiple regulators com- tional regulation is that it can be extremely pete for jurisdiction, not just nationally but difficult to distinguish which activity comes also internationally, they may act to gain within the jurisdiction of a particular favor with regulated entities by being more regulator. aggressive or permissive in ways that ben- As regulators expand the scope of efit the firms. Some may argue that regula- permissible activities of the entities under tory competition can lead to more efficient their watch, there is a general reluctance to outcomes, as no single monolithic bureau- cede to another agency authority for over- cracy has ultimate decision-making author- seeing those new activities. A related and ity. The contrary may be just as likely, quite significant concern with the Func- however. Regulatory competition may lead tional Approach is that product innovation to a “race to the bottom,” particularly if an can be inhibited as functional regulators institution has a choice of regulator for a spar over jurisdiction. This problem is particular activity and the regulator’s bud- often cited in the case of the SEC and the get is funded by assessments of the entities CFTC in the United States. Disputes over it oversees. At its worst, a regulator highly whether certain products are securities reliant on assessments may be particularly or futures, whether the SEC or the CFTC vulnerable to regulatory capture, which has authority to regulate them, and which can compromise its vigilance. rules apply have hindered the introduc- There are other challenges to the Func- tion of certain new products by securities tional Approach. A major disadvantage is and futures exchanges in the U.S. In some that no regulator has sufficient informa- instances, activity has migrated to countries tion concerning all the activities of any where this regulatory uncertainty does not particular entity or entities to monitor for exist. Thus, one negative consequence of systemic risk. Also, addressing systemic risk this jurisdictional uncertainly is to drive may require having a single regulator with business offshore. authority to mandate actions across the

35 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

entire financial system. No functional involved in multiple business lines can regulator may be in a position to fulfill be vastly simplified and presumably more that role. efficient and cost-effective with a single regulator. It is also undoubtedly the case The Integrated Approach that many supervised entities prefer an The Integrated Approach to financial integrated supervisory approach. Certainly, supervision garnered much favor in the last with one regulator, a firm is more likely to several years, as regulators and policymak- experience consistent application of rules ers in many jurisdictions recognized that and is less apt to be caught in jurisdictional changes in the business models of financial disputes between regulators. institutions and proliferation of financial Notwithstanding the merits of the Inte- products warranted commensurate reform grated Approach, there are also potential of oversight methodologies. Several juris- downsides to this model. Some observers dictions reviewed for this report, including suggest there are concerns related to Germany, Japan, Qatar, Singapore, the having a single point of failure. If an inte- United Kingdom and, as of Janu- grated regulator fails to spot an issue, there ary 1, 2009, Switzerland, have is not another agency to potentially fill the void. Defenders of fragmented regulation The Integrated adopted this approach. As with other models, there maintain that overlapping jurisdiction Approach has the are both positives and negatives potentially may increase the likelihood of a advantage of a about this approach. First, the supervisor recognizing a problem or issue. streamlined focus Integrated Approach has the With a single monolithic regulator, no such advantage of a streamlined focus system of checks and balances exists. on regulation and on regulation and supervision In a very large market, there may be supervision. without confusion or conflict concern that an integrated regulator might over jurisdiction lines that are simply be too large and thus too cumber- possible under both the Insti- some to be managed effectively. A large tutional Approach and the Functional integrated supervisor that regulates across Approach. This clarity of focus potentially all business sectors will likely have to divide leads to higher-quality regulatory out- its workflows into manageable functional comes. Another significant advantage of or other business units. For example, the the Integrated Approach is that it provides Japanese FSA, as an integrated supervisor, a more comprehensive, panoramic view regulates the financial institutions under of the regulated entity’s business. The its jurisdiction by function and is so orga- oversight perspective is potentially not nized internally. Likewise, BaFin, as the only deep but also broad. The supervisor integrated regulator in Germany, is gener- can test for compliance with regulatory ally organized along sectoral lines, with requirements and also review business separate departments created to handle issues, management quality, risk manage- entities that cross various lines. Thus, comment, and control issues on a prudential munication among the various functional basis. It essentially gives the supervisor the divisions of a large, unified regulator is as ability to look holistically at an entity and important and may be as challenging as to respond to changes in a timely manner. it would be across separate organizations. Oversight of financial institutions that are There is no certainty, for example, that a

36 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

derivatives expert within a single integrated in, among other things, responsibility for supervisor is more likely to draw upon the Northern Rock being under three different expertise of the insurance experts within heads of departments in as many years. the same organization than he or she The FSA also cites the possibility that a very would if the two disciplines were located in demanding workload may have strained separate entities. internal resources. It notes the breakdowns There are concrete examples of the in flows of intelligence and information challenges of coordination that are experi- both internally and externally. The FSA enced even when the Integrated Approach recommends internal structural changes is adopted. In Germany, notwithstanding and cultural shifts within the organization that BaFin is an integrated regulator, the to address the shortcomings identified Bundesbank continues to play a role in through its internal assessment.16 banking supervision. This reflects histori- A single, integrated regulator cal circumstances and is due in large part has the potential to become a to the Bundesbank’s expertise in banking classic monopolistic bureaucracy, A single, integrated supervision and its interest in having an in- with all the related inefficien- depth view of banking activity as it relates cies. This model by definition regulator has the to its monetary policy role. This has led to lacks regulatory competition. potential to become a some overlaps and duplication in audits, Some commentators advocate classic monopolistic issues that admittedly may be manageable competition among regulators to bureaucracy… through effective coordination efforts. The ensure that they are challenged Bundesbank and BaFin have addressed to outperform their competitors. this issue by entering into a Memorandum Of course, others observe that of Understanding regarding their respec- there is no certainty that the opposite will tive roles. A single, integrated regulator, not occur—that there will be a race to the by definition, mitigates coordination and bottom as regulators compete to be in the information-sharing problems, but the favor of the firms they oversee. agency must still work to ensure coordination between the central bank and ministry The Twin Peaks Approach of finance. The Twin Peaks Approach to financial The critical self-assessment by the FSA supervision is designed to garner all of the run on Northern Rock in the U.K. the benefits and efficiencies of the Inte- highlights the challenges of managing a grated Approach, while at the same time single, large agency that is responsible for addressing the inherent conflicts between the regulation, supervision, and examina- the objectives of safety and soundness tion of all sectors of the financial industry, regulation and consumer protection and including banks, insurance companies, transparency. The Twin Peaks Approach securities firms, mutual funds, hedge has been referred to as “regulation by funds, and private equity firms. In its objective.” One agency’s regulatory objec- analysis of lessons learned, the FSA points tive is prudential supervision with the to internal reorganizations that resulted primary goal of safety and soundness. The

16 FSA Internal Audit Division, The Supervision of Northern Rock: A Lessons Learned Review, March 2008 (available at www.fsa.gov.uk/pubs/other/nr_report.pdf).

37 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

second agency’s goal is to focus primarily appropriate expertise for their specific on business conduct and consumer protec- functions. Prudential regulators can tion issues. employ persons with business and eco- The Twin Peaks Approach may help nomic expertise while business conduct insulate prudential supervisors from an regulators focus on hiring enforcement- excessively intrusive consumer-oriented oriented staffs. Having the functions in approach. When safety and soundness separate entities can minimize the conflicts mandates conflict with consumer protec- between the disparate disciplines. This tion issues, the prudential supervisor may approach has been adopted in three of the give precedence to safety and soundness jurisdictions studied in the profiles—Aus- mandates, because these are closely inter- tralia, the Netherlands, and, in the near twined with financial stability. However, future, Spain. even when the two objectives are divided The U.S. Treasury Blueprint advocates among separate regulators, tensions the adoption, over the long-term, of a may remain, especially when model that is similar to the Twin Peaks prudential and systemic stability Approach, and is based on regulation by The Twin Peaks concerns are seen to override objective. The objectives encompass three consumer protection issues in key goals: market stability, prudential Approach may also be the case of institutional failures. supervision, and business conduct. The the optimal means of Such decisions concerning institutional structure underpinning these ensuring that issues of which goals take precedence are objectives differs from the classic Twin ultimately subjective, based on Peaks Approach in a number of ways. transparency, market the institutional positions of the The Treasury Blueprint differs from integrity, and consumer respective actors and regulatory existing Twin Peaks models in that it advo- protection receive agencies. cates having a business conduct regulator sufficient priority. The Twin Peaks Approach that is separate from the transparency may also be the optimal means of and markets regulator. It proposes that ensuring that issues of transpar- the latter two functions remain with the ency, market integrity, and con- SEC. The jurisdictions that currently have sumer protection receive sufficient priority. adopted the Twin Peaks Approach link Each of the investor protection and market investor protection with market fairness conduct mandates can receive singular and transparency mandates and have a focus. The approach is designed to ensure single regulator in charge of all three man- that sales practice protections apply uni- dates. Presumably, since most securities formly across all financial products, regard- regulators have significant experience with less of the legal status of the entity selling business conduct regulation, this role has the product. tended to be delegated to securities regula- This approach to financial supervision tors in the jurisdictions that have adopted is gaining currency as a means of achieving the Twin Peaks Approach. This conduct-of- the benefits of the Integrated Approach business focus is not limited to rulemaking with the added distinct emphasis on authority. It also encompasses developing consumer protection issues, particularly arbitration or mediation systems, ombuds- for retail customers. Under this approach, men programs, and other means of inves- each regulator can hire employees with tor remediation.

38 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

The Role of the Central Bank As banking supervisors, central banks The financial turmoil that unfolded in have a window into financial activity that several economic centers in 2008 tested the is essential to the performance of their ability of supervisors to respond effectively other functions, such as setting interest to financial crises. It also brought into rates and performing a lender-of-last-resort sharper focus the optimal role of central role. They are uniquely suited to function banks, both in benign market conditions as liquidity providers in a crisis and during times of severe financial stress. given their access to funding, In addition to the role of central banks in their knowledge of the financial Central banks have a implementing monetary policy, in most institutions they oversee, and supervisory competitive developed economies they perform one their relative independence from edge due to their superior or more additional essential functions, political pressures. including acting as a prudential supervisor, In the United States, for exam- knowledge of market ensuring financial stability, and acting as a ple, the Federal Reserve, in 2008, conditions and the depth provided access to the discount lender of last resort. of their staffs’ expertise. A threshold question arises whether window to systemically important the central bank should be a supervisor institutions such as primary deal- of financial services or whether that role ers and investment banks that, as is best performed by another agency. nondepository institutions, were not subject There are strong sentiments on both sides to central bank oversight. It became clear, of this issue. Those who support central however, that the Federal Reserve needs bank involvement in financial supervi- substantially more in-depth information sion maintain that central banks bring concerning these financial institutions significant expertise to the function that before it can prudently extend credit. This might be compromised if the role were information includes all of the financial, assigned to another supervisor. Indeed, business, and operational information that some believe that central banks have a is customarily available to a prudential supervisory competitive edge due to their supervisor. Thus, the Federal Reserve, in superior knowledge of market conditions July 2008, entered into a precedent-setting and the depth of their staffs’ expertise. Memorandum of Understanding (MOU) Central banks tend to understand well the with the SEC17 providing that the Federal business of financial institutions by virtue Reserve and the SEC will jointly formulate of their market functions. They may be in supervisory guidelines or rules concerning a uniquely advantageous position to shape capital, liquidity, and funding positions and the regulatory environment in ways that resources and associated risk management are particularly beneficial in times of finan- systems and controls for SEC-regulated cial crisis. Through their role as supervi- entities that have access to the discount sors, central banks can respond directly to window. The MOU further provides that issues they identify, and can require entities the Federal Reserve and the SEC will col- they supervise to take certain steps aimed laborate in communicating expectations at mitigating systemic risk. with these entities. It also provides that

17 Memorandum of Understanding between the U.S. Securities and Exchange Commission and the Board of Governors of the Federal Reserve System Regarding Coordination and Information Sharing in Areas of Common Regulatory and Supervisory Interest, July 7, 2008 (available at www.sec.gov/news/press/2008/2008-134_mou.pdf).

39 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

the joint oversight of these entities will Those who oppose having the central continue even if the lending facilities are bank take on a supervisory role for banks terminated. The latter provision illustrates raise concerns that the central bank might the strong desire of the Federal Reserve to become too powerful and omnipresent access key information on these systemically in financial matters. They also raise con- important non-bank players in order to cerns that the central bank may become better satisfy its monetary policy, financial overwhelmed by its equally challenging stability, and lender-of-last-resort mandates. mandates of setting monetary policy and A number of the jurisdictions reviewed regulating the banking sector. They oppose embrace the view that by virtue of its bank centralizing so much responsibility and supervisory function, the central bank is authority in a single entity. When the better equipped to perform its other roles central bank is involved in both supervision related to monetary policy, financial stabil- and monetary policy, senior management ity, and payment systems. Germany’s central time may be strained without additional bank, for example, has retained a number resources or careful resource allocation. of supervisory functions, even though the Others argue that there are inherent Integrated Approach has been adopted conflicts between the role of the central in Germany and a number of functions bank as a prudential supervisor and that have been shifted to the unified regulator, of a financial stability or monetary policy BaFin. The German central bank appears authority. Conversely, some would argue to want to continue to have a role in super- that these conflicts are better handled vising banks, in large part to stay abreast of within one agency that can balance the developments in the marketplace and to various objectives against one another bolster its lender-of-last-resort capability. before taking a decision. Jurisdictions we In Brazil, France, Hong Kong, Italy, reviewed in which the central bank’s role Spain, the Netherlands, Singapore, and does not include that of a prudential regu- the United States, the central bank is also lator include Australia, Canada, China, a safety and soundness supervisor of the Japan, Mexico, Qatar, Switzerland, and the banking sector. Thus, the central bank United Kingdom. performs this additional role in several The policy debate over the role of the countries without regard to the approach central bank has been particularly robust to financial supervision they employ. in the United Kingdom since the run Central bankers who are also safety and on Northern Rock. Since 1997, after the soundness supervisors believe that a bank’s problems with the Bank of Credit and supervisory activities contribute to its finan- Commerce International (BCCI) and Bar- cial stability role. They maintain that the ings, regulation and supervision of banks link between liquidity management and has rested with its unified regulator, the central bank operations is key to effectively FSA. At that time the Tripartite Authorities addressing financial crises and, moreover, in the United Kingdom entered into an that when supervision extends to invest- MOU, which was updated in 2006. Under ment banks, such as in France, a central the MOU, the Bank of England’s respon- bank’s supervisory activities garner insights sibilities include “the maintenance of the into nascent market issues, enabling it to stability of the financial system as a whole,” respond in a more timely manner. while the FSA has responsibility for the

40 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

authorization and supervision of individual The U.S. Treasury Blueprint contem- banks. In a crisis, the MOU provides that plates a similar division of duties between a the FSA is responsible for “the conduct of prudential supervisor and the central bank. operations in response to problem cases The Treasury Blueprint promotes a new affecting firms, markets and clearing and supervisory architecture for the U.S. that is settlements systems within its responsibili- an “objectives-based” regulatory approach ties,” which may include changing capital designed to focus on three goals of regula- or other regulatory requirements and tion—market stability, safety and sound- facilitating a market solution involving, for ness through prudential oversight, and example, an introduction of new capital. appropriate business conduct. Under this The lender-of-last-resort function in the regime, the Federal Reserve would be in U.K. resides in the Bank of England. charge of market stability regulation. The In light of criticism that the Tripartite Treasury Department believes the Federal Arrangements were found wanting and Reserve should be assigned this role due to that the Tripartite Authorities did not act its traditional central bank role in promot- quickly enough to avert a run on Northern ing overall macroeconomic stability. Ele- Rock, some have argued that the supervi- ments of this function would be conducted sory role for banks should be returned to through the implementation of monetary the Bank of England. These critics main- policy and the provision of liquidity in the tain that it is very difficult for a central system. The Federal Reserve would also be bank that is the lender of last resort to act given additional powers, such as the power quickly when the government agency with to gather information, make disclosures, knowledge of the particular failing bank is and collaborate with other regulators on not the same agency that is responsible for rule writing and corrective action. It also extending the credit. By definition, lenders would have the authority to require correc- of last resort need timely and complete tive action, but only when overall financial information on which to act promptly. The market activity was threatened. This role Tripartite Authorities have defended the would replace, and be in lieu of, the Fed- division of responsibility for the regulation eral Reserve’s current role as a supervisor of financial institutions and the lender- of banks and bank-holding companies. of-last-resort responsibility between the Under the proposal, prudential supervi- FSA and the Bank of England, with Her sion of banks and investment banks that Majesty’s Treasury chairing the Tripartite is currently performed by five banking body charged with making such decisions. agencies and the SEC and the CFTC would This division of responsibilities is thought be consolidated into a single, independent by some senior officials to be prudent regulator. because it is felt that one institution—a Since the publication of the Treasury central bank—may not be able to manage Blueprint, and as the credit crisis has deep- both monetary policy and the entire range ened in the United States, the role of the of financial supervision. In the U.K., the Federal Reserve as a supervisor, lender of Chancellor of the Exchequer has strongly last resort, and market stability supervisor supported these separate roles for the FSA increased perceptibly. This enhanced role and the Bank of England. for the Federal Reserve contrasts with the

41 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

tenor of the recommendations in the Blue- confidence that they will have ready access print. Indeed, the Federal Reserve is taking to their funds, depositors will have a strong a much more active role in supervision of incentive to join a bank run and withdraw primary dealers and systemically important their deposits. investment banks. It would appear that, Some observers believe that the U.K. notwithstanding previously expressed con- deposit insurance scheme’s inclusion of cerns over both the Federal Reserves’ abil- a complicated co-insurance element may ity to handle such large mandates and its have contributed to the run on Northern ability to balance the various and potential Rock. For example, depositors’ funds conflicting functions, in times of financial were insured 100 percent only on the stress there is a tendency to turn to the first £2,000 (British pound sterling), and central bank more than any other arm of 90 percent on the next £33,000. This the government for assistance. complexity detracted from depositor confidence and indeed incentivized depositors The Role of Deposit Insurance to withdraw all of their finds in order to Deposit insurance schemes have come avoid any potential for loss sharing on under greater scrutiny after the run on their part. The most successful deposit Northern Rock in the U.K. Deposit insur- protection schemes are those that are as ance can play a critical role in avoiding simple and transparent as possible. This bank panics and thus may contribute to means providing clear explanations of how financial stability. A consensus seems to depositors can maximize their protection. have emerged in the U.K. that the existing To provide the optimal financial stability deposit insurance regime was inadequate benefits, the details of the scheme must be to inspire depositor confidence and well advertised and readily accessible. prevent a run on the bank. The Depositors also expect that a deposit House of Commons Treasury insurance scheme will be adequately Any regime must be Committee, in its Fifth Report of funded in order to meet any potential obli- structured to ensure that Session 2007–2008, entitled “The gations. Failure to provide this assurance Run on the Rock,”18 reached a likewise fails to meet the objective of finan- depositors’ funds can be series of conclusions and recom- cial stability. This entails the ex ante capital- accessed promptly. mendations that have informed ization of a deposit protection fund, most recent U.K. legislative proposals. likely with monies provided through assess- These “lessons learned” are ments from the banks. The size of the fund highly instructive in fashioning a successful depends on the amount of insured deposits deposit insurance scheme. in the system and the likelihood that any Any regime must be structured to particular institution will fail. It may be ensure that depositors’ funds can be particularly challenging to adequately fund accessed promptly. Among other things, a deposit insurance scheme in a small juris- insured deposits should be segregated to diction where there is a high concentration reassure depositors that their funds are of deposits in only a few dominant institu- both safe and accessible. In the absence of tions. In the absence of collecting very high

18 Issued January 24, 2008 (available at www.publications.parliament.uk/pa/cm200708/cmselect/ cmtreasy/56/5602.htm).

42 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

deposit insurance assessments from those expanded in 2008 by the U.S. President institutions, the only means to adequately pursuant to recommendations made in the fund such a regime may be through direct Treasury Blueprint. Its focus now includes government funding. Failure to do so may the entire financial system rather than increase the likelihood that depositors will solely capital markets. It also will focus on not be fully protected in accordance with four discrete areas: mitigating system risk their expectations. to the financial system, enhancing financial An examination of the jurisdictions we market integrity, promoting consumer and reviewed reveals the widespread adoption investor protection, and supporting capital of deposit protection schemes in most market efficiency and effectiveness. Also, financial centers. The exceptions include the Treasury Blueprint recommended Australia and China, although both are that membership of the PWG should be now in the process of establishing deposit expanded to include the Comptroller of protection schemes. We can conclude the Currency and the heads of the Federal that all jurisdictions studied recognize the Deposit Insurance Corporation and the importance of such schemes and their role Office of Thrift Supervision. in shoring up depositors’ confidence in the In addition to the PWG, there are vari- financial system generally, and in the safety ous bilateral MOUs between the federal of the deposits in covered bank accounts agencies that relate to information sharing. specifically. These MOUs have taken on increased importance in the aftermath of the Bear Domestic Coordination Issues Stearns wind down, where the inability of among Supervisors the firm, which appeared to be adequately Virtually all supervisors cite the importance capitalized, to obtain financing in the of intragovernmental coordination and overnight repo (repurchase agreements) information sharing for successful over- markets seems to have caught the regula- sight of the financial system and the mitiga- tors by surprise. This event has exposed the tion of systemic risk. Maintaining adequate weaknesses of a regulatory system in which levels of cooperation and information functional regulators may be well informed sharing across governmental agencies of the financial condition of the regulated appears to be both equally important and entity, but not have timely information on challenging regardless of the supervisory the state of the markets in which they are approach adopted in the jurisdiction. operating. This entails bringing together In the United States, one of the pri- the disciplines of multiple supervisors, in mary means of coordination among the this case the SEC and the Federal Reserve, Treasury, the Federal Reserve, the SEC, the latter having a better perspective on and the CFTC is the President’s Working the funding markets given its own open Group on Financial Markets (PWG), which market operations. The MOU between was formed in the aftermath of the 1987 the Federal Reserve and the SEC signed in stock market crash. The PWG has been July 2008 was in direct response to this per- the interagency coordination mechanism ceived need for greater coordination and for financial market regulation and information sharing with respect to certain policy issues since 1988. Its mandate was systemically important firms.

43 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

A majority of the jurisdictions reviewed securities, and derivatives markets for in this report employ a PWG-type financial stability. The Committee is approach, which melds an MOU (or series chaired by the Financial Secretary and of MOUs) between agencies with some includes the HKMA, the SFC, and OCI. form of financial stability committee tasked The other committee is the Council of with ensuring information exchange and Financial Regulators. This forum for dis- coordination between the leadership of cussion for high-level officials is chaired by the central bank and other supervisory the Finance Minister and includes, among agencies. In most cases, this coordination others, the SFC, OCI, and the MPFA. committee is a permanent feature of the Similarly, Spain employs a series of bilat- structure; it works in both nor- eral MOUs and a Financial Stability Com- mal times and in times of crisis. mittee (CESFI) to coordinate the efforts of A majority of the In other cases, such as in Japan, the Ministry of Economy and Finance, the jurisdictions reviewed the committee may only be trig- Bank of Spain, the National Securities and in this report employ a gered when a banking failure is Exchange Commission (CNMV), and the imminent. General Directorate of the Insurance and PWG-type approach… Where this structure is Pension Fund (DGSFP). This Committee employed, those interviewed was created in 2006 in response to recom- indicate a financial stability com- mendations from the European Union mittee helps deliver better agency coordi- (EU) that all national financial regulatory nation, allowing for a frank exchange of authorities should seek to establish similar views among a small leadership group, on a coordination mechanisms designed to regular basis. In addition, such a coordinat- anticipate and coordinate in times of finan- ing committee structure often results in cial stress and/or crisis. The Committee closer coordination between and among meets once a month. It focuses on contin- agencies at a deputy or lower level, in part gency planning for financial stress and for because of necessary preparatory work for unforeseen events such as terrorist attacks. the regular principals’ meetings and the Spain also employs a technique for ongoing linkages among agencies that this coordination that is used in several other creates. jurisdictions as well; that is, cross-board In Hong Kong, for example, the four memberships. The Ministry, the Bank of main regulatory bodies—the Hong Kong Spain, and the CNMV, for example, have Monetary Authority (HKMA), the Securi- representatives on their boards from the ties and Futures Commission (SFC), the other agencies. Office of Commissioner of Insurance France makes liberal use of interlocking (OCI), and the Mandatory Provident Fund boards to enhance the opportunities for Schemes Authority (MFSA)—have all coordination among financial supervisors. signed a series of bilateral MOUs to fur- For example, each of the boards of the ther enhance cooperation on regulation, Insurance and Mutual Societies Supervisory supervision, information exchange, and Authority (ACAM) and the Banking Com- mutual assistance. There are also two high- mission has representatives from the other. level coordinating committees. One is the France also has a board—the Board of Financial Stability Committee, which meets Financial Sector Authorities (CACESF)— once a month. It monitors the banking, that brings together the Governor of the

44 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

Bank of France, the Chair of ACAM, the Authorities. Among other things, the Chair of the Financial Markets Authority legislation would explicitly recognize the (AMF), and the Minister of the Economy Bank of England as the financial stability to discuss issues of common concern. regulator, introduce a resolution regime to Mexico also employs similar coordina- deal with failing banks, change the deposit tion techniques. It has interlocking boards insurance regime in a manner that would among the financial supervisors, it makes make it easier to understand, and provide use of bilateral MOUs, and it established for faster payments to depositors and mea- a Financial Stability Committee modeled sures to improve coordination among the after the PWG in the United States. Tripartite Authorities. Of course, having a PWG-type structure These arrangements, in normal circum- in place does not guarantee coordination stances, would provide for the FSA to be among principals, who may not concur the supervisor of financial institutions, with on policy matters, but those interviewed the Bank of England having access to infor- felt that having a structure of MOUs and a mation obtained by the FSA. In troubled financial stability committee in place helps times, when it appears that a financial insti- engender closer ties and better coordina- tution is having difficulties, the entity will tion that can pay dividends in times when become subject to heightened supervision, speed is of the essence and decisions must and the Bank of England, as a potential be taken with dispatch. lender of last resort, may want more direct In “The Run on the Rock,” the House and fulsome data from the entity. There of Commons Treasury Committee exam- would also be heightened infor- ined the role of the Tripartite Authorities mation sharing among Tripartite at the time of the Northern Rock crisis. Authorities during this period. Having a structure of The report notes the Tripartite Authori- Thus, the legislative proposal MOUs and a financial ties could have perhaps more effectively in the U.K. seeks to create an stability committee in coordinated in order to act to thwart a run arrangement for benign periods on the bank. While the U.K. has a single that can more expeditiously shift place helps engender unified supervisor that was widely viewed into effective crisis management closer ties and better as quite effective during normal times, in arrangements as necessary. coordination. times of crisis, when coordination with It is noteworthy that under other areas of the government was crucial, the Integrated Approach, which these arrangements were viewed as inad- could be viewed as the most equate. Accordingly, it has been proposed streamlined approach to financial supervi- by the government that one of the two sion, supervisors still must work tirelessly to existing Deputy Governor positions at the coordinate with other financial oversight Bank of England also be designated as bodies—primarily with their ministries of Head of Financial Stability, have a specific finance and central banks—in order to focus on systemic issues, and be respon- effectively monitor for financial stability sible for handling failing banks and over- and systemic risk. The U.K. experience seeing the Deposit Protection Fund. The points to the challenges of ensuring that proposed legislation would strengthen, arrangements that are viewed as highly without radically changing, the existing effective in benign periods will also with- arrangements among the Tripartite stand the shocks of a financial crisis.

45 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

In summary, those interviewed agree and insurance. As the business models that close and effective coordination of financial institutions have converged, and cooperation among the ministry of the need for greater coordination and finance, the central bank, and supervisors interaction among these international fora is essential, whatever form of financial has become more acute. This need for regulatory structure a country or market coordination is to a degree addressed by a adopts. Efforts to enhance coordination geographic concentration of a number of at the highest levels of the agencies can be these bodies in Geneva (for example, the adversely affected if principals clash person- Basel Committee, the Financial Stability ally or disagree over respective roles and Forum, and the International Association objectives. Ultimately, a collab- of Insurance Supervisors). orative tone must be established Perhaps the best known of the interna- …close and effective at the top by the individuals in tional committees is the Basel Committee coordination and charge. MOUs may provide a on Banking Supervision, which provides necessary underpinning of these a forum for international cooperation on cooperation among linkages in that they can set banking supervisory matters. The Com- the ministry of finance, the ground rules and establish mittee members come from Belgium, the central bank, and responsibilities, but they are not Canada, France, Germany, Italy, Japan, in and of themselves sufficient Luxembourg, the Netherlands, Spain, supervisors is essential… to ensure smooth coordination. Sweden, Switzerland, the United Kingdom, In many cases, the supervisory and the United States. The Committee’s authorities have felt it necessary mission is to enhance understanding of key to supplement these agreements with a supervisory issues and improve the quality financial stability committee of principal of banking supervision worldwide. The regulators. Linkages at the top of the Committee is known for its development central bank and supervisory agencies of guidelines and supervisory standards can be further cemented by cross-board that have been widely adopted worldwide, memberships. However, what appears to including its Capital Adequacy Standards work in “peacetime” cannot be assumed to and its Core Principles for Effective Bank- work as smoothly in a time of crisis. Many ing Supervision. of the frameworks for domestic coordina- The International Organization of tion described in the profiles in Part II of Securities Commissions (IOSCO) brings this Report have yet to be tested by the together securities regulators from around failure of a systemically important financial the world to promote high standards of institution, and few of those interviewed securities regulation in order to promote felt entirely confident that the structures in fair and efficient markets. It functions place were adequate to the task of handling as a forum for information exchange on a major systemically important bank failure. domestic experiences in order to promote the development of better markets world- Cross-Border Coordination Issues wide. It is also a standard-setting body There are several international fora for and promotes enforcement cooperation cooperation among financial supervi- through its multilateral MOUs. sors. With a few exceptions, these groups The International Association of Insur- are organized along the traditional ance Supervisors (IAIS) was established in institutional lines of banking, securities, 1994 to bring together insurance regulators

46 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

from almost 200 jurisdictions, representing exchange among the various authorities about 97 percent of the world’s insur- responsible for financial stability.”19 ance premiums. It seeks to contribute to The FSF brings together senior rep- improved supervision of the insurance resentatives of national authorities (for industry in order to maintain efficient, fair, example, representatives of the central safe, and stable insurance markets, pro- bank, securities regulators, and treasury motes the development of well-regulated officials), international financial institu- insurance markets, and contributes to tions (such as the IMF, the World Bank, the global financial stability. Bank for International Settlements [BIS], Two more recently formed international and the Organization of Economic Coop- fora seek to foster cooperation and coor- eration and Development [OECD]), inter- dination among supervisors across the national regulatory and supervisory groups financial services sectors. The Joint Forum (such as IOSCO, the Basel Committee on was formed in 1996 under the aegis of the Banking Supervision, the IASB, and the Basel Committee on Banking Supervision IAIS), committees of central bank experts (BCBS), the IOSCO, and the International (such as the Committee on Payment and Association of Insurance Supervisors Settlement Systems and the Committee (IAIS). It addresses issues common to the on the Global Financial System), and the banking, insurance, and securities sectors, European Central Bank. Thus, the FSF is a including the regulation of financial con- coordinating body that spans all sectors of glomerates. The membership comprises an financial services, but its primary focus is equal number of senior bank, insurance, on financial stability and systemic risk. and securities supervisors representing In addition to participation in these each financial sector. A representative of international groupings, a number of the European Union is an observer. jurisdictions engage in information shar- The Financial Stability Forum (FSF) is ing and cooperation bilaterally through the newest entrant in the field of interna- MOUs. There have also been some very tional fora designed to bring supervisors promising efforts of late for cooperative together from various financial services dis- efforts relating to areas of common con- ciplines. It was convened in April 1999 at cern that may impact financial stability. the initiative of the G-7 Finance Ministers One particularly noteworthy effort was the and Central Bank Governors to “promote joint work of the Banking Commission of international financial stability, improve France; the Federal Financial Supervisory the functioning of the financial markets Authority of Germany; the Federal Bank- and reduce the tendency for financial ing Commission of Switzerland; the FSA shocks to propagate from country to coun- in the United Kingdom; and the Federal try, thus destabilizing the world economy.” Reserve Board, the Federal Reserve Bank The FSF’s mandate is “(1) to assess of New York, the Office of the Comptrol- vulnerabilities affecting the international ler of the Currency, and the SEC in the financial system, (2) to identify and oversee United States that resulted in a report action needed to address these, and (3) entitled, “Observations on Risk Manage- to improve coordination and information ment Practices During the Recent Market

19 Mandate of the Financial Stability Forum, www.fsforum.org/about/mandate.htm.

47 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

Turbulence.” The effort brought together Such colleges may indeed be good fora for senior supervisors of major global financial more formalized information exchanges services organizations to assess which risk and cooperation between home and host management practices worked well and supervisors. However, a number of those which did not during the recent period of interviewed felt that they should not market turmoil. It summarizes the results become overly large and must remain of supervisory reviews and a roundtable flexible as to membership, size, and discussion that the supervisory agencies composition, with these decisions being held with industry representatives. The taken by the home supervisor. report is significant not only for its find- Within the European Union, some ings, but also for its success in achieving supervisors favor establishing a more collaboration among supervisors on an elaborate system of coordination first ad hoc basis to examine a significant issue at the EU level, and then exporting the of global importance. It has encouraged concept internationally. Some supervisors supervisors to share findings and work cited international cooperation as the first cooperatively to address weaknesses in the and necessary step toward convergence of financial system. Also, observa- supervisory practices and regulations, and tions noted in the report have believe the new EU MOU will be an impor- …virtually all of the helped to define an agenda for tant step forward when enacted. This EU jurisdictions we strengthening supervisory over- MOU is only part of the European Commu- sight in certain relevant areas. nity’s structure designed to deal with crisis reviewed support Representatives of virtually all management. (See Part II of this Report for the efforts of these of the jurisdictions we reviewed a more detailed description.) None of the international groups in support the efforts of these European supervisors reviewed supported international groups in further- the creation of an EU-level supervisor at furthering cooperation ing cooperation and information this stage, preferring instead to work on and information sharing. sharing. There is significant reinforcing the structures for coordination debate, however, concerning and cooperation among national agencies whether these efforts are enough and central banks. or whether greater coordination efforts In general, the review found support need to be in place, particularly in crisis for the use of colleges if they can enhance situations. information exchange and coordination. Some jurisdictions favor more formal Many supervisors believe that international mechanisms for cooperation and informa- groupings such as Basel, the FSF, and tion sharing. Still others indicate the need the IOSCO need to be supplemented by for more real-time access to information colleges that facilitate communication and believe that formal mechanisms between home and host supervisors in will promote more timely information normal times so as to prepare the lines of exchange. communication for times of systemic crises. A number of those interviewed were But not all of those interviewed felt supportive of more widespread use of a that more colleges are necessary. Some series of “colleges of supervisors” on the supervisors believe that the current levels international level focused on large sys- of coordination and information exchange temically important financial institutions. are adequate. They express concern that a

48 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

formal, structured college to deal with cri- On the other hand, notwithstanding its ses is unnecessary and potentially cumber- somewhat dated and complex regulatory some. Critics of colleges do not want exces- structure, U.S. regulators have sive and prescriptive over-formalization of been viewed by some as respond- the process. They point to recent events as ing in a timely and aggressive Regulatory approaches having shown that supervisors know whom manner to recent conditions. to call when a problem arises. If answers The sale of Bear Stearns to and methodologies that are not timely, it is generally due to the fact JPMorgan Chase that U.S. finan- may have worked well that supervisors are overwhelmed with the cial regulators facilitated over a under benign financial tasks at hand, and not to any reluctance weekend, followed promptly by conditions may break to share information. These regulators the unprecedented access to the expressed the view that bilateral and multi- Federal Reserve discount window down during a major lateral coordination is far more successful that was granted to government market disruption. than a college system. They are generally dealers and systemically impor- pleased with the level of cooperation and tant investment banks, evidenced do not recommend structural changes at the relative success of existing this time. arrangements. Clearly, the U.S. regulatory approach Lessons Learned From did not alone contribute to this success. Recent Experiences What seems to have worked well were the As the turmoil caused by the credit mechanisms that financial supervisors had crisis in the United States spread to other in place that fostered efficient coordina- economies, it provided financial supervi- tion in a crisis. In particular, the ongoing sors across the globe with unanticipated and fluid communication among regula- opportunities to test the effectiveness of tors, fostered by coordinating devices their supervisory approaches under stress such as the President’s Working Group on conditions. Regulatory approaches and Financial Markets, provided the backdrop methodologies that may have worked for U.S. financial supervisors to respond well under benign financial conditions quickly and decisively. That said, some may break down during a major market observers believe that the U.S. regulatory disruption. structure did not effectively identify the The study has found no simple cor- emergence or mitigate the results of the relation between the regulatory approach credit turmoil, highlighting the need for adopted in a jurisdiction and its effective- a significant restructuring of the financial ness during a financial crisis. The U.K. supervisory architecture. experience in the case of Northern Rock Similarly, one can point to the French illustrated that even those using an Inte- regulatory response to the unprecedented grated Approach to financial supervision, losses due to unauthorized trading at with its streamlined unified regulator, may Société Générale as evidence of the success also face challenges in times of a banking of the French regulatory structure, and in failure. While this approach was viewed particular the ability of all concerned to as highly successful in periods of calm, coordinate effectively. existing arrangements were found to need This is not meant to suggest, however, strengthening after the run on the bank. that regulatory approach does not matter.

49 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

The Integrated Model and the Twin Peaks importance of regulatory frameworks Model may more rationally reflect the accommodating and keeping pace changes that have taken place in the finan- with dramatic changes and innova- cial services business over the past several tion in financial markets. years, and thus are widely viewed as more 2. Many jurisdictions studied have mod- efficient and cost-effective by both regula- ified or restructured financial regulators and regulated entities. tory systems within the last 15 years, Those who operate under the legacy and a majority are in the process of models—the Institutional Approach and further restructuring or are actively the Functional Approach—expressed debating the need for significant confidence in their ability to changes to modernize their systems. meet the goals of regulation, but The Integrated Model there are clearly challenges to 3. All those interviewed stress the need to have effective coordination among and the Twin Peaks doing so in efficient ways, given the redundancies in jurisdic- the regulatory agencies, the central Model may more tion. However, making changes banks, and finance ministries. It is rationally reflect the to these legacy models should critical to maintain good contacts changes that have taken not be undertaken lightly. The and interaction at all levels in the process of reform can create agencies, including at the principal place in the financial costs and burdens. Also, as level and the operational levels. services business… measured by ability to respond 4. Coordination and communication to crises, no one model seems to create challenges, even in jurisdic- be clearly superior to the others. tions that have an integrated regula- Ultimately, to be successful, any regulatory tor, although, other things equal, model must also encompass coordination the challenges are often greater the and information sharing among all rel- larger the number of regulatory evant supervisors—finance ministries, cen- agencies. Whatever the structure, tral banks, and financial regulators. These there is a need for a consolidated mechanisms must be in place and actively view of each supervised institution. functioning. MOUs and other contractual coordination arrangements may not prove 5. Well-functioning groups or coor- to be as effective in a crisis as ongoing, dinating bodies that comprise the dynamic arrangements. heads or senior officials of the regulatory agencies, the central bank, and Twelve Principal Concluding the finance ministry are particularly Observations important during times of crisis, but Having compiled this report, the Working can also prove very useful in normal Group offers the following observations, times. which have emerged out of the discussions 6. We see a trend toward the adoption with scores of central bank governors, of integrated regulators and also supervisors, and finance ministries. toward regulation by objective (Twin Peaks), although no one model has 1. All policymakers and regulators proven unambiguously superior interviewed underscore the critical

50 The Structure of Financial Supervison: Approaches and Challenges in a Global Marketplace Analysis

in achieving all the objectives of A Final Comment regulation. Issues of structure and design of financial supervisory systems are important, and policymakers 7. Most supervisors stress the impor- should carefully consider reforms aimed at tance of an effective, transparent, updating their structures to better reflect market and efficient deposit protection realities. That said, recent events have demon- scheme as a part of today’s financial strated that underlying substantive rules are also regulatory architecture. key to exercising effective regulation. Thus, while 8. Regardless of structure or model, all a focus on regulatory structure alone clearly will supervisors stress the importance of not lead to optimal outcomes, it can undoubtedly communication and coordination contribute to greater regulatory success. with the central bank and the bank’s There are many questions related to involvement in crisis management. financial supervision that remain unan- 9. Irrespective of structural approach, swered by this review, however comprehen- central banks everywhere express sive it may be. As such, they will have to the critical importance of their hav- be addressed by subsequent work, by the ing information about, and a direct G30 or another body. For instance, should relationship with, large systemically unregulated entities (for example, hedge important financial institutions. funds and private equity funds) ultimately be integrated into the regulatory structure? 10. A majority of supervisors recognize Given their monetary policy, financial the value of supervisory colleges for stability, and lender-of-last-resort responsi- systemically important global finan- bilities, what is the optimal role of central cial institutions, but most also believe banks in the future regulatory landscape? that flexibility in the procedures and How effectively will regulators deal with the operations of these colleges is critical failure of a large financial institution that to their success going forward. has systemically important operations in 11. Central banks and supervisors remain several jurisdictions? What does it mean to concerned that current structures “rescue” a failing institution? Do supervi- for international coordination have sors have the right mechanisms in place yet to be tested by the failure of a to permit the orderly liquidation of major systemically important international financial institutions? Some of these key financial institution. questions going to the heart of the current debate over the reform of national super- 12. Strong leadership and high-quality visory responsibilities will be addressed in people can, to some degree, offset a forthcoming G30 study of the future of impediments/deficiencies that stem financial reform. from suboptimal regulatory structures, but at some point regulatory regimes need to be updated and modernized to accommodate financial evolution, market realities, and global integration.

Part II: Profiles the institutional approach

The institutional approach is one in which a firm’s legal status (for example, a bank, broker-dealer, or insurance company) determines which regulator is tasked with overseeing its activity from both a safety and soundness and a business conduct perspective.

China · Hong Kong · Mexico china The Institutional Approach

Market Description monetary policy, maintaining financial China’s banking sector is dominated by stability, and overseeing anti-money laun- five state-owned commercial banks: the dering. However, the PBC maintains con- Agricultural Bank of China, the Bank of siderable influence on supervisory policy China, the Bank of Communications, the matters through its Governor’s member- China Construction Bank Corporation, ship on the State Council. and the Industrial and Commercial Bank In 1992, to promote development of China. In 2007, these banks held over 50 and regulation of the stock market and percent of total assets of all Chinese bank- enhance the socialist market economy, ing institutions. There are approximately the Securities Commission of the State 8,800 other banking institutions in China, Council and the China Securities Regula- including 29 foreign banks. Total assets tory Commission (CSRC) were established held in banking are approximately 52.5 to supervise the stock market jointly with trillion Renminbi (RMB). The securities the PBC. These two institutions merged in market in China is relatively new and con- April 1998 and took the name of the latter, tinues to develop. At the end of 2007, there the CSRC, creating an agency to supervise were approximately 106 securities firms and regulate the securities sector. and 59 fund management firms.1 There are In 1998, to ensure more effective super- approximately 3,000 insurance institutions vision and sound development of the insur- with total assets of 2.9 trillion RMB. ance industry, the State Council established the China Insurance Regulatory Commis- Background sion (CIRC) as an agency to supervise and Today’s financial supervisory and regula- regulate the insurance sector. tory framework in China is quite new; all In April 2003, the China Banking Regu- major reforms have taken place in the latory Commission (CBRC) was established last 25 years. The current institutional to supervise and regulate the banking approach to supervision in China has sector. Its responsibilities include the begun to exhibit elements of the func- supervision of banks, financial asset man- tional approach toward financial supervi- agement companies, trust and investment sion. The system is the result of supervisory companies, and other depository financial and structural reforms that have taken institutions. place over a relatively short time. The current organizational setup replaced a previ- Statutory Framework ous structure where the People’s Bank of The Law of the People’s Republic of China on China (PBC) was the sole financial supervi- Banking Regulation and Supervision, passed sor. In 1983, the State Council2 authorized by the National People’s Congress (NPC) the PBC to act exclusively as a central bank in 2003, authorizes the CBRC to oversee and as the country’s financial supervisor.3 all banks and all non-banking financial Currently, the PBC’s supervisory role is institutions. This law, together with the Law limited to formulating and implementing of the People’s Republic of China on Commercial

1 www.oecd.org/dataoecd/5/32/18469881.pdf. 2 The State Council is the chief administrative authority of China. 3 Before 1983, the PBC served as both a central bank and a commercial bank.

58 Profile: china

Banks, is the legal foundation for China’s securities industry. It functions under the banking industry, combining financial guidance and supervision of the CSRC and administrative regulations and prudential the Ministry of Civil Affairs of China. The supervisory rules. With the development SAC supervises and inspects members’ con- of banking supervisory measures, in which duct, and executes disciplinary measures off-site surveillance and on-site examina- against those members violating laws and tion complement and coordinate with regulations. each other, risk assessment and warning Government agencies work with mechanisms for the banking industry have the Insurance Association of China, to been preliminarily established. strengthen its professional self-discipline The 2006 amendment to the Law of the and risk-prevention mechanisms. People’s Republic of China on Banking Regula- tion and Supervision extended rights to the Institutional Structure CBRC, transforming regulatory oversight. of the Regulators The Guidance on Compliance Risk Manage- China’s financial supervision system is insti- ment of Commercial Banks and the amended tutional in nature but is exhibiting func- Regulations of the People’s Republic of China on tional aspects as the economy and financial Administration of Foreign-Funded Banks have markets develop. It includes a central bank further improved the banking risk supervi- (PBC) and three parallel institutional sion system. supervisory agencies (CBRC, CIRC, and The CSRC has been strengthened CSRC), as well as others, as follows. through changes in the Company Law of the People’s Republic of China and the Securities Ministry of Finance (MOF) Law of the People’s Republic of China, which The MOF has financial supervision updated the existing securities regulatory responsibility. The Minister of Finance, as a laws. Administrative regulations, such as member of the State Council, has input on the Regulation on the Supervision and Manage- supervisory aims and matters of coordina- ment of Listed Companies and the Regulation tion among the agencies. on Supervision and Management of Securities Companies, have been passed into law. People’s Bank of China (PBC) The CIRC introduced a series of laws to The PBC is the central bank of China. The standardize the insurance industry, such as Governor of the PBC is a member of the Regulations on Qualifications of the Directors State Council. The PBC formulates and and Senior Managers of Insurance Companies, implements monetary policy, mitigates Regulations on Administration of Insurance financial risks, and safeguards financial sta- Salespersons, Provisional Guidelines for Stan- bility. The main duties and responsibilities dardization of Governance Structure of Insur- of the PBC include issuing and enforcing ance Companies, Regulations on Investment orders and regulations, formulating and Insurance Actuarial System, and Regulations implementing monetary policy, issuing on Flexible Insurance Actuary. Renminbi and administering its circula- tion, and regulating the interbank lending Nonstatutory Elements and interbank bond markets. Since the The Securities Association of China (SAC) reforms of the supervisory system and the is the self-regulatory organization for the creation of the CBRC, the PBC no longer

59 The Institutional Approach

has a direct financial supervisory role, but ment companies, financial companies, it nevertheless retains considerable influ- and the financial lease companies estab- ence over policymaking. The PBC contin- lished within China, and other financial ues to be the primary supervisory body for institutions established within China anti-money laundering. upon approval of the CBRC. The duties The PBC management is composed of and responsibilities of the CBRC include a Governor and several Deputy Governors. approving new banking institutions, for- The Governor, nominated by the Premier mulating prudential rules and regulations, of the State Council and approved by the and a wide range of powers of examina- NPC, is appointed by the President of tion, including off-site and on-site investi- China. The Deputy Governors are gation. The commission is also responsible appointed by the Premier of the State for detecting risk in the banking sector and Council. Funding for the PBC, which is a establishing an “early-warning system.” government agency, comes from the State The CBRC is led by a board consisting Budget. of a Chairman, the Discipline Commis- sioner, and the General Secretary. In 2006, State Administration of . the CBRC had a staff of 18,445, of which Foreign Exchange (SAFE) 6,680 were engaged in banking supervisory SAFE manages China’s foreign exchange activities.4 Funding for the CBRC comes reserves. It is responsible for drafting from the State Budget. regulations and authorizing national and foreign financial institutions in conducting China Securities Regulatory . foreign exchange operations. It adminis- Commission (CSRC) ters the regulations that China uses to keep The CSRC is responsible for conducting its currency convertible on the current supervision and regulation of the securi- account (that is, for trade and other pur- ties and futures markets in China. Major poses), but closed on the capital account functions of the CSRC include supervision (for most types of investment). These of securities and futures firms, stock and systems shield the domestic economy and futures exchange markets, publicly listed its banking system from global capital companies, fund management companies, flows. SAFE is an agency within the PBC the securities and futures investment and is managed by an administrator and consulting firms, and other intermediar- four deputies. ies involved in the securities and futures business. The CSRC seeks to protect inves- China Banking Regulatory . tors’ rights and interests and to mitigate Commission (CBRC) market risks. The CBRC is responsible for the supervi- The CSRC has a Chairman, four Vice- sion of nationwide financial institutions Chairmen, a Secretary General, and two and operations. The Banking Supervision Deputy Secretary Generals. Funding for Law applies to the supervision of financial the CSRC comes from the State Budget. asset management companies, trust invest-

4 CBRC 2006 Annual Report, page 104.

60 Profile: china

China Securities Investor Protection Fund ment of insurance companies; supervising In 2005, the CSRC, MOF, and PBC jointly the insurance business operations; and established the China Securities Inves- conducting investigations on irregularities tor Protection Fund Co., Ltd, which is and imposing penalties. The insurance responsible for the collection of fees, daily supervision system has gradually been management, and use of the fund. In 2007, established through the CIRC. In 2005, the CSRC and the MOF jointly issued the the China Insurance Protection Fund was Regulation on Futures Investor Protection Fund. established and is under the supervision The CSRC is responsible for the use and and management of the Insurance Protec- daily management of the fund. tion Fund Council. The CIRC is governed by a Chairman, China Insurance Regulatory . four Vice-Chairmen, a Secretary General, Commission (CIRC) and two Deputy Secretaries General. Fund- Similar to the CBRC’s role in the banking ing for the CIRC comes from the State industry, the CIRC oversees China’s insur- Budget. ance market. The State Council authorizes Figure 1 provides a graphic depiction the CIRC to supervise and regulate the of the relationship among the above- Chinese insurance market. Major respon- mentioned institutions. sibilities of the CIRC include formulating insurance industry policies, strategies, and Enforcement plans; drafting laws and regulations regard- When administrative violations occur, the ing insurance supervision and regulation; CBRC, CIRC, CSRC, and the PBC have examining and approving the establish- the authority to take enforcement actions,

Figure 1. The Financial Services System Regulatory Structure, China

State Council

Ministry of Finance People’s Bank of China (MOF) (PBC)

China Securities Regulatory China Banking Regulatory China Insurance Regulatory Commission (CSRC) Commission (CBRC) Commission (CIRC)

SECURITIES BANKING INSURANCE

State Administration of Foreign Exchange (SAFE)

Note: Dotted lines indicate a cooperative relationship.

61 The Institutional Approach

including imposing fines, the takeover of tion, the avoidance of supervisory gaps and an institution in crisis, and the injection redundancies, and enhanced supervisory of liquidity. If a bank faces problems, the efficiency, in June 2004, the CBRC, CIRC, CBRC takes the lead, gauging whether it is and CSRC signed the Memorandum a liquidity or solvency risk. The CBRC uses on Division of Labor and Cooperation on-site supervision to assess the health of in Financial Supervision, establishing a the institution. If necessary, the CBRC can tripartite system to coordinate activities in request that the PBC inject liquidity into financial supervision and coordination. the institution. The Memorandum provides for semian- The CSRC also has various options and nual meetings at the level of principals. sanctions available in case of failing securi- There are further quarterly meetings at ties firms. It can require capital injections, the senior deputy level. The chairmanship provide provisional liquidity support, and of the tripartite meetings rotates among back the introduction of overseas strategic each institution on an annual basis. The investors. When necessary, the CSRC has tripartite meetings discuss issues related the power to liquidate and close compa- to financial stability, financial supervision, nies. Governance reforms related to these and regulation. The respective roles of powers were put in place in 2005. The each institution are clearly defined in the CIRC has similar enforcement powers. Memorandum, in particular the agencies’ Violations of specific laws, such as individual and collective supervisory roles money laundering, are prosecuted by state as applied to holding companies. prosecutors, who file lawsuits against the Further coordination on securities responsible institutions and/or individuals. policy matters is aided by the Task Force on Capital Market Reform and Development, Framework for Domestic Coordination composed of senior representatives of the The State Council, the MOF, the PBC, and CSRC, MOF, and PBC, and other related the National Development and Reform agencies. The task force, chaired by the Commission (NDRC)5 speak with and CSRC, advises the State Council on finan- coordinate on a regular basis with financial cial markets reform matters. supervisory institutions on various signifi- None of the coordinating mechanisms cant issues associated with monetary policy, above have been tested by financial insta- financial reforms, and financial supervision bility and institutional failures. Chinese matters. In August 2000, the CIRC, CSRC, authorities recognize that strengthening and PBC established a joint conference for coordination and cooperation among all financial supervision to discuss issues relat- the financial regulatory authorities and ing to financial supervision and regulation. establishing and improving the mecha- To meet the challenges posed by the nisms for coordination of financial supervi- trend toward integrated business opera- sion are a prerequisite for further improv- tions in the financial industry, the need for ing and safeguarding financial stability strengthened coordination and coopera- and security. To that end, the revised Law

5 The NDRC is a macroeconomic management agency under the State Council, which studies and formulates policies for economic and social development, maintains a balance of economic aggregates, and guides the overall economic system restructuring. Although not a financial regulator, the NDRC has significant impact on financial markets through its economic decision-making powers and prerogatives.

62 Profile: china

of the People’s Republic of China on the People’s tinue to adjust their regulatory approaches Bank of China specifies in Article 9 that “the and structures. The State Council has State Council shall establish a coordinating stressed the need to improve coordination mechanism for financial supervision and among the banking, securities, and insur- regulation.” Furthermore, in Article 35, it ance regulatory authorities and macroeco- states, “the PBC shall establish a supervi- nomic departments of the PBC and MOF, sory information sharing system together to enhance transparency and efficiency with the banking regulatory authority and of financial supervision, and to further other financial supervisory authorities strengthen information sharing. under the State Council.” The CBRC, CIRC, CSRC, MOF, and PBC are monitoring the development of International Coordination businesses and product lines that blur the China’s supervisory agencies have Memo- distinctions among banking, securities, and randa of Understanding (MoUs) with insurance activities and offerings. They are other supervisory agencies. For example, aware of the possible supervisory overlap the CBRC has MoUs with over 20 agencies or lack of regulatory clarity that can occur internationally. The CSRC also has MoUs among agencies when seeking to exert with 39 other securities regulators. The supervisory authority over new business or CIRC has MoUs with relevant authorities product lines. in Germany, the Republic of Korea, Singa- As part of the continuing evolution of pore, and the United States, and Coopera- China’s supervisory structure, the PBC tive Agreements on Insurance Supervision and the CBRC are in the final stages of with Hong Kong and Macau. designing a deposit guarantee scheme for Please refer to the chart of international banking institutions. The scheme will likely coordination activities and organizational be implemented during 2008, and it will participation on page 234. be funded ex ante through fees paid to the CBRC. Current Issues China’s financial markets continue to evolve at a rapid pace. Supervisors and regulators understand the need to con-

63 The Institutional Approach

Acronyms and Abbreviations

CBRC China Banking Regulatory Commission CIRC China Insurance Regulatory Commission CSRC China Securities Regulatory Commission MOF Ministry of Finance MoUs Memoranda of Understanding NDRC National Development and Reform Commission NPC National People’s Congress PBC People’s Bank of China RMB Renminbi SAC Securities Association of China SAFE State Administration of Foreign Exchange

64 hong kong The Institutional Approach

Market Description Background Hong Kong1 is a major international finan- The financial regulatory system in Hong cial center, composed of an integrated Kong is best described as having an insti- network of institutions and markets that tutional approach with some functional provide a wide range of products and characteristics. The principal regulators in services to local and international custom- Hong Kong are the Hong Kong Monetary ers and investors. In 2006, financing, Authority (HKMA), the Securities and insurance, real estate, and business services Futures Commission (SFC), the Office of constituted 25 percent of gross domestic the Commissioner of Insurance (OCI), product (financing and insurance, 16 per- and the Mandatory Provident Fund cent; real estate, 4 percent; and business Schemes Authority (MPFA). These entities services, 5 percent).2 are responsible for regulation in their At the end of February 2008, there were respective industries of banking, securities 200 authorized institutions: 142 licensed and futures, insurance, and retirement banks, 29 restricted license banks, and 29 schemes. deposit-taking companies.3 Of these, 66 The current supervisory institutions are percent were owned by foreign investors. relatively new, resulting from the reform A total of 68 of the largest 100 banks in the of previous institutions, as in the case of world, from 38 countries, have an opera- banking, securities, and pensions, or the tion in Hong Kong. In addition, there are recognition of new needs, as in the case of 80 local representative offices of overseas the insurance sector. banks in Hong Kong.4 In the case of banking supervision, it was In 2007, there were more than 1,4005 decided, in 1992, in preparation for Hong licensed corporations in the securities and Kong becoming a Special Administrative asset management industry and 1786 autho- Region of the People’s Republic of China, rized insurers in Hong Kong, 91 of which to give statutory recognition to certain were incorporated in overseas countries. monetary policy objectives, including the At the end of February 2008, there were 40 maintenance of the general stability of the Mandatory Provident Fund (MPF) schemes monetary and financial systems of Hong and 337 Approved Constituent Funds,7 Kong, with a view to maintaining Hong both of which are the retirement schemes Kong as an international financial center. in Hong Kong.

1 On July 1, 1997, Hong Kong became a Special Administrative Region of the People’s Republic of China (HKSAR). In this profile, HKSAR refers to Hong Kong. 2 Hong Kong Census and Statistics Department, at www.censtatd.gov.hk. 3 Licensed banks are the only institutions permitted to conduct banking business in Hong Kong. Restricted license banks may take time, call or notice deposits from members of the public in amounts of HK$500,000 and above without restriction on maturity. Deposit-taking companies are restricted to taking deposits of HK$100,000 or more with an original term to maturity of at least three months. 4 www.info.gov.hk/hkma/eng/statistics/msb/index.htm. 5 www.sfc.hk/sfc/doc/EN/research/stat/c01.doc. 6 www.oci.gov.hk/download/poi.pdf. 7 www.mpfa.org.hk/english/quicklinks/quicklinks_sta/quicklinks_sta_sh.html.

66 Profile: hong kong

This was achieved by amending, in 1992, In 1987, further deficiencies in the the Exchange Fund Ordinance,8 to enable the regulatory structure became apparent with Exchange Fund to be used by the Financial the October stock market crash, which Secretary to maintain the stability and resulted in a four-day closure of both the integrity of Hong Kong’s monetary and Hong Kong stock exchange and the stock financial systems. At that time, banking index futures markets. In the aftermath supervision was conducted by the Office of the crash, a committee was created to of the Commissioner of Banking. To assist examine Hong Kong’s regulatory structure the Financial Secretary in achieving the and regime. In its report, the committee statutory monetary policy objectives, it was concluded that the Office of the Commis- decided to give the Financial Secretary sioner for Securities and Commodities the power to appoint a person to be the Trading had insufficient resources to Monetary Authority and to merge the properly regulate the rapidly growing Office of the Commissioner of Banking and changing Hong Kong securities and with the Office of the Exchange Fund to futures market. It recommended replacing create the Hong Kong Monetary Authority the existing structure with a single statutory (HKMA) (with the Monetary Authority as body outside the civil service, headed and its chief executive). The HKMA might be staffed by full-time professional regulators described as a de facto central bank in that and funded primarily by the market. In it has the policy objectives of maintaining 1989, the SFC was created. currency stability within the framework of In the early 1990s, the Office of the the linked exchange rate system, managing Commissioner of Insurance (OCI) was the Exchange Fund, promoting the stabil- established within the government to ity and safety of the banking system, and oversee the administration of the Insurance maintaining and developing Hong Kong’s Companies Ordinance (ICO), governing the financial infrastructure. operation of insurance companies and Current securities supervision in Hong insurance intermediaries in Hong Kong. Kong was a reaction to the stock market At present, the insurance sector remains crash of 1987, and to earlier shocks during regulated by the government. 1973–74. A review of the 1987 crash led The MPF Scheme, the mandatory, directly to the creation of the Securities privately managed, and fully funded and Futures Commission (SFC) in 1989. contributions scheme for retirement Until the mid-1970s, stock and commod- protection, was launched in 2000. ity markets in Hong Kong were largely Before that time, retirement schemes unregulated. After the stock market crash established voluntarily by employers for of 1973–74, the government intervened, their employees were regulated under the and the core legislation governing the Occupational Retirement Schemes Ordinance securities and futures industry, the Securi- (ORSO).9 Employers are now required to ties Ordinance and the Protection of Investors enroll employees in MPF schemes. Ordinance, were enacted in 1974.

8 This ordinance deals with the control, use, and management of the Exchange Fund, a discrete government fund, which includes Hong Kong’s foreign reserves. 9 ORSO schemes covered approximately 30 percent of the workforce, primarily employees working for larger companies. Faced with an aging population, the Hong Kong government decided to implement a Mandatory Provident Fund, which mandated compulsory coverage of all workers.

67 The Institutional Approach

Statutory Framework update previous ordinances, resulted in the The powers, functions, and responsibilities enactment of the Securities and Future Ordi- of the Monetary Authority are enumerated nance in 2003. The ordinance consolidated in the Exchange Fund Ordinance, the Banking and modernized 10 existing ordinances Ordinance, the Deposit Protection Scheme Ordi- into a single law governing the securities nance, the Clearing and Settlement Systems Ordi- and futures markets. Various rules and nance, and other ordinances. The division of requirements were amended, including the functions and responsibilities in monetary introduction of a new licensing regime and and financial affairs between the Financial new provisions on misconduct, standards, Secretary and the Monetary Authority is and authorization of investment products enumerated in an Exchange of Letters offered to the public; rules on investment dated June 2003. This Exchange of Letters offering and price stabilization; and disclo- describes the delegations of authority made sure of interests. by the Financial Secretary to the Monetary The Insurance Companies Ordinance, Authority under these ordinances.10 enacted in 1983, prescribes the regulatory The Banking Ordinance, which was framework for insurers and insurance enacted in 1986 (and which has since been intermediaries. Any company wishing to regularly amended and updated), provides carry on insurance business in or from the legal framework for banking supervi- Hong Kong must obtain authorization sion in Hong Kong. Hong Kong maintains from the Insurance Authority (IA). a three-tier system of deposit-taking institu- The Occupational Retirement Schemes tions—licensed banks, restricted license Ordinance (ORSO), enacted in 1993, is the banks, and deposit-taking companies. They governing legislation for the regulation of are collectively known as authorized institu- voluntary occupational retirement schemes tions (AIs).11 operating in or from Hong Kong. The Exchange Fund Ordinance, originally In 1995, Hong Kong enacted the Man- enacted as the Currency Ordinance of 1935, datory Provident Fund Schemes Ordinance, established the Exchange Fund under which provided the framework for the the control of the Financial Secretary. establishment of the privately managed, The Monetary Authority, under delegated Mandatory Provident Fund (MPF) system. authority from the Financial Secretary, has The ordinance, amended in 1998 and responsibility for the use of the fund. supplemented by subsidiary regulations The Deposit Protection Scheme Ordinance enacted in 1998 and 1999, enumerated the of 2004 provided for the establishment of detailed rules governing the operation of a Deposit Protection Scheme (DPS). The the MPF system, including the coverage, HKMA assists the Hong Kong Deposit types of schemes, contributions, compensa- Protection Board (the Board) in operating tion claims, and exemption of members the DPS. covered by certain occupational retirement The reform of the securities industry, schemes.12 The MPF system began opera- driven by the need to streamline and tion in 2000.

10 HKMA Annual Report 2007, www.info.gov.hk/hkma/eng/public/ar07/pdf/04_about_hkma.pdf. 11 www.info.gov.hk/hkma/eng/bank/index.htm. 12 www.mpfa.org.hk/english/leg_reg/leg_reg_leg/leg_reg_leg.html.

68 Profile: hong kong

Nonstatutory Elements Financial Secretary of Hong Kong The Hong Kong Association of Banks, The Financial Secretary, appointed by the which was created by the Hong Kong Chief Executive of Hong Kong, oversees Association of Banks Ordinance, in 1981, pro- policy formulation and implementation of vides a framework for the government to financial, monetary, and economic policies. exchange views with the banking sector for All four regulatory authorities—the the further development of the industry. HKMA, MPFA, OCI, and SFC—are subject The Hong Kong Securities Institute to the supervision of the Financial Secre- was formed in 1997 as a professional body tary of the HKSAR Government in terms to raise the standards of securities and of achieving the policy objectives set by the finance practitioners in Hong Kong. Financial Secretary, appointment of the The Hong Kong Investment Funds Asso- chief executives and independent advisory ciation, established in 1986, represents the committees, business and budget plan fund management industry of Hong Kong, approval, financial reporting and auditing, and aims at fostering the development of and coordination of resources. the industry in Hong Kong, while main- In addition, the Financial Secretary taining Hong Kong’s competitiveness as chairs and participates in the principal a major fund management center in Asia coordinating committees dealing with and enhancing the professional standards financial stability. of the industry. The Hong Kong Federation of Insurers Hong Kong Monetary Authority (HKMA) (HKFI), a self-regulatory body of insurers, The HKMA acts as the central bank of was established in 1988 to advance and Hong Kong, with responsibility for main- promote the development of the insurance taining currency and financial stability. The business in Hong Kong. The Insurance HKMA has four main functions: maintain- Agents Registration Board was established ing the stability of the Hong Kong dollar, under the HKFI for the registration of promoting the safety of Hong Kong’s agents and for dealing with complaints banking system (through the regulation about agent malpractice. The Insurance of banking and deposit-taking businesses Claims Complaints Bureau was established and the supervision of authorized institu- in 1990 to provide a speedy and inexpen- tions), managing Hong Kong’s official sive avenue for resolving claims disputes reserves, and maintaining and developing arising from personal insurance. Hong Kong’s financial infrastructure.13 The HKMA maintains currency stability Institutional Structure and promotes the efficiency, integrity, and of the Regulators development of the financial system, which Hong Kong’s financial regulatory system is generally consistent with the roles under- can be characterized as an institutional taken by central banks around the world. system with functional characteristics, in The supervisory approach of the HKMA which the following individuals and entities is based on a policy of continuous supervi- have a role. sion through on-site examinations, off-site

13 HKMA Annual Report 2007, www.info.gov.hk/hkma/eng/public/ar07/pdf/04_about_hkma.pdf.

69 The Institutional Approach

reviews, prudential meetings, cooperation The Exchange Fund derives most of its with external auditors, and sharing infor- income from its investment activities, mation with other supervisors. although revenue also accrues from license The HKMA may, under delegated fees paid by AIs, rental payments from authority from the Financial Secretary, use tenants, and custodian and transaction fees the Exchange Fund to affect the exchange from users of the HKMA’s Central Money- value of Hong Kong’s currency, and markets Unit. The HKMA is accountable actively manages the fund’s assets. These to the Financial Secretary. The HKMA’s are held mainly in the form of marketable, annual budgets and strategic plans are interest-bearing instruments, and equities approved by the Financial Secretary on the in certain foreign currencies. advice of EFAC, and certain of the HKMA’s The HKMA has a high degree of auton- powers are exercisable only after consulta- omy in its pursuit of stated policy objectives tion with the Financial Secretary. determined by the government. The HKMA carries out the day-to-day Securities and Futures Commission (SFC) administration of the Deposit Protection The SFC is an autonomous statutory body Scheme (DPS) on behalf of an inde- responsible for administering the laws gov- pendent Deposit Protection Board (the erning the securities and futures markets Board), whose functions are confined to in Hong Kong and facilitating and encour- the assessment and collection of contribu- aging the development of these markets. tions, investment of funds, and paying Within the regulatory framework, the SFC compensation to depositors in the event of also has regulatory oversight of Hong Kong a bank failure. The HKMA implements the Exchanges and Clearing Limited (HKEx) decisions of the Board. and its subsidiaries, namely the Stock The Chief Executive of the HKMA is Exchange of Hong Kong, the Hong Kong appointed by the Financial Secretary, who Futures Exchange, and three recognized is advised by the Exchange Fund Advisory clearinghouses. The SFC works closely with Committee (EFAC) on matters relating to HKEx in listing regulations and supervision the control of the Exchange Fund and on of the listed companies. the operation of the HKMA. The Financial The constitution and proceedings of the Secretary is the ex officio Chairman of 14-member SFC Board are defined by the EFAC, and the other members of EFAC are Securities and Futures Ordinance. All mem- appointed by the HKSAR Chief Executive. bers of the Board are appointed by the Chaired by the Financial Secretary, the Bank- HKSAR Chief Executive for a fixed term.14 ing Advisory Committee and the Deposit- All important policies and decisions are taking Companies Advisory Committee approved by the SFC Board. established by the Banking Ordinance advise The SFC generates income from fees on matters relating to that ordinance, in par- raised from regulated entities, and from ticular those relating to the business activities interest, dividend, and investment income of authorized institutions. from various financial instruments. It is The operating and staff costs of the subject to budgeting, plan approval, and HKMA are charged to the Exchange Fund. monitoring by the Financial Secretary.

14 www.sfc.hk/sfc/html/EN/aboutsfc/corporate/governance/governance.html.

70 Profile: hong kong

Figure 2. The Financial Services System Regulatory Structure, Hong Kong

Financial Secretary of Hong Kong

Hong Kong Securities and Futures Office of the Commissioner Mandatory Provident Fund Monetary Authority (HKMA) Commission (SFC) of Insurance (OCI) Schemes Authority (MPFA)

BANKING SECURITIES INSURANCE RETIREMENT SCHEME

Deposit Protection Scheme (DPS)

Note: Dotted lines indicate a cooperative relationship.

Office of the Commissioner of Insurance OCI is within the government structure, it The Insurance Authority (IA) is respon- receives public funds through the annual sible for regulation and supervision of government budget. It is subject to budget- the insurance industry in Hong Kong. ing, plan approval, and monitoring by the The Office of the Commissioner of Insur- Financial Secretary. ance (OCI) operates under the Financial Services and the Treasury Bureau of the Mandatory Provident Fund . Hong Kong Special Administrative Region Schemes Authority (MPFA) Government.15 The principal functions of The structure of the MPFA consists of a the IA are to ensure that the interests of Management Board, which oversees vari- policyholders or potential policyholders ous aspects of the MPF System and which are protected, and to promote the general is advised by two statutory committees, the stability of the insurance industry, that is, MPF Schemes Advisory Committee, and authorization of insurers, regulation of the MPF Industry Schemes Committee. insurers and insurance intermediaries, and The Management Board is the governing liaison with the insurance industry. body of the MPFA. There are at least 10 Similar to other regulatory authorities, directors appointed by the Chief Executive the OCI received government funding of the HKSAR. upon its initial establishment. Since the

15 There are two branches under the Treasury Bureau. The policy responsibility of the Financial Services Branch is to maintain and enhance Hong Kong’s status as a major international financial center, ensuring, through the provision of an appropriate economic and legal environment, that Hong Kong’s markets remain open, fair, and efficient. While market regulatory functions are performed by independent statutory regulators, the Financial Services Branch facilitates and coordinates initiatives to upgrade overall market quality and to ensure that Hong Kong’s regulatory regime meets the needs of modern commerce.

71 The Institutional Approach

The MPFA generates income from fees Exchange Fund can also be used to prevent raised from regulated entities, and from problems of individual AIs from worsening interest, dividend, and investment income and spreading to other parts of the bank- from various financial instruments. It is sub- ing system, if there is a danger of systemic ject to budgeting, plan approval, and moni- crisis, contagion, or other problems or toring by the Financial Secretary. The MPFA potential problems. is required to submit a draft corporate plan The Banking Ordinance mandates no spe- and a budget of estimated expenditures to cific statutory responsibility for the HKMA the Financial Secretary for approval before with respect to consumer protection. Its the start of each financial year. It is also main responsibility under that ordinance required to deliver an annual report. is to ensure that AIs are financially sound Figure 2 provides a graphic depiction and prudently managed. However, of the relationship among the above-men- the HKMA does require AIs to handle tioned institutions. customer complaints properly and, if a customer complaint against an AI raises an Enforcement issue of supervisory concern in the context The HKMA closely supervises authorized of the sound and prudential management institutions (AIs) to ensure their compli- of AIs, the HKMA will follow up on that ance with the Banking Ordinance and to complaint. The HKMA cannot, however, promote proper standards of conduct and intervene in an AI’s commercial decisions, sound and prudent business practices. In arbitrate disputes between AIs and their the case of misconduct, the HKMA has customers, or order AIs to pay compensa- various supervisory powers, including, tion to their customers. in extreme cases, revocation of an AI’s The SFC closely monitors the activi- license. The Banking Ordinance creates a ties of the market and intermediaries to variety of criminal offenses for failure to combat misconduct that jeopardizes the comply with its provisions and, in serious interests of investors. It can take regulatory cases of noncompliance, the HKMA can actions, including disciplinary or legal recommend that the Department of Justice proceedings against the parties concerned. prosecute an AI’s directors, chief executive, For misconduct, manipulation, or similar or managers, as appropriate. If a bank actions in the market, the SFC monitors supervised by the HKMA is facing difficul- the daily trading, reviews the market, inves- ties, the HKMA can assist in a number of tigates fraud and unlawfulness, and revokes ways. It can give directions (for example, licenses. It may ultimately proceed to court to stop taking large deposits), appoint an with prosecution. adviser to the AI, or appoint a manager of The OCI seeks to ensure that com- the AI (in which event the Board of the plaints are handled properly by the insurer AI will automatically be removed). The or self-regulatory body. However, the OCI HKMA, under delegated authority from has no statutory power to intervene in com- the Financial Secretary, acts as the lender mercial disputes among insurers, insurance of last resort (LOLR) and, under its pub- intermediaries, and policyholders. The licly available LOLR policy, can lend if the OCI, nevertheless, maintains a monitor- preconditions for LOLR support are met ing role to ensure that the complaints are against specified types of collateral. The properly handled in accordance with the

72 Profile: hong kong

rules and regulations of the self-regulatory tance to ensure the fairness and efficiency framework established under the ICO. of the markets. In addition, they have The overriding objective of enforcement signed MoUs or formulated other forms by the MPFA is the protection of employ- of cooperation with other Hong Kong ees’ rights and benefits, and upholding institutions on specific issues. For example, the integrity and credibility of the MPF the HKMA administers the deposit pro- system.16 To achieve this objective, the tection scheme on behalf of the Hong MPFA may apply a number of enforcement Kong Deposit Protection Board, and the measures against noncompliant employers. SFC has signed an MoU with Hong Kong Exchanges and Clearing Limited, regard- Framework for Domestic Coordination ing the listing and surveillance of the stock There are two high-level coordination and futures market. committees in Hong Kong. The first is the Financial Stability Committee, which International Coordination monitors banking, securities, and deriva- The dynamics unleashed by financial tives markets for financial stability, and services convergence, globalization, and deals with issues and developments with growth of financial conglomerates continue cross-market and systemic implications. It to drive financial supervisors and regula- is chaired by the Secretary for Financial tors to seek mechanisms to cooperate and Services and the Treasury, and includes coordinate worldwide. Hong Kong’s regula- representatives from the HKMA, OCI, tory authorities are actively strengthening and SFC. The Committee meets monthly. coordination and cooperation with overseas The second is the Council of Financial authorities and institutions, in the areas of Regulators, which provides a forum for cross-border and cross-sector supervisory discussion of medium- and longer-term cooperation, exchange of information, structural issues. Its terms of reference and investigatory assistance. Hong Kong include facilitation of coordination and maintains a close working relationship with cooperation among regulators, enhance- its counterparts in China. For example, ment of information sharing, minimization the HKMA entered into an MoU with the of duplication or gaps in regulation or China Banking Regulatory Commission in supervision, and review of international 2003 when the Commission was first estab- developments in financial sector regula- lished, and the HKMA also cooperates with tors. It is chaired by the Financial Secretary the People’s Bank of China (PBC) on vari- and includes representatives from the ous matters. Meetings are held regularly at HKMA, MPFA, OCI, SFC, and the Financial both the management and working levels, Services and Treasury Bureau. The Council with exchange of opinions and cooperation meets quarterly. on a wide range of subjects such as banking The four supervisory agencies have supervision, monetary and financial issues, signed a series of Memoranda of Under- market development initiatives, and staff standing (MoUs) to further enhance training. cooperation on regulation, supervision, Hong Kong has adopted many interna- exchange of information, and mutual assis- tional regulation principles and standards.

16 www.mpfa.org.hk/english/enforc/enforc.html.

73 The Institutional Approach

It is a member of the Bank for Interna- Current Issues tional Settlements, a participant in the The development of China’s economy Basel Committee on Banking Supervision’s and financial markets has stimulated the Policy Development Group, the Interna- interaction and cooperation between tional Liaison Group, the Working Group China and Hong Kong. However, the Hong on Liquidity, and the Working Group on Kong financial institutions that want to do Definition of Capital, and is a member of business in China need to understand the the Executives’ Meeting of East Asia and regulatory and legal environment there, Pacific Central Banks. which is changing very rapidly and differs Hong Kong agencies have bilateral from that in Hong Kong. agreements with supervisors in Singapore, Such developments affect the regulators Thailand, and other jurisdictions. The differently, given their different focuses. agreements are primarily nonbinding and As the regulator of the banking industry based on mutual cooperation. Hong Kong and the guardian of the monetary system supervisors also participate in “colleges of in Hong Kong, the HKMA tries to balance supervisors,” providing another layer of financial innovation and financial stability. cooperation and coordination. On the other hand, the SFC emphasizes Please refer to the chart of international best practices and development of corpo- coordination activities and organizational rate governance. Furthermore, the OCI participation on page 234. and MPFA are more cautious about protecting the interests of the public investors.

Acronyms and Abbreviations

AIs Authorized institutions DPS Deposit Protection Scheme EFAC Exchange Fund Advisory Committee HKEx Hong Kong Exchanges and Clearing Limited HKFI Hong Kong Federation of Insurers HKMA Hong Kong Monetary Authority HKSAR Special Administrative Region of the People’s Republic of China (Hong Kong) IA Insurance Authority ICO Insurance Companies Ordinance LOLR Lender of last resort MoUs Memoranda of Understanding MPF Mandatory Provident Fund MPFA Mandatory Provident Fund Schemes Authority OCI Office of the Commissioner of Insurance ORSO Occupational Retirement Schemes Ordinance PBC People’s Bank of China SFC Securities and Futures Commission

74 Mexico The Institutional Approach

Market Description banks) aimed at satisfying the needs of The total assets of Mexico’s financial more specific types of consumers, as system are approximately 67 percent of opposed to most current financial institu- gross domestic product (GDP). Commer- tions, which operate under a universally cial banks account for approximately 55 oriented banking system. percent of these assets, followed by pension In 1982, commercial banks were nation- funds, with 13 percent. alized after a major financial crisis, the Mexico’s banking sector (42 com- result of falling oil prices, rising interest mercial banks) is highly concentrated, rates, a high fiscal deficit, and a general- with the seven largest banks accounting ized external debt bailout. for approximately 84 percent of all bank During that decade, banks were subject assets. Foreign financial institutions own to deposit and lending rate controls, and approximately 82 percent of total bank high reserve requirements prevailed. High assets, including the five largest banks. The fiscal deficits and difficulties in accessing majority of financial institutions belong foreign financing forced banks to limit to a financial group, which is formed by their business mostly to public sector lend- a financial holding company controlling ing. As a result, credit to the private sector at least two of the following institutions: a decreased during most of the 1980s. The commercial bank, a brokerage house, an nationalization of banks and a high absorp- insurance company, or other credit auxil- tion of savings by the public sector, had iary institutions.1 important implications for the financial In addition, there are 18 pension fund system and credit risk management poli- operators, 83 mutual fund management cies. Government supervisory expertise companies, 6 government-owned develop- was undermined since bank liabilities were ment banks,2 94 insurance companies, 10 perceived as a direct government debt. bond companies, 32 brokerage houses, 39 Thus, incentives to monitor bank perfor- regulated non-bank banks, and 224 credit mance eroded. Supervisory and regulatory auxiliary organizations. functions were oriented toward satisfying a series of accountancy criteria, rather than a Background risk management approach. The current Mexican financial regulatory In the late 1980s, the government structure can be described as an institu- embarked on an ambitious financial liber- tional system, and has evolved in response alization and comprehensive deregulation to a series of financial and economic crises. process. Both borrowing and lending rates Prior to the creation of the “multiple were deregulated, reserve requirements bank” entities in the mid-1970s, there were eliminated, and the direct (politically- were different types of specialized banks oriented rather than financially-viable) (for example, savings banks and mortgage credit allocation directives were abolished.

1 Examples of credit auxiliary institutions include financial leasing companies, factoring companies, warehouses, money exchange houses, and credit unions. 2 Development banks are established for special purposes, such as financing of foreign trade, housing, or agriculture.

76 Profile: mexico

In addition, in the early 1990s, the govern- During the years that followed the 1994 ment sold the former commercial banks banking crisis, a series of legal reforms back to the private sector. were implemented, including the strength- The financial liberalization, the signing ening of bank capitalization rules in of the North American Free Trade Agree- accordance with Basel I, and the removal ment (NAFTA) in the early 1990s, and of all of the remaining limits on foreign a favorable macroeconomic framework, shareholding in banks. Deposit insurance partly sustained by a quasi-fixed exchange limits on the protection of bank savings rate policy, induced a large volume of were introduced, and financial regulation predominantly short-term capital inflows and supervision was revamped to allow for into the Mexican economy. As a result, a comprehensive risk-oriented approach. bank foreign currency liabilities increased Other measures included the operation of rapidly, and the current account deficit credit bureaus; new regulations for disclo- reached 7 percent of GDP. sure and transparency of financial informa- The combination of financial deregu- tion; the implementation of prompt cor- lation, unprecedented availability of rective actions and an early-warning system; resources for lending to the private sector, a banking resolution regime; updated and a weak regulatory and supervisory regulations for credit rating agencies and framework, resulted in mounting problems external auditors; reallocation of powers in the banking system. For example, dur- of the Ministry of Finance and Public ing 1989–94, bank loan portfolios grew at Debt (SHCP) and the National Banking an average annual rate of more than 30 and Securities Commission (CNBV), so percent in real terms, and bank loans to the latter became responsible for the full the private sector increased from 10 per- regulatory cycle of banking and brokerage cent of GDP to almost 40 percent. houses (that is, the licensing, supervision, In early 1994, the leading presidential and license-revoking process); strengthen- candidate was assassinated, an event ing the cooperation with home financial coincidental with the U.S. Federal Reserve authorities for purposes of supervision; Board’s tightening of its monetary policy. and, more recently, the initial implementa- Both actions produced large outflows of tion of Basel II. capital and precipitated the devaluation Bank credit to the private sector began of the peso in December 1994, resulting to recover in 2004, when banks were finally in a large hike in both inflation and inter- able to raise sufficient capital to finish est rates. A deep recession followed, and improving their balance sheets. By 2006, the fall of real disposable income sharply credit to households was growing, in real limited borrowers’ capacity to service their terms, above 40 percent. debts. As a result, many depositors either To promote more competition and withdrew their resources from the Mexi- facilitate the access of more people can financial system or asked for higher to financial services, several new bank borrowing interest rates to compensate licenses were granted to commercial retail for inflation. As a result, some banks lost chains in 2006 and 2007, and new licenses their capital, others required government were granted to other types of financial intervention, and many were merged with institutions, thus increasing the number larger, more capitalized banks. of financial competitors, products, and

77 The Institutional Approach

services available in the financial market. The Auxiliary Credit Organizations Law Also, other financial companies known as (1985) regulates foreign exchange firms, non-bank banks (leasing, factoring, and credit unions, and other financial compa- non-bank banks) that provide credit but do nies that provide credit and belong to not receive deposits from the public were a bank. deregulated.3 The Law of Banking Savings Protection (1998) established the Institute for the Statutory Framework Protection of Banking Savings (IPAB), a The Bank of Mexico Law (1993) states that federal deposit insurance scheme. the Bank is autonomous, its purpose being The Securities Market Law (2005) regu- to maintain the currency’s purchasing lates the activities and operations of enti- power, and to promote the sound devel- ties participating in the securities market, opment of the financial system and the promoting the sound development of the integrity of the payment system. The Bank sector and consumer protection. of Mexico is also a lender of last resort. The Mutual Funds Law (2001) regulates The National Banking and Securities Com- the operations of mutual funds. mission Law (1995) established the National The Insurance Companies Law (1935) Banking and Securities Commission as a regulates the organization and functioning specialized agency (organo desconcentrado, of insurance companies. thus granted technical and operational The Financial Services and Transparency autonomy) of the Ministry of Finance and Law (first passed in 2004, and revised in Public Debt. It is charged with prudential 2007) empowers financial authorities to supervision and regulatory responsibilities regulate specific issues concerning banking over financial intermediaries (with the services and consumer protection, such as exception of insurance companies, bond contracts, bank statements, receipts, adver- companies, and pension funds), in order tising, disclosure of annual percentage to ensure their stable functioning and the rates, interest rates, and bank fees. sound development of the financial system. The Protection and Defense for Financial The Payment System Law (2002) regulates Services Users’ Law (1999) regulates financial payment systems that are regarded as services consumer rights. It established systemically important. This law recently the National Commission for the Protec- granted additional powers to the Bank tion and Defense of the Financial Services of Mexico to regulate and supervise pay- Users, which acts as a mediator between ment systems. financial institutions and the general The Credit Institutions Law (1990) regu- public. lates commercial and development banks, The Retirement Funds System Law (1996) including the banking resolutions regime. regulates (mandatory) pension funds. It The Financial Groups Law (1990) regu- also established the National Commission lates the organization of financial interme- for Retirement Savings. diaries within a financial group.

3 Two typical schemes operate for non-bank banks. In the first one, provided that they do not belong to a holding financial institution, they are not regulated by the National Banking and Securities Commission. However, when these financial companies actually belong to a banking group, they remain under the supervisory and regulatory scope of the above-mentioned financial sector authority.

78 Profile: mexico

Nonstatutory Elements Commission and the National Securities No nonstatutory elements have been noted. Commission. Its main responsibilities are the issuance of prudential regulation and Institutional Structure the supervision of all financial interme- of the Regulators diaries (with the exception of insurance The current Mexican financial regulatory companies, bond companies, and pension structure can be described as an institu- funds). The CNBV’s President is appointed tional system. Seven entities are in charge by the Secretary of Finance. The National of regulating and supervising the financial Banking and Securities Commission Law system, as explained below. grants technical and operational autonomy to the CNBV, so it can perform its duties Ministry of Finance and Public Debt (SHCP) with minimal external interference from The SHCP is responsible for the design of other authorities. the overall financial sector, including its legal framework, and for the coordination National Insurance and Bond . of the different supervisory commissions. Companies Commission (CNSF) In this respect, the ministry retains consid- The CNSF was established in 1989 and is erable influence over financial supervision the prudential regulator and supervisor because the CNBV, CNSF, and CONSAR for insurance and bond companies. The are specialized agencies of the SHCP. The President of the Board of Governors of Secretary of Finance of the SHCP appoints the CNSF is appointed by the Secretary the presidents of the CNBV, CNSF, CON- of Finance. DUSEF, and CONSAR. National Commission for the Retirement Bank of Mexico Savings System (CONSAR) The Bank of Mexico is Mexico’s central CONSAR was established in 1994 and is bank. Created in 1925, it became autono- the prudential regulator and supervisor mous in 1994. It is headed by a board for pension fund managers. The President composed of a Governor and four Deputy of the Board of Governors of CONSAR is Governors. Board members serve staggered appointed by the Secretary of Finance. eight-year terms (six for the Governor). The Governor and Deputy Governors are National Commission for the . appointed by the President and ratified Protection and Defense of Financial . by the Senate. The Bank of Mexico has its Services Users (CONDUSEF) own revenue (seigniorage), and its budget CONDUSEF was established in 1999 and is is not submitted to the Congress for responsible for consumer protection. The approval. However, it must submit annual President of the Board of Governors of reports to the Congress. It is also the CONDUSEF is appointed by the Secretary lender of last resort. of Finance. To ensure a proper functioning and National Banking and Securities . coordination of duties among the above- Commission (CNBV) mentioned authorities, each Commission’s The CNBV was formed in 1995 as a result Board of Governors is composed of (top) of a merger of the National Banking officials from the Ministry of Finance

79 The Institutional Approach

and Public Debt and the Bank of Mexico, coverage of 1,615,134 pesos (US$158,731) with the participation of representatives per legal person and per bank. of the other Commissions. However, the The Executive Secretary of IPAB and CONDUSEF and the CONSAR boards also the President of each Commission are include members from (trade) unions and appointed by the Minister of Finance. chambers from the private sector. IPAB’s budget is part of the government’s The CNBV, CNSF, CONDUSEF, and annual budget, which is approved by the CONSAR receive part of their financing Congress. through the government’s annual budget, Figure 3 provides a graphic depiction which is approved by Congress, and three of the relationship among the above-men- commissions (all except CONDUSEF) tioned institutions. charge authorized firms’ fees, the income from which is transferred back to the SHCP. Enforcement The Bank of Mexico has the power to Institute for the Protection . impose fines on financial intermediaries of Banking Savings (IPAB) that do not comply with the central bank’s IPAB was established in 1999 and is in regulations. charge of deposit insurance in Mexico. The CNBV carries out both on-site IPAB’s Board of Governors is composed of inspections and off-site analysis of financial the Minister of Finance, the Governor of entities under its regulatory and supervi- the Bank of Mexico, the CNBV’s President, sory scope. Taking into account the inter- and four nongovernment officials desig- nationalization of the banking system, the nated by the Executive and approved by at CNBV has entered into several Memoranda least two-thirds of the Senate. The board of Agreement with foreign supervisors, to designates an Executive Secretary, who is ensure effective surveillance and enforce- in charge of the administration of the insti- ment cooperation. In addition, there is tute. IPAB’s Deposit Insurance provides a system in place for early warning and

Figure 3. The Financial Services System Regulatory Structure, Mexico

Ministry of Finance Bank of Mexico and Public Debt (SHCP)

Financial Stability Committee (FSC)

Institute for the National Banking National Insurance National Commission National Commission Protection and Securities and Bond Companies for the Retirement for the Protection of Banking Savings Commission Commission Savings System of Financial Services (IPAB) (CNBV) (CNSF) (CONSAR) Users (CONDUSEF)

BANKING INSURANCE PENSIONS CONSUMER PROTECTION

SECURITIES

Note: Dotted lines indicate a cooperative relationship.

80 Profile: mexico

prompt corrective actions that provides topics that are presented for approval to for a series of actions and restrictions to the board of any Commission and the financial institutions operations that do IPAB are usually fully discussed and agreed not comply with minimum capital require- within these committees. ments.4 The CNBV also has the power to If a financial institution that is “too big impose fines and issue regulations. When to fail” faces a possible crisis of liquidity or necessary, other agencies (such as the Bank solvency, bank resolution can be dealt with of Mexico, the IPAB, and the SHCP) are by a Financial Stability Committee (FSC) consulted on developments. that is composed of the principals of the The CNSF carries out on-site inspections Bank of Mexico, the CNBV, the IPAB, and of insurance and bond companies, and can the SHCP. The FSC has yet to be tested via impose sanctions if intermediaries do not an intervention in the case of a systemi- comply with the regulations. cally important financial institution. In the The CONSAR has various enforcement case of a financial institution failure, the powers over pension fund operators. If the SHCP would lead, supported by the Bank CONSAR is concerned about the activities of Mexico, the CNBV, the IPAB, and other of a pension fund provider, it can require agencies. a report from the provider’s board, intervene directly in the fund, or move funds International Cooperation from the firm to another fund or to the Please refer to the chart of international Bank of Mexico for the duration of the coordination activities and organizational investigation. participation on page 234. The IPAB can take enforcement action when required. In conjunction with Current Issues the SHCP and the CNBV, the IPAB can Congress recently approved modifications commence banking resolution, pursue to the Credit Institutions Law aimed at bankruptcy if necessary, liquidate assets, improving the competitiveness of the bank- create a bridge bank, and ultimately pay ing sector and addressing prudential issues guaranteed liabilities. related to banks linked to commercial retail chains. The main changes were as Framework for Domestic Coordination follows: (a) reductions in capital require- All supervisory Commissions and IPAB ments for banks—minimum capital is now boards include representatives of each set in accordance with each bank’s activi- other and of the SHCP and the Bank of ties; (b) restrictions to banks’ operations Mexico. with related commercial retail chains; and In addition to the coordination fostered (c) changes to the regulations of banks’ by the above linkages, representatives operations, with third parties used to chan- from the Bank of Mexico, the SHCP, the nel some bank services. Commissions, and the IPAB share several Authorities are working on additional formal and informal committees where modifications to update the bankruptcy regulations and other financial matters are regime for credit institutions. discussed and coordinated. All important

4 For a list of prompt corrective action steps, see www.ipab.org.mx/english/02proteccion/ 02_04_acciones.htm.

81 The Institutional Approach

Acronyms and Abbreviations

CNBV National Banking and Securities Commission (Comisión Nacional Bancaria y de Valores) CNSF National Insurance and Bond Companies Commission (Comisión Nacional de Seguros y Finanzas) CONDUSEF National Commission for the Protection and Defense of Financial Services Users (Comisión Nacional para la Protección y Defensa de los Usuarios de Servicios Financieros) CONSAR National Commission for the Retirement Savings System (Comisión Nacional del Sistema de Ahorro para el Retiro) FSC Financial Stability Committee GDP Gross domestic product IPAB Institute for the Protection of Banking Savings (Instituto para la Protección al Ahorro Bancario) SHCP Ministry of Finance and Public Debt (Secretaría de Hacienda y Crédito Público)

82 the functional approach

The functional approach is one in which supervisory oversight is determined by the business that is being transacted by the entity, without regard to its legal status. Each type of business may have its own functional regulator.

Brazil · France · Italy · Spain

Brazil The Functional Approach

Market Description bonds have grown rapidly, and this may be Brazil’s banking sector comprises approxi- expected to continue. mately 2,500 firms1 and represents about Approximately 160 companies comprise 6 percent of the country’s gross domestic the insurance, (open) private pension,3 product (insurance services included). and capitalization market. Insurance Banking institutions provide services companies make up the majority (72 per- to the public through branches, post cent), 17 percent are entities exclusively office outlets, electronic banking, and dedicated to offering open private pension correspondents.2 schemes, and 11 percent are dedicated to By 2007, there were about 18,000 capitalization plans. In 2007, total premi- bank branches, a 12 percent increase ums within the insurance sector reached over 1996. Electronic services are grow- approximately R$74 billion, making Brazil ing more rapidly than traditional branch the largest insurance market in Latin banking, due not only to enhancements America, and there were more than 370 in technology, but also to reorganization closed pension funds holding R$260 bil- in response to mergers and acquisitions. lion in assets. Services being provided by correspondents have also been experiencing growth in Background excess of traditional branch banking. In The Brazilian regulatory structure is 2006, approximately 1,450 branches were characterized as functional system with opened, while within the same time period, institutional aspects. The Brazilian finan- 6,800 correspondents were opened. cial supervisory system has developed The securities market is growing rap- gradually, primarily during the second half idly, albeit from a relatively low base. The of the 20th century, and mostly in response volume of primary capital market offers, to various pressures, financial crises, and including stocks, debentures, and promis- changes in the nature of financial services sory notes registered with the Securities over time. In the mid-1960s, following and Exchange Commission (CVM), totaled implementation of the macroeconomic R$48.5 billion in 2005, compared to stabilization plan, called the Government R$16.3 billion in 2004. The 197 percent Plan for Economic Action, a need for growth was driven primarily by debenture restructuring the financial system was rec- issues. The easing of monetary policy ognized. This led to passage of the National reinforced investor expectations about the Financial System Law (Law 4.595/64), which economy. Since then, the volume and total is still the principal legislation underpin- value of private issues of stocks and private ning the Brazilian financial markets. The

1 These firms include holding companies and savings, commercial, development, and investment banks (Uni- cad [Information System for Entities of Interest to the Central Bank], September 2007). 2 A correspondent is a bank that accepts deposits of, and performs services for, another bank. In most cases, the two banks are in different cities, but they can also be in different countries. 3 There are two types of pension funds in Brazil: closed (entidades fechadas) and open (abertas). Closed funds are occupational pension plans, organized as pension funds, sponsored by corporations and, until recently, only for organizations with more than 100 employees. They are nonprofit organizations. The open funds can be either for-profit or nonprofit organizations, although the majority are for-profit organizations run by commercial banks and insurance companies. The closed funds are regulated by the Complementary Pension Secretariat (SPC) and the open funds by the Superintendence of Private Insurance (SUSEP).

86 Profile: brazil

act established the National Monetary lishment of the Securities and Exchange Council (CMN), through which all major Commission (CVM). monetary and financial resolutions are By the 1980s, Brazil was experiencing issued, and which includes the Minister of rapid inflation and a prolonged economic Finance, the Minister of Planning, and the crisis, leading to a drastic fall in demand Governor of the Central Bank. for bank loans, increases in liquidity, and The National Financial System Law also significant decreases in credit volume. created the Brazilian Central Bank (BCB). However, financial institutions succeeded The BCB is an independent federal insti- in maintaining relatively high profits due tution that took over the functions of a to income from non-interest-bearing monetary authority. These functions were deposits. While bank assets became increas- previously performed by the Currency and ingly concentrated in highly liquid govern- Credit Superintendence (SUMOC),4 the ment securities, the government abolished Bank of Brazil (BB),5 and the National the charter requirement for setting up new Treasury.6 Although some improvement was institutions and authorized the incorpora- achieved through the creation of a formal tion of multipurpose banks, which led to Central Bank, the institutional process was an increase in the number of banks. not complete because the BCB was not Then, in 1985, the government further given the full authority and responsibilities reorganized the financial supervisory struc- of a central bank. The BCB became the ture. The main change was the removal currency-issuing bank, but acted according of the financial linkages and overlapping to the needs of the BB. The BCB was the functions among the BCB, the BB, and the bank of banks but was not the only holder National Treasury. In 1987, the automatic of deposits from financial institutions, since transfer of funds from the BCB to the BB many institutions placed their voluntary was eliminated, which had hampered the reserves in the BB. Nonetheless, the BCB BCB’s management. Through 1988, full was the government’s financial agent in monetary authority was progressively charge of managing the federal public transferred from the BB to the BCB, while debt. It was not the cashier to the National atypical activities carried out by the BCB Treasury since this was also a function of (such as those related to economic incen- the BB. tives and administration of public debt) In the 1960s and 1970s, Law 6385/76 were transferred to the National Treasury. mandated reforms aimed at fostering the The 1988 Constitution continued the emergence of a capital market and enhanc- clarification of the BCB’s role, explicitly ing supervision through the 1976 estab- assigning to it the responsibility of issuing

4 The SUMOC, created in 1945, was responsible for monetary control, and it laid the foundation for a central bank. Decisions related to reserve requirement ratios for commercial banks, discount rates (linked to development funds) and financial assistance for liquidity, and the interest rate on bank demand deposits were established by the SUMOC. It was also the commercial bank’s supervisor and the agency responsible for managing the exchange policy. 5 The BB had an important role as a government bank, controlling foreign trade and foreign exchange operations, executing foreign exchange operations on behalf of public sector enterprises and the National Treasury, and collecting reserve requirements and voluntary deposits of commercial banks. 6 The National Treasury was the currency-issuing authority, part of a complex issuance process that involved several other governmental entities.

87 The Functional Approach

currency and specifying that its board, As for insurance, Brazil’s government which is appointed by the President, has regulated all insurance and reinsur- requires Senate approval. The 1988 ance operations since 1966. It created Constitution forbade direct or indirect the National System of Private Insurance, granting of loans to the National Treasury which was formed by the National Private and called for a Complementary Law of the Insurance Council (CNSP), the Private National Financial System to replace the Insurance Superintendence (SUSEP), Bra- National Financial Systems Law of 1964. zil RE, companies that operate in private Brazil experienced further economic insurance, and qualified brokers. In 1967, strains in the early 1990s. In July 1994, the National System of Capitalization was inflation rates reached almost 46 per- created. In 2003, SUSEP began a modern- cent per month, and the Real Plan was ization process based on the International enacted to cut inflation. A systemic crisis Association of Insurance Supervisors Core was imminent; seven small banks filed Principles. for bankruptcy. In 1995, after 13 other In 2007, Complementary Law 126 bankruptcies, the BCB intervened at the eliminated the previous state monopoly Banco Economico (a large Brazilian bank) on reinsurance. CNSP became the regula- to avoid a bank run. To address this crisis, tor for co-insurance, reinsurance, and in late 1995, the government announced retrocession7 transactions, with regulatory a strategy that included a commitment supervision provided by SUSEP. Brazil RE to bear the costs of losses instead of the would continue to operate as a local rein- banks’ creditors in order to encourage surer only. mergers and acquisitions of the banks fac- Closed pension funds have been regu- ing difficulties. lated since 1977, when these funds were In response to the bank failures, a designated as depository institutions. The further, more fundamental restructur- law was updated in 1998 and 2001 with ing of the banking system safety net was general rules to define the relationship implemented. Prudential regulations were between the government bodies and their enacted and supervision was strength- respective pension entities. ened to ensure safety and soundness of the financial system. In addition, other Statutory Framework changes were instituted, including a The National Financial System Law (Law direct line of liquidity and the creation 4.595/64) is the fundamental law of Brazil’s of a deposit insurance scheme. In April financial system. In effect since 1964, it 2002, the Brazilian Payment System was created the National Monetary Council reformed. Under the new system frame- (CMN) and the Brazilian Central Bank work, the BCB would not accept negative (BCB). The CMN was given the responsi- balances on the reserve accounts of any bility for formulating monetary and credit bank at any time. policies, and the BCB is responsible for

7 Retrocession is the practice of one reinsurance company insuring another reinsurance company by accepting business that the other company had agreed to underwrite. Example: Company “B” has accepted reinsurance from Company “A,” and then obtains for itself, on such business assumed, reinsurance from Company “C.” This secondary reinsurance is called a retrocession.

88 Profile: brazil

executing those policies. Resolutions can funds, which are supplemented by other be issued without Congressional approval if laws dealing with SUSEP’s prudential they comply with the existing law. functions. Law 6.024/1974 deals with issues of In 1998, Constitutional Amendment 20 intervention and judicial liquidation. provided legislative guidance for comple- Related to this law is Executive Act Nº mentary pensions. Additional guidelines 2.321/87, which institutes the Special Tem- were addressed in Complementary Law porary System of Administration. Together, 109/2001. Article 74 of this law established they allow the BCB to place companies into the Complementary Pension Council administration and remove or replace a (CGPC) as the primary regulator and the company’s board of directors. Complementary Pension Secretariat (SPC) Law 7.492/1986 defines financial crimes as the provisory supervisor. and related penalties. This includes, but Public Social Insurance and Social is not limited to, unauthorized bond issu- Assistance Ministry Resolution 01/1986 ances, omission of relevant information, established the oversight for closed pen- and fraud against the supervisory process. sion fund entities. Standards including Law 9.613/1998 defines money-launder- prudential limits are further described in ing crimes and associated penalties. Law Complementary Law 109/2001 and CMN 9.613 established the Council for Financial Resolution 3.121/2003. Activity Control, which is responsible for the enforcement of anti-money laundering Nonstatutory Elements activities. Many Brazilian financial market operators Law 9.447/1997 increased the formal have established self-regulatory mecha- powers of the BCB, allowing it to take nisms. For example, for banking activities, preventive measures, such as requiring the Brazilian Federation of Banks has capitalization, transfer of shareholder self-regulation components that include control, and/or stockholder structure principles of transparency, fair competi- reorganization (acquisition, merger, or tion, confidentiality, and compliance with split-up). Various other legislative actions formal rules and regulations. provide the BCB additional powers and Within capital markets, the National establish standards within the financial Association of Investment Banks estab- services industry. lished in 1998 five codes for self-regulation The main laws that guide the securi- relative to investment funds, public offer- ties industry are the Securities Law (Law ings, qualified services to capital markets, 6.385/1976) and the Corporation Law private banking activities, and the qualified (Law 6.404/1975), amended through certification program. Law 9.457/1997 and Law 10.303/2001, The National Association of Financial respectively. Market Institutions was established in 1971, SUSEP was created by Decree-Law and its members include commercial, 73/1966 and Decree 60.459/1967. These universal, and investment banks, as well as decrees regulate capitalization compa- stockbrokers and securities distributors. nies and, along with Complementary Law The group has a formal Code of Ethics and 109/2001, set the guidelines for pension formal standards of conduct.

89 The Functional Approach

Within the insurance industry, there is system. It has the formal authority to a published Code of Ethics of the National supervise all financial institutions and has Federation of Insurance Companies, which licensing responsibilities. addresses general principles, institutional As the monetary authority, the BCB responsibility, social responsibility, ethics acts as the lender of last resort. It has the and internal relations, ethics and con- authority to intervene as necessary and sumer relations, and fraud and money liquidate financial institutions if there is a laundering, and established a Market Disci- threat to the safety and soundness of the pline and Ethics Council. financial system. The BCB has seven main areas of opera- Institutional Structure of the Regulators tion, each run by a Deputy Governor: (a) As noted, the regulatory structure in Brazil administration, (b) bank liquidation and is characterized as functional with some privatization, (c) international affairs, institutional aspects, and includes the fol- (c) monetary policy, (d) supervision, lowing entities. (e) financial system regulation, and (f) organization and economic policy. The National Monetary Council (CMN) BCB generates income from its activities The CMN is responsible for management as monetary policy executor and from the of liquidity, protection of the currency, and Treasury budget. Any profits are returned coordination of monetary, fiscal, and credit to the Treasury and any losses are covered policies. It also has supervisory responsibili- by the Treasury. In 2006, approximately 97 ties that include guiding the allocation of percent of its budget was generated from funds by financial institutions, improving interest income. financial instruments and institutions, and monitoring financial institution liquidity The Securities and Exchange . and solvency. Commission (CVM) The CMN has authority to draft regula- The CVM oversees and supervises the tions implementing the laws enacted by stock market and other securities activities the National Congress. The rules issued by (debentures, commercial papers, stock CMN, typically referred to as “Resolutions,” index futures, stock options, over-the- must be adhered to by all the members of counter markets). It also supervises the financial system, including the BCB the institutions operating in the capital and the CVM. markets and the listed companies. The The CMN is composed of the Minister CVM has the legal duty to protect securities of Finance (Chairman), the Minister of holders against fraudulent issues and/or Planning, and the Central Bank Governor, illegal actions, and to ensure fair trading all of whom are appointed by the President practices, including access by the public to of Brazil. accurate and relevant information. One governor and four deputy gov- Brazilian Central Bank (BCB) ernors oversee the CVM, all of whom The BCB is responsible for maintaining are appointed by the President of Brazil. national currency purchasing power and The CVM is funded through the central monitoring the stability of the financial government’s annual budget; however, on

90 Profile: brazil

Figure 4. The Financial Services System Regulatory Structure, Brazil

Ministry of Finance

National Monetary Council (CMN)

Brazilian Central Securities and Exchange National Council Complementary Bank Commission of Private Insurance Pension Council (BCB) (CVM) (CNSP) (CPGC)

BANKING SECURITIES Superintendence of Complementary Private Insurance Pension Secretariat (SUSEP) (SPC)

Note: Dotted lines indicate a cooperative relationship.

average, 91 percent of its income is derived to promote customer protection. It has from supervision fees, debts, and fines.8 four main departments: administration, actuarial techniques, economic control, National Council for Private . and supervision. Funds for SUSEP are Insurance (CNSP) allocated from the government’s annual The CNSP establishes the guidelines and budget. In 2006, approximately 59 percent regulations for the private insurance of its income was derived from fees and market. It is run by the Minister of Finance fines collected from supervised institutions. (its chairman) and representatives from The Complementary Pension General the Ministry of Justice, the Ministry of Council supervises closed pension funds in Social Security, the BCB, the CVM, and the conjunction with the SPC and is funded via Superintendent of SUSEP. receipts from the Treasury. Figure 4 provides a graphic depiction Superintendence of Private . of the relationship among the above-men- Insurance (SUSEP) tioned institutions. The SUSEP was created by Decree-Law 73/66 and is directly linked to the Ministry of Enforcement Finance. It is the executive body of the CNSP, The Brazilian Central Bank (BCB) has and is also the insurance commissioner, broad powers to take actions to safeguard responsible for the supervision and control banking activities and depositors and credi- of the insurance, open private pension funds, tors with the goal to maintain financial and capitalization markets in Brazil. stability. These powers include warn- SUSEP’s objectives are to ensure that ings, fines, suspensions, and temporary market participants remain solvent and disqualifications.

8 CVM Annual Report 2005.

91 The Functional Approach

When a situation of noncompliance Framework for Domestic Coordination with minimum capital, net worth require- Coordination between the governor of the ments, or excess risk is identified, various BCB and the Minister of Finance occurs measures can be taken by the BCB. These through the CMN. Membership of the measures include warnings, fines, license CMN allows for sharing of information suspension, and/or temporary disqualifica- related to supervisory actions of the BCB. tion. In addition, the BCB can also require Coordination between the BCB and the restructuring, the injection of capital, or CVM is based on standards set by the CMN. can liquidate the institution. In addition, the BCB has two agree- The Securities and Exchange Commis- ments in place with other agencies sion (CVM) has similar powers within the addressing matters of coordination and securities industry. Law 6 385/76, which cooperation: an agreement between the governs the securities market, states that BCB and the CVM of February 2004, which the CVM shall perform the duties provided concerns exchange of information and for under the law in order to “protect other activities to better perform respective securities holders and market investors… tasks; and an agreement between the BCB against illegal acts of officers and control- and the SUSEP of July 2005, concerning ling shareholders of publicly held corpora- the coordination of activities and informa- tions, or managers of securities portfolios.” tion exchange. Law 6 385 requires that the accounts of listed companies, and other companies International Coordination regulated by CVM, be audited. The BCB works closely with other interna- There are a number of applicable tional supervisory agencies and has formal requirements under relevant laws and rules agreements with various countries and that seek to ensure the independence of territories, including Argentina, Germany, external auditors in Brazil. In that regard, Mexico, Panama, Paraguay, Spain, the external company audits may be carried Bahamas, the Cayman Islands, and the out only by audit firms or independent United States. accounting auditors registered with the Brazil also participates in various CVM. These auditors are subject to the international regulatory organizations. rules of the CVM and the Federal Account- Please refer to the chart of international ing Council, and also the Independent coordination activities and organizational Auditors’ Institute, with regard to profes- participation on page 234. sional conduct. The BCB adopts the same procedure for financial institutions. The Current Issues CVM may impose penalties on auditors Several issues regarding financial system and audit firms, including warnings, fines, regulation are currently being considered suspension, or cancellation of authoriza- by Brazilian regulators and policymakers. tion or registration, where they acted in In addition to ongoing efforts relating to breach of the securities or company laws Basel II9 implementation, another area of and regulations. reform within banking is related to bank-

9 Basel II created an international standard for banking regulators to use when drafting regulations about how much capital banks need to put aside to guard against financial and operational risks.

92 Profile: brazil

ruptcy (Intervention and Liquidation Law Council for Economic Defense, appointed 6.024). Consideration is being given to how by the Judiciary, is responsible for ensuring best to align the existing financial system fair competition within the banking sec- laws with the new corporate bankruptcy tor. To address this overlap of duties and law and to achieve better alignment with responsibilities, the government presented international practices. a bill, currently under consideration by The opening of the insurance market Congress, calling for the Brazilian System is also under discussion. In January 2007, of Defense of Competition to oversee Complementary Law 126 eliminated the pre- mergers of financial institutions only in vious state insurance monopoly. The regu- cases where there is no systemic risk related lation of co-insurance, reinsurance, and to the merger. If the merger could impact retrocession transactions is now assigned the soundness of the financial system, the to the CNSP, supervised by the SUSEP. The BCB would retain ultimate authority. law authorizes three types of reinsurance Finally, the Competition Protection companies to operate in Brazil: the local Code (CPC), established in 1990, is under reinsurer, the admitted reinsurer (rein- discussion. From 1990 to June 2007, there surer with registered offices abroad and was confusion in the marketplace as to with a representative office in Brazil), and the applicability of the CPC to banking the eventual reinsurer. consumers. Banks had claimed it was not Competition within the banking indus- applicable; however, the Federal Supreme try is also under review. The BCB has the Court ruled against the bank claims and authority to approve mergers and to inves- confirmed that the CPC does apply to tigate conduct. However, the main antitrust banking consumers. authority in Brazil, the Administrative

Acronyms and Abbreviations

BB Bank of Brazil (Banco do Brasil) BCB Brazilian Central Bank (Banco Central do Brasil) CGPC Complementary Pension Council (Conselho de Gestão de Previdência Complementar) CMN National Monetary Council (Conselho Monetário Nacional) CNSP National Council of Private Insurance (Conselho Nacional de Seguros Privados) CPC Competition Protection Code (Codigo de Defesa do Consumidor) CVM Securities and Exchange Commission (Comissão de Valores Mobiliários) R Real SPC Complementary Pension Secretariat (Secretaria de Previdência Complementar) SUMOC Currency and Credit Superintendence (Superintendência da Moeda e do Crédito) SUSEP Superintendence of Private Insurance (Superintendência de Seguros Privados)

93 france The Functional Approach

Market Description French banking law of 1941. In 1967, The French financial industry comprises France was the first European country to 747 credit institutions, 685 investment establish a specific authority for market firms (including 536 asset management supervision, the Market Operations Com- companies), 1,522 insurance entities, and mission (COB). approximately 6,000 investment funds. The The regulatory structure has been modi- industry contributes 4.6 percent of French fied several times in recent decades to com- gross domestic product. The French asset ply with European Union (EU) directives. management industry has assets of more In 1984, a new Banking Act was enacted, than �1.25 trillion (euros). following the first EU Banking Directive, to The domestic market for banking and establish a single regulatory framework for financial services is highly concentrated, all banking institutions and activities and with seven large banking groups holding to create the Committee of Credit Institu- a market share of 80 to 90 percent. These tions and Investment Firms (CECEI) and groups are universal banks, serving retail the Banking Commission (CB). In 1996, and corporate clients, and they are active, this Act, along with others, among which directly or through subsidiaries, in com- the Act of 1989 on market security and mercial and investment banking; special- transparency, was amended to implement ized finance (consumer credit, housing the EU Investment Services Directive and to credit, leasing, factoring, payment, credit introduce the concept of investment ser- cards, and so forth); asset management; vices and investment firms, and to create and insurance. A number of French finan- the Financial Markets Council (CMF) as cial groups maintain an important interna- the body responsible for supervising finan- tional presence, with more than 50 percent cial markets and business codes. of all BNP Paribas, Société Générale, and Insurance regulation and supervision AXA employees located outside of France. were organized in the 1930s within the The insurance sector has assets amount- central government, and were allocated to ing to �1.785 trillion.1 Independent insur- two independent authorities in 1989. ance groups have a market share of more The framework for financial supervision than 80 percent. Banks are not very active was further reformed in 2003 to improve in general insurance, but have a larger role the efficiency of the financial regulatory in life insurance. system. The review was not a response to a particular crisis; rather, it was a reaction to Background the perception that the former structures The French regulatory structure can be were complicated and duplicative. The characterized as a functional system with new structure maintains a general distinc- some aspects of a twin peaks approach, one tion between supervisory agencies and the that has evolved over the years. The Bank licensing bodies. of France (BDF), the central bank, has Although many institutions were played a central role in both the prudential changed as part of the reform process, and supervisory framework since the first prudential banking supervision was not

1 Figures mentioned in this document are drawn from the 2007 annual reports of the Bank of France, the Financial Markets Authority (AMF), and the Insurance and Mutual Societies Supervisory Authority (ACAM).

96 Profile: France

affected by the reforms of 2003. Prudential cooperation, and coordination. First, the supervision remains the task of the CB. reform created the Advisory Committee The CB is legally separate from the central on Legislation and Financial Regulation bank. However, its staff and budget are pro- (CCLRF), replacing two existing bodies vided by the BDF. The licensing of credit that separately provided advice on bank- institutions is a function of the CECEI, ing and insurance matters.2 Although the a legally independent authority housed CCLRF is only an advisory body, it must be within the BDF. consulted on draft regulatory and legisla- The 2003 reform led to the simplifica- tive provisions in the fields of insurance, tion of the regulatory structure and the banking, and investment firms. Second, the merger of a number of institutions, partic- reform established the Board of Financial ularly those dealing with securities markets Sector Authorities (CACESF). This col- and consumer protection. The Financial lege of supervisors is designed to enhance Security Act of August 2003 established the cooperation and exchange of information Financial Markets Authority (AMF). The among the leadership of key supervisory AMF was the result of the merger of the agencies. Third, the reforms created for- COB, the CMF, and the Council on the Dis- mal links among the principal agencies at cipline of Financial Management (CDGF). the level of the board to enhance informa- The AMF is a public agency that has finan- tion sharing, coordination, and high-level cial autonomy. Its remit is to safeguard policy debate. investments in financial instruments and in all other savings and investment vehicles, Statutory Framework to ensure that investors receive material Since 2000, the legislation dealing with information, and to maintain orderly banking activities, investment services, financial markets. and asset management services has been Insurance activities are supervised contained in a single compendium, the by the Insurance and Mutual Societies Monetary and Financial Code (COMOFI), Supervisory Authority (ACAM), which is which is amended each time new provi- an independent agency. The Ministry of sions are enacted by the National Assembly Economy, Finance and Industry (MINEFI) or by a government decree. remains responsible for licensing insurance companies. The Committee of Article L. 611-1: Regulation (2003). This arti- Insurance Companies (CEA) was created cle addresses the scope of the rulemak- in 2003. Its purpose is to grant individual ing capabilities of the MINEFI (under authorizations or exemptions applicable Authorities Common to Credit Institu- to insurance firms and firms underwriting tions and Investment Companies). reinsurance. Article L. 621-1: Financial Markets Authority The 2003 reforms also addressed per- (2003). This article delineates the mis- ceived challenges faced as government sion, composition, working rules, and agencies sought to improve consultation, powers of the AMF, and the guidelines

2 The CCLRF replaced the Banking and Financial Regulation Committee (Comité de la Réglementation Ban- caire et Financières) and the Regulatory Commission of the Insurance National Council (Commission de la Réglementation du Conseil National des Assurances).

97 The Functional Approach

for its relations with auditors and for Nonstatutory Elements means of redress. No nonstatutory elements have been Article L. 613-1: Banking Commission (1984, noted. 2007). This article details the mission, composition, exercise of control, and Institutional Structure of the Regulators disciplinary powers of the CB. It also The French regulatory structure is char- addresses judicial reorganization and acterized as a functional system with some liquidation of credit institutions and elements of a twin peaks approach. investment firms and the implementation of the Deposit Guarantee Funds. Ministry of Economy, . Article L. 612-1: Committee of Credit Institu- Finance and Industry (MINEFI) tions and Investment Firms (2001, 2003, The MINEFI has a role in the supervisory 2007). This article covers the missions, structure of the financial regulatory system. composition, and working rules of the It is responsible for drafting new legislation CECEI. and issuing regulations regarding banking Article L. 614-1: Consultative Authorities operations, investment services, and insur- (2000). This article deals with the ance activities, in consultation with the Advisory Committee on Legislation and CCLRF. The MINEFI is also responsible Financial Regulation and other consul- for approving the General Regulations tative authorities. of the AMF, which include, among other Existing legislation for insurance provisions, the rules of professional prac- comes from three different codes: (a) tice applicable to issuers and to takeover the Insurance Code, which applies to bids, the rules of good conduct and other insurance entities organized in the form professional obligations of investment of commercial or cooperative corpora- service providers, the conditions under tions, (b) the Mutual Insurance System which investment service providers render Code, which applies to certain entities their services, the conduct-of-business rules providing health insurance organized as for custody and administration of financial mutual corporations, and (c) the Social instruments, and the general organiza- Security Code, which applies to certain tional and operational principles for set- providers of pension schemes. tlement-delivery systems and for regulated Article 310: General Provisions and State Con- markets and multilateral trading facilities. trol (1981). This article describes general The Director General of the Treasury is a provisions and penalties associated with member of the governing boards of CB, state-controlled insurance activities and the CECEI, and the CEA. The government information on the Insurance Supervi- also provides a commissioner to the boards sory Commission. of the ACAM and the AMF. Article 413: Insurance Firms’ Committee The MINEFI supervises the French (2003). This article provides general Deposit Guarantee Funds (FGD). Upon a information on the Insurance Firms’ request from the CB, the FGD can release Committee, which licenses insurance funds in the event of a bank failure. (See firm activity. below.)

98 Profile: France

Deposit Guarantee Fund (FGD) Director of the Treasury; the Chairman The FGD is a private institution funded by of the ACAM; and the following four contributions of all credit institutions and members or their deputies appointed by investment firms to guarantee deposits up the Minister for Economy, Finance and to s70,000, with no co-insurance. It also Industry to a five-year term, renewable covers investment firms. Funds can be once: a Counselor of State proposed by released only with the agreement of the CB the Vice-Chairman of the State Council; a (with the advice of the AMF). In certain counselor member of the Court of Cassa- circumstances, the FGD can be authorized tion proposed by the Executive Chairman to use a portion of its funds preventively, to of the Court of Cassation, and two financial provide financial support to a failing credit industry specialists. institution or investment firm. A similar The BDF provides human resources and guarantee scheme is in place for the insur- other support to the General Secretariat of ance industry, linked to the ACAM. the CB to conduct inspections and ongoing supervision. Bank of France (BDF) The BDF is the central bank of France and Committee of Credit Institutions . provides prudential supervision for credit and Investment Firms (CECEI) institutions and investment firms. It issues The CECEI licenses credit institutions and currency and determines monetary policy investment services providers and shares within the parameters of its membership information related to approved institu- in the Eurozone and as a member of the tions and service providers with the AMF European System of Central Banks. The and other authorities within the EU. BDF has a further supervisory role through The CECEI is chaired by the Governor its linkages with, and leadership in, the of the BDF. The CECEI governance boards of other supervisory agencies. The structure also includes the Director of the Governor of the BDF is the Chairman of Treasury, the Chairman of the AMF, the the CB and the CECEI. The Governor also Chairman of the Executive Board of the sits on the boards of the CCLRF, the AMF, FGD, and eight members or their depu- and the ACAM. ties, appointed by order of the Minister of Economy, Finance and Industry to three- Banking Commission (CB) year terms. The members of the CECEI The CB’s mission is to oversee the banking report on an annual basis to the Minister and financial system to ensure safe and and the advisory committee of the financial sound practices and financial stability. The sector. The BDF provides human resources CB is responsible for prudential supervi- and other support to the CECEI. sion of credit institutions, investment service providers, and persons authorized Financial Markets Authority (AMF) to exercise custody or administration of The AMF oversees the protection of public financial instruments. The CB examines savings invested in financial instruments and the credit institutions’ operations and all other investments offered to the public, financial condition. the disclosure of financial information to The CB is composed of the Governor investors, and the proper functioning of of the BDF, who serves as Chairman; the financial markets. In doing so, it establishes

99 The Functional Approach

the organizational and operational princi- unions, and federations governed by the ples for markets, sets conduct-of-business Social Security Code, complementary rules for the professionals under its supervi- retirement institutions, and the organiza- sion, and oversees the collective investment tions governed by Article L727-2 of the vehicles that are subject to its approval. The Rural Code, and it ensures that they com- AMF also contributes to the regulations ply with the law and contractual commit- applicable to these markets at the European ments that bind them with the insured and and international level. The AMF monitors members. The ACAM, as the prudential securities transactions and collective invest- supervisor, examines firms’ financial status ment products to ensure compliance with and monitors general business conditions investor disclosure requirements. in the sector. The AMF has a governing body referred The ACAM governing body is composed to as a “college,” a disciplinary committee, of nine members: (a) a Chairperson named and, when required, specialist committees by decree; (b) the Governor of the BDF; and consultative committees. The college (c) a Counselor of State, nominated by the is composed of 16 members, each with Vice-President of the State Council; (d) a a five-year term, with some exceptions.3 Counselor Member of the Final Court of The AMF also has a Sanctions Committee Appeals, nominated by the First President (Commission des Sanctions) responsible of the Final Court of Appeals; (e) a Coun- for imposing disciplinary actions. This selor, Head of the State Audit Office, nomi- Committee has 12 members, each of whom nated by the First President of the State serves a five-year term. Audit Office; and (f) four members chosen The AMF has financial autonomy. Its for their industry expertise. The Chairper- budget is determined by the college on a son, the Counselor of State, and the four proposal from the Secretary General of the members chosen for their expertise serve AMF. It receives income from taxes paid by five-year terms. the institutions it supervises. The ACAM has financial autonomy. It receives its income from the contributions Insurance and Mutual Societies . paid by the insurance and mutual societies Supervisory Authority (ACAM) under its supervision. The ACAM is an independent public agency and is the prudential supervi- The Committee of Insurance . sor of the insurance sector. It oversees Companies (CEA) insurance companies, firms underwriting The CEA licenses insurance firms, mutual reinsurance, mutual insurance companies, insurance companies, provident institu-

3 The AMF’s governing board is composed of (a) a Chairman, appointed by presidential decree; (b) a Counsel- lor of State, appointed by the Vice-Chairman of the Council of State; (c) a Counsellor Member of the Court of Cassation, appointed by the President of the Court of Cassation; (d) a Chief Advisor to the Court of Auditors, appointed by the President of the Court of Auditors; (e) a representative of the BDF, appointed by the Gov- ernor (who serves until another is appointed); (f) the Chairman of the National Accountancy Council (who serves during the length of the chairmanship); (g) three members appointed, respectively, by the President of the Senate, the President of the National Assembly, and the President of the Economic and Social Council; (h) six members, appointed by the Minister of the Economy, Finance and Industry; and (i) a shareholder- employee representative, appointed by the Minister of Economy, Finance and Industry after consulting the representative trade unions.

100 Profile: France

Figure 5. The Financial Services System Regulatory Structure, France

Ministry of the Economy Finance and Industry European Union (EU) (MINEFI)

DEPOSIT GUARANTEE FUNDS (FGDs)

Board of Financial General Director Sector Authorities of the Treasury (CACESF)

Advisory Committee on Legislation Bank of France and Financial Regulation (BDF) (CCLRF)

Insurance and Mutual Societies Banking Commission Financial Markets Authority Supervisory Authority (CB) (AMF) (ACAM)

Consumer Protection Prudential Regulation Prudential Regulation & Market Conduct

BANKING SECURITIES INSURANCE

SECURITIES INVESTMENT PRODUCTS

Committee of Credit Sanctions Committee Committee on Insurance Institutions and Investent Companies Firms (CEA) (CECEI)

LICENSING LICENSING

Note: Dotted lines indicate a cooperative relationship. tions, and firms underwriting reinsurance, companies, mutual insurance companies, but not underwriting direct insurance. In and provident institutions; the Secretary- addition to its licensing role, the CEA can General of said committee; and eight address competition matters and issues of other members named by decree to three- concentration concerning, directly or indi- year terms. rectly, an insurance firm or a firm underwriting reinsurance but not underwriting Advisory Committee on Legislation . direct insurance. and Financial Regulation (CCLRF) The CEA board is composed of a chair- The CCLRF is a legislative advisory com- person named by decree of the Minister mittee that deals with broad policy issues of Economy, Finance and Industry; the related to credit institutions, investment Director of the Treasury; the chairperson firms, and insurance companies and their of the supervisory committee for insurance customers. The CCLRF may draft opinions

101 The Functional Approach

or recommendations of a general nature. or permanent prohibition on providing The Committee is composed of the Minis- all or part of the services a firm previously ter of Economy, Finance and Industry, who provided. They can be fined, for instance, serves as Chairman, and 14 other mem- in the case of the AMF, by up to a1.5 bers.4 Except for the Governor of the BDF, million or 10 times the unlawful profits the Chairman of the ACAM, the Director earned (five times when the professional in of Civil Affairs, a representative of the question is an individual, except in cases of Ministry of Justice, and the other members market manipulation). These sanctions are of the Committee are appointed by decree subject to a normal appeals process. of the Minister of Economy, Finance and When necessary in a time of crisis, Industry. Emergency Liquidity Assistance is at the The CCLRF reports annually to the discretion of the BDF, in coordination with President of France and to the Parliament. the European System of Central Banks. CCLRF members are not paid employees. However, when public funds are required The BDF provides the CCLRF with a gen- and matters of solvency arise, the Minister eral secretariat and budgetary resources. of Economy, Finance and Industry must Figure 5 provides a graphic depiction agree before the release of funds. In of the relationship among the above-men- addition, the Ministry retains oversight of tioned institutions. the FGD, whose action is triggered by the Banking Commission. Enforcement The supervisory authorities have broad Framework for Domestic Coordination enforcement powers, covering all areas The CACESF is a key part of the framework from licensing and individual authoriza- for domestic coordination. It is composed tion to disciplinary actions. The authorities of the Governor of the BDF as Chairman can take administrative measures in the of the CB, the Chairman of the ACAM, form of revocation of license, warning, and the Chairman of AMF. The college injunction, reprimand, or a formal recom- was established to facilitate information mendation that may be published. In exchanges among the principals of all addition, the supervisory authorities are supervisory authorities of financial groups empowered to take disciplinary actions, engaged in lending, investment, and insur- which may include capital infusions, ance activities, and to address any question increased reporting, and/or requiring a of common interest relating to coordina- change of management. tion and information exchange. Institutions are subject to a range of The CACESF meets at least three times sanctions for misconduct, including: a year. It may be consulted for an opinion warnings, reprimands, and a temporary by the Minister of Economy, Finance and

4 The membership of CCLRF includes (a) a representative of the French Assembly, appointed by its chairman; (b) a Senator, nominated by the Senate Chairman; (c) a Counsellor of State, nominated by the Vice-Chairman of the State Council; (d) the Governor of the BDF or his or her representative; (e) the Chairman of ACAM or his or her representative; (f) the Director of Civil Affairs and the Seal at the Ministry of Justice or his or her representative; (g) two representatives of credit institutions and investment firms; (h) two representatives of insurance companies; (i) a trade union representative that represents, at the national level, the staff of the companies in the banking and insurance sectors and the investment firms; (j) a representative of the customers of credit institutions, insurance companies, and investment firms; and (k) two people chosen for their expertise.

102 Profile: France

Industry; the Governor of the BDF, as there is no public disclosure. If a case Chairman of the CB; the Chairman of involves a matter of solvency, the Governor ACAM; and the Chairman of AMF on any of the BDF must secure the agreement of question within its purview. the MINEFI. Additional coordination is facilitated through the series of cross-board member- International Coordination ships in the reformed structure, with prin- Please refer to the chart of international cipals or their representatives participating coordination activities and organizational in the governing boards of associated participation on page 234. In addition, see agencies. the European Union profile for an expla- Further coordination in times of crisis nation of coordinating activities within or bank failures is aided through direct the EU. links between the BDF and CB, because the Governor of the BDF is Chairman of Current Issues the CB. As such, the Governor has regular The Minister of Economy, Finance and meetings with the General Secretary of the Industry has commissioned a study on how CB to review financial supervisory matters to further improve cooperation between and, in particular, the ongoing health of the two prudential supervisory authorities, systemically important banks. In times of the CB and the ACAM. As part of this stress, these meetings can escalate from review, consideration will be given to a pro- weekly to daily to ensure coordination, posal to merge the two bodies. It is unclear and can also involve other agency heads, how much support these further reform as needed. Discussions are private; there proposals have in the National Assembly. is no public disclosure. If a case involves a Moreover, some resistance to the change is matter of public support, it is referred to evident from the insurance sector, parts of the MINEFI. Supervisory decisions are to which remain supportive of the ACAM as be taken by the board of the Banking Com- a separate regulator. Given the high level mission, which is chaired by the Governor, of cooperation that already exists between joined by a representative of the MINEFI. the CB and the ACAM, it is unlikely that When dealing with a possible bank a merger would, in the short term, have failure, the Governor of the BDF takes the a significant impact on the concrete pru- lead, supported by the General Secretary dential supervision of the French financial and staff of the CB. Discussions are private; institutions.

103 The Functional Approach

Acronyms and Abbreviations

ACAM Insurance and Mutual Societies Supervisory Authority (Autorité de Contrôle des Assurances et des Mutuelles) AMF Financial Markets Authority (Autorité des Marchés Financiers) BDF Bank of France (Banque de France) CACESF Board of Financial Sector Authorities (College des Autorités de Contrôle des Entreprises du Sectuer Financier) CB Banking Commission (Commission Bancaire) CCLRF Advisory Committee on Legislation and Financial Regulation (Comité Consultatif de la Légis- lation et de la Réglementation Financierès) CDGF Council on the Discipline of Financial Management (Conseil de Discipline de la Gestion Financière) CEA Committee on Insurance Companies (Comité des Entreprises d’Assurances) CECEI Committee of Credit Institutions and Investment Firms (Comité des Establissements de Crédit et des Enterprises d’Investissement) CMF Financial Markets Council (Conseil des Marchés Financiers) COB Market Operations Commission COMOFI Monetary and Financial Code (Code Monetaire et Financier) € Euros EU European Union FGD Deposit Guarantee Funds (Fonds de Garantie des Dépôts) MINEFI Ministry of Economy, Finance and Industry

104 Italy The Functional Approach

Market Description (for example, Generali SpA, Fondiaria- The Italian financial system is composed SAI). At the end of 2007, 172 companies of a variety of financial institutions, with were authorized to conduct insurance and banks playing, directly or indirectly, the reinsurance business in Italy, 163 of which dominant role. In 2007, there were 806 were domestic firms. banks, comprising 249 commercial banks, 38 cooperative banks, 440 mutual banks, Background and 79 branches of foreign banks.1 A wave The Italian financial regulatory structure of bank mergers occurred in the 1990s, can be described as a combination of two and additional consolidation took place approaches, because it is partly structured in 2007, significantly increasing market along functional lines (banks, insurance, concentration. The top five institutions’ securities) and partly along institutional (Unicredito, Intesa Sanpaolo, Monte dei lines. The structure is the result of the Paschi, Banco Popolare, and UBI) share of way the financial system was reshaped in total domestic banking assets rose from 45 the 1930s, in the aftermath of the Great percent in 2005 to 52 percent in 2007. Depression, and the reforms brought about Non-bank financial companies play an in the 1980s and 1990s, driven by financial important role in the financial markets, innovation and European integration. In and during the past several years have the 1930s the government and the Central increased in number, due mainly to secu- Bank rescued the major commercial banks ritization special-purpose vehicles, which from collapse. The main response took make up more than half of all registered two forms. The first was a major shift from financial companies. Financial companies’ private to public ownership of major banks share of the consumer credit market and industrial groups, achieved through grew moderately, but banks continued to the creation of a large, publicly owned dominate the sector with 55 percent. The entity, the Institute for Industrial Recon- market share of independent intermediar- struction (IRI), which acquired the equity ies decreased from 21 percent to 15 per- holdings of the ailing banks and a control- cent. Foreign intermediaries maintained a ling stake in the banks themselves. The presence, directly or indirectly controlling second was passage of a new Banking Law approximately 40 registered financial (1937), which required a sharp separation companies. between banking and industry. The Italian asset management industry The Banking Law (the Law) of 1936 is based on a vertical integration between established the Bank of Italy as a public distribution networks (banks and insur- institution functioning as a central bank, ance companies) and asset management and prohibited from lending to non-banks. companies owned by banks that distribute The Law also reformed credit and financial their products. At the end of 2007, there supervision, revamping the credit system were 107 registered investment firms. through a separation between banking and The insurance sector includes some of industry and between short- and long-term the largest European insurance companies credit (these provisions were repealed

1 Banca d’Italia, Annual Report, Abridged Version, Ordinary Meeting of Shareholders 2006, 113th Financial Year, Rome, 31 May 2007, www.bancaditalia.it.

106 Profile: italy

almost entirely in 1993). Supervision was uncompetitive, protected, and publicly concentrated in a newly created state body, owned configuration inherited from the the Inspectorate for the Defense of Sav- 1930s. In 1990, three laws were passed. ings and the Exercise of Credit, chaired The first established a level playing field by the Central Bank Governor and using for banks, specified the shareholder- resources and personnel of the Bank of owned company as the general model for Italy, but directed by a ministerial commit- the banking business, prepared for the tee chaired by the Prime Minister. privatization of banks, and regulated credit Until the 1980s, the banking system groups. The second regulated securities was predominantly composed of publicly intermediaries and stock markets. The owned intermediaries and was highly third introduced antitrust principles and fragmented. Institutions were classified as instruments. “ordinary” (commercial) banks or as special credit institutions. While all operated Statutory Framework largely in the same way, ordinary banks The three main pillars of the present regu- had different legal status: commercial latory framework are: the Consolidated Law banks, saving banks (mainly established on Banking (CLB), the Consolidated Law on as public institutions controlled by local Finance, and the Code of Private Insurance. communities), cooperative banks, and The Consolidated Law on Banking (CLB) mutual banks. Each bank had geographic (1993). Under the CLB, the Bank of restrictions on its activity. Competition was Italy issues the regulations governing discouraged. The creation of new banks the activity of banking and non-banking was forbidden and the opening of new intermediaries and monitors their opera- branches was strictly limited and subject to tions to preserve financial stability. The authorization. Bank of Italy exercises regulatory powers, Changes began in the 1980s and accel- issuing general rules concerning capital erated in the 1990s. They were largely adequacy, limitation of risk in its various the result of the progressive creation of a forms, permissible holdings, administrative single European market for banking and and accounting procedures, and internal financial services. The implementation of control mechanisms. the European Union’s (EU) First Banking The Consolidated Law on Finance (1998), Directive (1977) removed the prohibition known as the Finance Code, regulates the to create new banks, and the EU’s Second financial services sector and the relation- Banking Directive (1988) removed most ships among different authorities on a of the other substantial barriers to entry. functional basis. At the end of the 1980s, impediments The Code of Private Insurance (2005) to foreign operations of banks were also reformed the insurance sector and removed, and foreign exchange controls, strengthened the role of the Insurance which had been in place in Italy in one Industry Regulatory Authority (ISVAP) as form or another since 1934, were lifted. the insurance sector supervisor and regula- In the 1980s and 1990s, both the indus- tor. The Code introduced the principle that try and the regulatory structure of the the primary purpose of supervision is the Italian financial system made a decisive sound and prudent management of insur- departure from the closed, static, ance and reinsurance entities.

107 The Functional Approach

In addition to these main pillars, other bring Italy’s legislation into line with Euro- relevant legislation was introduced in the pean Community law. course of this decade, partly as a response The Italian Regulation on Pension Funds to financial episodes affecting the Italian (2005) regulates the pension funds system. market and partly as a result of newly introduced European legislation. Nonstatutory Elements The Company Law (2004), the law gov- No nonstatutory elements have been erning the organization of Italian compa- noted. nies, contains provisions on corporate governance of banks and banking groups. Institutional Framework Antitrust powers were shifted from the of the Regulators Bank of Italy to the Antitrust Authority. Italian financial regulation is organized The Law also strengthened the role of the as a mixed functional and institutional securities supervisory agency, the Com- system, involving the following institutions. panies and Stock Exchange Commission (CONSOB), as the authority regulating Ministry of the Economy and Finance companies, securities, and financial The Ministry of Economy and Finance markets. coordinates with the supervisory agencies. The Law on the Protection of Saving and Although the Ministry and the Treasury are Financial Market Regulation (2005) intro- not primary supervisors of financial institu- duced rules to strengthen companies’ tions, they retain overall responsibility for internal controls and public controls for providing general policy guidance. In addi- the protection of savings, to enhance the tion, the Minister of Economy and Finance transparency of markets, to enhance the is Chair of the Interministerial Committee quality of financial information, and to for Credit and Savings (CICR).2 The Min- foster cooperation among authorities. The istry and Treasury also have a major role in law marginally modified the supervisory the event of financial crisis. framework, strengthening the indepen- The coordination among the Ministry, dence of the supervisory authorities, the Bank of Italy, CONSOB, and ISVAP reinforcing the division of regulatory and is aimed at the prevention, management, control functions, and emphasizing coop- and resolution of financial crises. At the eration among the authorities. level of principals, the Ministry sits on the The Competition and Fair Trading Act Financial Stability Committee (FSC), which (1990) established the Antitrust Author- is tasked with dealing with financial crises ity (the Authority). The Authority is an and institutional failures with potential independent public agency. Parliament cross-border implications. In the rare cases introduced national antitrust legislation when action might be deemed necessary in response to the requirements of Article either via special administration or com- 41 of the Constitution, which protects and pulsory administrative liquidation, guarantees the right of free enterprise, to the action is initiated by a decree of the

2 The CICR is staffed by the Bank of Italy and chaired by the Minister for Economy and Finance. It provides a link betweeen the two institutions, primarily for matters concerning supervision, and handles relations with customers of banks and financial intermediaries regarding matters of a general nature.

108 Profile: italy

Ministry, based on a proposal from the maximum insured amount of €103,291. Bank of Italy or CONSOB. A similar pro- There is no co-insurance. cedure is followed for insurance failures: Cooperative banks are members of a on advice from ISVAP, the Ministry has the similar but separate fund, the Deposit power to issue a decree placing the entity Guarantee System of Mutual Banks, which under administrative control. has the same structure. This fund also has ex post funding, with a maximum insured Bank of Italy amount of €103,291. There is no co-insur- The Bank of Italy is the central bank of ance. The Bank of Italy has full powers to Italy and is independent. As the supervi- supervise and coordinate the activities of sory authority, the Bank of Italy seeks to both deposit protection funds. ensure the sound and prudent management of intermediaries and the overall sta- Companies and Stock Exchange . bility and efficiency of the financial system. Commission (CONSOB) The governance of the Bank of Italy CONSOB is the government agency consists of the Directorate (for policy- responsible for the supervision of the making) and the Board of Directors (for Italian securities market and investment administration). The Board is composed services. It was established in 1974, to of the Governor and 13 directors, and is perform supervisory functions over stock responsible for the general administration, exchanges that were previously performed management supervision, and internal con- by the Ministry. It became an independent trol of the Bank. The Directorate consists entity in 1985, when it was granted broad of the Governor, a Director General, and organizational and operational autonomy. three Deputy Directors General. The Gov- CONSOB’s responsibilities include ensur- ernor is appointed by the government and ing transparency and responsible market approved by the President of the Republic. conduct by securities market participants He or she serves a six-year term, which may and disclosure of complete and accurate be renewed once. The Deputy Directors information to shareholders, including General serve six-year terms, renewable prospectuses related to securities offerings. once. The Bank reports annually to Parlia- CONSOB conducts investigations into ment on its activities. The Bank of Italy’s potential violations of insider dealing and funding comes from management of the market manipulation. assets it owns as a central bank. CONSOB’s governing body is a Com- mission of five members, including the Deposit Insurance Schemes Chairman. The Chairman and the mem- The Interbank Deposit Protection Fund, bers are appointed by the government and established in 1987, is supervised by the approved by the President of the Republic Bank of Italy. The Fund, (which became for a seven-year term and may be reap- operative in January 1997), guarantees pointed once. Funding for CONSOB is the deposits of member banks, which provided through a state budget allocation pay contributions to the Fund and make supplemented by fees paid by licensed regular payment to defray operating costs. entities. The scheme has ex post funding with a

109 The Functional Approach

Insurance Industry Regulatory . appointed to four-year terms and may be Authority (ISVAP) reappointed once. ISVAP’s President acts ISVAP is the independent supervisory as Director General of the organization. Its authority for the insurance industry. expenditures are covered by fees generated Its objective is to ensure the sound and from the supervision of the supervised prudent management of insurance and entities, along with interest earned on reinsurance entities by regulating and bank deposits and income from financial monitoring their activities. ISVAP can management. adopt any regulation required for the sound and prudent management of com- Pension Fund Regulatory Authority (COVIP) panies and the transparency and fairness in COVIP is responsible for supervising pen- the behavior of supervised entities. sion funds. Its main responsibilities are The President of ISVAP is appointed by to authorize and supervise pension funds the President of the Republic to a five-year and ensure transparency. The agency is term, renewable once. The governing body governed by four members and a Chair- of ISVAP is a Board of Directors, which man, appointed by the Prime Minister. The consists of six members, in addition to Chairman and the four members serve the President. The board members are four-year terms, renewable once.

Figure 6. The Financial Services System Regulatory Structure, Italy

European Union (EU)

Financial Stability Committee (FSC) Ministry of the Economy and Finance

Companies and Stock Exchange Insurance Industry Pension Fund Regulatory Bank of Italy Commission (CONSOB) Regulatory Authority (ISVAP) Authority (COVIP)

BANKING SECURITIES INSURANCE PENSIONS

Deposit Gurantee Funds

Note: Dotted lines indicate a cooperative relationship.

110 Profile: italy

Antitrust Authority (Authority) intermediaries in special administration or The Authority is responsible for enforcing liquidation. legislative provisions against anticom- ISVAP has the same powers of enforce- petitive practices: agreements that impede ment as the Bank of Italy. competition, abuses of dominant position, and mergers and acquisitions that Framework for Domestic Coordination eliminate or restrict competition. The The Bank of Italy, CONSOB, and ISVAP Authority is a collegiate body composed of have various mechanisms in place to a Chairman and four Members appointed facilitate cooperation and coordination. jointly by the Presidents of the Senate and Procedures for cooperation among these the Chamber of Deputies. The Chairman supervisory authorities have been estab- and the four members remain in office lished by the Consolidated Law on Banking, for a seven-year, nonrenewable term. The and the Consolidated Law on Finance and, Authority is funded by the government more recently, by a Memorandum of through an annual budgetary allocation. Understanding (MoU). The three agencies Figure 6 provides a graphic depiction cooperate with the judicial authorities of the relationship among the above-men- by providing information requested and tioned institutions. reporting significant violations of law identified in the performance of their activities. Enforcement In 2007, pursuant to the new European The Bank of Italy has broad powers of Union Markets in Financial Instruments enforcement. These include the power to Directive (MiFID), the Bank of Italy and take disciplinary action, impose admin- CONSOB signed an MoU regarding each istrative sanctions and, where necessary, other’s supervisory responsibilities, tasks, propose to the Minister of the Economy and the exchange of information. and Finance the initiation of special crisis In 2008, the Ministry of Economy and procedures of supervised entities under Finance, the Bank of Italy, CONSOB, and special administration and compulsory ISVAP signed an MoU for the prevention, administrative liquidation. Moreover, management, and resolution of financial the Bank of Italy, acting as supervisory crises. The agencies established a Financial authority, is responsible for the direction Stability Committee (FSC), whose main and coordination of those special crisis task is to strengthen information exchange procedures for all banking and financial for the coordination of the decision-mak- intermediaries. ing process aimed at preventing and man- CONSOB has broad enforcement aging systemic financial crises with poten- powers similar to the Bank of Italy. It tial cross-border implications. Each agency exchanges information with the judicial has a crisis management unit designed authorities to identify violations of rules to support the work of the FSC, when and regulations on market abuse, insider required. The FSC is based on a voluntary trading, and market manipulation. It can agreement; it is not established by law and prohibit intermediaries from engaging has yet to be tested by a financial crisis, but in new transactions, suspend the Board it was created in line with an approach and of Directors, impose fines, and place a model agreed to at the EU level.

111 The Functional Approach

Italian law provides for two main crisis bank ceases to do business and its assets management procedures for financial and liabilities are determined according intermediaries: special administration and to the bankruptcy rules. The receivers may compulsory administrative liquidation. In assign all or part of the bank’s assets and both cases, the procedure is initiated by a liabilities to another intermediary, with a decree from the Ministry of Economy and view to limiting the repercussions of the Finance, acting on a proposal from the failure. Bank of Italy or CONSOB. In case of a crisis in the insurance industry, the Minister International Considerations of Economy and Finance, upon ISVAP’s Please refer to the chart of international proposal, may establish by decree that an coordination activities and organizational entity be dissolved when there are serious participation on page 234. In addition, see irregularities in administration or serious the European Union profile for an expla- violations of rules of law, administrative nation of coordinating activities within provisions, or articles of association regu- the EU. lating the undertaking’s activity; or when serious financial loss is foreseen. Current Issues Special administration involves the The national debate over the efficacy of appointment of one or more special the current mixed institutional system con- administrators, who replace the troubled tinues. In 2007 the Prodi Government sub- bank’s management and take over the mitted to Parliament a regulatory reform running of the company, with all the func- aimed at fully implementing the twin peaks tions and powers attributed to its former approach. The proposal vested all financial directors. Its purpose is to ascertain the stability and prudential powers within the real situation of the bank, eliminate the Bank of Italy, and placed transparency and irregularities, and foster solutions in the market conduct responsibilities under the interest of depositors. Therefore, it is pre- authority of CONSOB; ISVAP and COVIP ventive in nature and may be adopted at would have been suppressed. The new an early stage of a bank crisis or where the legislation failed to pass because of the preconditions needed to ensure correct per- mature dissolution of Parliament in early formance of banking are lacking. Compul- 2008. However, both center-left and center- sory administrative liquidation is ordered right party coalitions had expressed sup- when a crisis is irreversible. As happens in port for the reform. New legislation may be bankruptcy proceedings for commercial proposed by the current government. businesses, with the liquidation order, the

112 Profile: italy

Acronyms and Abbreviations

CICR Interministerial Committee for Credit and Savings (Comitato Interministeriale per il Credito ed il Risparmio) CLB Consolidated Law on Banking (Testo unico bancario) CONSOB Companies and Stock Exchange Commission (Commissione Nazionale per le Società e la Borsa) COVIP Pension Fund Regulatory Authority (Commissione di Vigilanza sui Fondi Pensione) EU European Union FSC Financial Stability Committee (Comitato per la Stabilità Finanziaria) IMI Italian Industrial Finance Institute (Istituto Mobiliare Italiano) IRI Institute for Industrial Reconstruction (Istituto per la Ricostruzione Industriale) ISVAP Insurance Industry Regulatory Authority (Istituto per la Vigilanza delle Assicurazioni Private) MiFID Markets in Financial Instruments Directive of the European Union MoU Memorandum of Understanding

113 spain The Functional Approach

Market Description Background The Spanish financial system comprises Spain’s current financial regulatory system three groups of institutions that cover is evolving from a functional model to a distinct but increasingly integrated markets modified twin peaks system. There are of unequal size: banking, insurance and three prudential supervisors for banks, pension funds, and securities markets enti- investment firms, and insurance compa- ties. The dominant sector is banking, with nies: the Bank of Spain (BDE), which is approximately 70 percent of total assets; also the Spanish central bank; the National followed by investment funds and securi- Securities and Exchange Commission ties, with 20 percent of assets; and by insur- (CNMV), which is responsible for the ance and pension funds, with 10 percent supervision of financial markets’ conduct- of total financial assets.1 Total assets within of-business and for investor protection, for the banking system are subdivided among the prudential supervision of investment banks, with 43 percent of total activity; firms, mutual funds, and risk capital savings banks, with 40 percent; credit coop- management entities, and for all Spanish eratives, with 4 percent; and specialized securities trading and post-trading infra- credit institutions, foreign subsidiaries, and structures; and the General Directorate of branches, with 13 percent of the activity. Insurance and Pension Funds (DGSFP). The Spanish banking system encompasses While the BDE and CNMV are indepen- a wide range of credit institutions (365), dent agencies, the DGSFP falls under the whose business model is focused on auspices of the MEH. retail banking and traditional financial Over the last 20 years, the development intermediation. of an appropriate regulatory and supervi- The second-largest segment of the finan- sory framework has paved the way for the cial services market is the securities market, modernization of the Spanish financial which includes securities firms (about system. The Spanish economic and bank- 120), mutual funds (more than 6,000 ing crisis in the late 1970s and early 1980s including their management entities), and resulted in calls for a reform of the finan- money market funds. During 1991–2006, cial system, supported by a parallel liberal- the total assets administered by the ization and re-regulation of the regulatory industry (including Collective Investment and supervisory framework. It has evolved Institutions, pension funds, and venture from an interventionist and protectionist capital entities) increased from 13 percent approach to a more flexible one. It focuses of gross domestic product to 44 percent. on preventive rather than corrective mea- Insurance companies, the third sec- sures, in compliance with European Union tor, are backed by a Public Insurance (EU) harmonized legislation and inter- Consortium, which is part of the Ministry national standards. Spain joined the EU of Economy and Finance (MEH). The pen- in 1986, the European Monetary System sion fund market, a relatively new market, in 1989, and the Economic and Monetary began operating in 1989, and comple- Union in 1999. ments the compulsory “pay-as-you-go” Among the measures taken, the BDE pension fund with a private system. was vested with the powers, tools, and

1 International Monetary Fund, Financial Sector Assessment Process for Spain.

116 Profile: spain

resources to act as an independent supervi- Institutional Structure sor and central bank, and as a member of of the Regulators the European System of Central Banks. Spain’s current financial regulatory system Spain’s financial market became increas- can be described as evolving toward a mod- ingly integrated with European and global ified twin peaks system. As explained, there markets as restrictions to capital flows were are three prudential supervisors for banks progressively eliminated, new monetary (BDE), investment firms (CNMV), and and financial instruments developed as a insurance companies (DGSFP). In addi- result of technological and communication, the Regional Governments (Comuni- tion innovations, and as business was dades Autónomas) have limited regulatory internationalized. and supervisory powers over certain financial intermediaries in their respective Statutory Framework jurisdiction. In particular, they have limited Law 13/1994 of Autonomy of the Banco de powers over savings banks and credit coop- España established BDE’s objectives, func- eratives, which do not include solvency tions, and powers as a central bank within or financial stability issues but pertain to the Eurosystem, and as a banking supervi- certain aspects of corporate governance, sor and regulator. consumer protection, transparency, and Law 26/1988 of Discipline and Intervention social contributions. In these areas, there of Credit Institutions established the supervi- is smooth cooperation between the BDE sory framework of the BDE, in particular, and Regional Governments. The Regional its enforcement and sanction capacity. Governments also have certain supervisory The basic law for securities and the authority over regional markets and their CNMV is Law 24/1988 of Securities Markets trading and post-trading infrastructures. (Ley 24/1988 del Mercado de Valores), which created the agency and granted regula- Ministry of Economy and Finance (MEH) tory and supervisory powers. Another key The MEH has wide regulatory powers over law is Law 35/2003 of Collective Investment the financial system within the framework Institutions (Ley de Instituciones de Inversión of the rule of law. The development of Colectiva). laws and MEH’s regulations on technical The key laws for insurance and the implementation rules can be delegated to DGSFP are Law 50/1980 of Private Insur- the BDE and the CNMV, which, according ance Contract; the Insurance Supervising Law to their lawful duties, have the techni- (Texto Refundido de la Ley de Ordenación cal knowledge and expertise to directly y Supervisión de los Seguros Privados, RDL address the more complex sectoral issues. 6/2004); the Insurance Intermediation The involvement of the MEH in the finan- Activity Law (Ley de Mediación de Seguros cial regulatory process is meant to ensure y Reaseguros Privados, 26/2006); and the consistency among the three financial sec- Pension Funds Law (Texto Refundido de la Ley tors (banking, securities, insurance), the de Regulación de Planes y Fondos de Pensiones, supervision of which is assigned to three RDL1/2002). different agencies. The MEH grants credit institution and Nonstatutory Elements investment firm licenses, based on the No nonstatutory elements have been reports of the BDE and CNMV. It is also noted.

117 The Functional Approach

responsible for imposing the most serious hensive Central Credit Risk Register. In sanctions on institutions, when such action addition, all Spanish credit institutions are is proposed by their prudential supervisor. subject to an external statutory audit of Decisions taken by the BDE and the CNMV their annual financial accounts, which is in relation to institutions can be appealed complemented by a supplementary ad hoc before the MEH. report to the BDE. The BDE follows a risk-focused supervi- General Directorate of Insurance . sory model in order to gain and maintain and Pension Funds (DGSFP) updated, in-depth knowledge of each The DGSFP, which is part of the MEH, credit institution’s risk profile. This model is responsible for supervision of private allows for the BDE’s efficient systematiza- insurance and reinsurance, insurance tion of working methods and for the adop- intermediation, capitalization, and pension tion of timely preventive measures, while funds. The DGSFP does not have regula- also providing incentives for risk manage- tory powers; however, the MEH takes into ment and internal governance improve- account its proposals before issuing insur- ments in supervised entities. ance regulations. The DGSFP receives its BDE is led by a Governor and Deputy budget as part of the government’s budget. Governor, the first proposed by the Presi- dent of the Government and appointed Bank of Spain (BDE) by the King, and the second proposed The BDE is the prudential supervisor and by the Governor and appointed by the regulator of banks (credit institutions) Government. Both are appointed for in Spain, and is also the Spanish central six-year, nonrenewable terms. BDE’s gov- bank. It is responsible for the supervision erning board includes the Governor and of the solvency and performance of credit Deputy Governor, and six other members institutions, and for their compliance with proposed by the MEH (board members sectoral regulations. It is an independent serve for six years, renewable for another authority, with operational and budgetary six), the Director General of the Treasury, autonomy. Its financial resources come and the Vice-President of the CNMV. The from its operational income and not from managing directors of the BDE, the BDE’s fees charged to supervised institutions. Secretary General, and a representative of The BDE has the authority to formulate the BDE’s employees have nonvoting rights detailed rules for credit institutions, called on the board. Reporting to the govern- “circulars.” For example, it is within the ing board is an Executive Commission, BDE’s jurisdiction as banking supervisor to composed of the Governor and Deputy issue circulars on credit institution solvency Governor, two of the six board members, and accounting rules. The BDE conducts the Managing Directors of the BDE, and ongoing supervision of Spanish credit the Secretary General (nonvoting). institutions, based on close monitoring, on both an individual and a consolidated Spanish Financial Intelligence . basis, underpinned by frequent on-site Unit (SEPBLAC) visits by in-house bank examiners, and The SEPBLAC has the legal authority and detailed regular and ad hoc supervisory responsibility for supervising and enforcing reporting, complemented by a compre- compliance with anti-money laundering

118 Profile: spain

and terrorist financing (AML) rules. once. Other members of the Governing Although the BDE is not empowered with Council include three members appointed supervisory responsibilities regarding AML, by the Ministry of Finance, each appointed the BDE and the SEPBLAC have signed a for four years, renewable once; the Direc- Memorandum of Understanding (MoU) tor General of the Treasury; and the for cooperation and information sharing. Deputy Governor of the BDE. Reporting BDE assists SEPBLAC by providing it with to the CNMV is an Executive Commission human and financial resources. composed of the members of the Board, excluding the Director General of the National Securities and Exchange . Treasury and the Deputy Governor of Commission (CNMV) the BDE. The CNMV has a Consultative The securities markets and investment Committee, chaired by the CNMV Vice- firms are supervised by the CNMV, which President, which consists of 17 members oversees Spanish stock markets and the representing the different members of the activities of all the participants in those securities markets, issuers, and investors in markets. The CNMV’s statutory regulatory Spain. competences are delegated by the MEH. The Investor Guarantee Fund The CNMV’s financial resources come (FOGAIN) guarantees money or securi- from fees paid by the institutions subject ties entrusted to an investment firm, up to supervision. Distribution of excess funds to a maximum of €20,000 per investor, to the Treasury can occur. The agency’s when the firm is unable to return them budget must be approved annually by the to its client for reasons related to its own Parliament as part of the normal govern- financial position (not market risk). When mental budgetary process. the money or securities are entrusted to The objective of the CNMV is to ensure credit institutions, this same guarantee is the transparency of the Spanish markets provided by the three Deposit Guarantee and to protect investors. The CNMV Funds for banks, cooperatives, and savings focuses on promoting the improvement banks. All deposit guarantee funds have ex of the quality of information disclosed to ante funding, and a maximum payout limit investors and enforcing rules of conduct, of €20,000 per investor. In exceptional but it also has prudential authority over a circumstances, they may receive additional number of securities entities. The CNMV contributions from the BDE. devotes considerable effort to detecting Figure 7 provides a graphic depiction and pursuing illegal activities by unreg- of the relationship among the above-men- istered intermediaries. It uses primarily tioned institutions. off-site supervision, requiring extensive regular and ad hoc information from all Enforcement publicly quoted companies, but also on-site The BDE and CNMV have enforcement supervision, focusing on areas of higher powers over Spanish credit institutions potential risk. Like the BDE, the CNMV and investment firms. The BDE has a wide has a risk-focused supervisory model. range of preemptive tools to address an The CNMV is led by a President and entity facing major difficulties, including Vice-President, both appointed by the the issuance of requirements or binding Government for four years, renewable instructions, commonly accompanied by

119 The Functional Approach

Figure 7. The Financial Services System Regulatory Structure, Spain

European Union (EU)

Committee of Financial Ministry of Economics Stability (CEFSI) and Finance (MEH)

National Level Bank of Spain National Securities and General Directorate of Insurance (BDE) Exchange Commission (CNMV) and Pension Funds (DGSFP)

BANKING SECURITIES INSURANCE

Deposit Guarantee Investor Guarantee Funds (DGFs) Funds (FOGAIN)

Regional governments have some Regional governments have Regional Level limited powers over savings certain supervisory powers banks and credit cooperatives over regional markets

Note: Dotted lines indicate a cooperative relationship.

action plans encompassing limitation of ance of their supervisory duties. For this activities, disinvestment in specific assets, purpose, they have signed bilateral MoUs, and measures to increase own funds. including the sharing of confidential The BDE and the CNMV can use sanc- supervisory information. Coordination tions against supervised entities. The BDE among regulators is further supported via has the power to levy varying degrees of cross-membership of the boards of the sanctions on credit institutions, their man- BDE and CNMV. agement, and relevant shareholders. The In 2006, the three financial authori- decision over the imposition of sanctions ties, together with the MEH, endorsed a for very severe infringements rests with the multilateral MoU for financial stability MEH, upon the advice of the BDE, except and the prevention and management of for the revocation of a banking license, systemic crises. As a result, the Committee which is the responsibility of the Council of for Financial Stability (CESFI) was created Ministers. The CNMV has an almost identi- to promote the exchange of information cal legal disciplinary framework. related to financial stability and the cooperation among financial authorities during Framework for Domestic Coordination both normal times and when financially The three supervisors—BDE, CNMV, and stressed conditions risk causing systemic DGSFP—are legally obliged to cooperate effects. The CESFI is an informal commit- with each other for the effective perform- tee for the coordination of systemic crises

120 Profile: spain

management and resolution. It is chaired International Coordination by the Secretary of State for Economy and The BDE cooperates with foreign finan- includes the Deputy Governor of the BDE, cial authorities in accordance with the the Vice-President of the CNMV, the Direc- principles of the Basel Committee and tor General of Insurance, and the Director the European directives. The BDE has General of the Treasury. This commit- endorsed bilateral MoUs with banking tee follows the recommendation of the supervisors of EU and non-EU countries, multilateral MoU for cooperation in crisis where there are branches or subsidiaries of situations, signed in 2005 and renewed in some importance on either side. In addi- June 2008, with the rest of the financial tion, the BDE has endorsed multilateral supervisory authorities, central banks, and MoUs within the EU with other central finance ministries of EU countries. banks, financial supervisors, and ministries The responsibilities of the different of economy. authorities during financial crises are Finally, according to the 2008 MoU explicitly set out in Spanish laws and among EU financial supervisory authori- regulations. The BDE, acting both as the ties, central banks, and finance ministries, central bank and as the banking supervi- Cross-Border Stability Groups are foreseen sor, is the authority in charge of managing to be established for the management of banking crises. As a central bank, it plays cross-border financial crises within the EU. the role of lender of last resort, within the The CNMV also signed the 2008 EU MoU. framework of the Eurosystem. In extreme The CNMV cooperates with the Ibero- circumstances, the BDE may take the deci- American Institute of Stock Markets to sion of intervening in a credit institution, foster progress and modernization of Latin replacing its management, or involving the America’s securities markets through train- corresponding Spanish Deposit Guarantee ing and cooperation programs. Fund (DGF).2 The DGFs in Spain have a Please refer to the chart of international twofold function, which constitutes a dis- coordination activities and organizational tinctive feature compared with other Euro- participation on page 234. pean guarantee schemes: they not only act as guarantee schemes (maximum €20,000 Current Issues per depositor), but they can also take part The current model has demonstrated its in banking crises management (direct efficacy over the years, supported by the financial assistance, capital restructuring, fact that large financial groups in Spain are and measures aimed at favoring a merger dominated by banks, as opposed to other or acquisition by a sound institution), countries where financial conglomerates within the framework of restructuring play a major role. In recent years, there plans approved by the BDE. The CNMV has been a recurrent internal policy debate also has crisis management powers over the about a potential change in the current entities under its responsibility, and there model of sectoral financial supervision, is also, as previously noted, an Investor with the prevailing alternative being the Guarantee Fund. twin peaks model, which would consist

2 There are three DGFs—for banks, saving banks, and credit cooperatives.

121 The Functional Approach

of the BDE’s integrating the prudential markets and investors and financial cus- supervision of banking, securities, and tomer protection. The MEH has publicly insurance, while another authority would announced its intention to propose this be in charge of the supervision of financial institutional change to the Government.

Acronyms and Abbreviations

AML Anti-money laundering BDE Bank of Spain (Banco de España) CESFI Committee for Financial Stability (Comité de Estabilidad Financiera) CNMV National Securities and Exchange Commission (Comisión Nacional del Mercado de Valores) DGF Deposit Guarantee Fund DGSFP General Directorate of Insurance and Pension Funds (Dirección General de Seguros y Fondos de Pensiones) EU European Union FOGAIN Investor Guarantee Fund (Fondo de Garantía de Inversores) MEH Ministry of Economy and Finance (Ministerio de Economía y Hacienda) MoU Memorandum of Understanding SEPBLAC Spanish Financial Intelligence Unit (Servicio Ejecutivo de la Comisión de Prevención del Blanqueo de Capitales e Infracciones Monetarias)

122 the integrated approach

The integrated approach is one in which a single universal regulator conducts both safety and soundness oversight and conduct-of-business regulation for all sectors of financial services business.

Canada · Germany · Japan · Qatar · Singapore · Switzerland · The United Kingdom canada The Integrated Approach

Market Description total industry revenues—73 percent. Retail In 2007, the Canadian banking sector, firms accounted for 15 percent of revenues representing approximately $2.5 trillion1 while institutional firms accounted for 12 in assets,2 comprised 20 domestic banks, 24 percent. foreign bank subsidiaries, and 29 foreign Canada’s insurance sector includes 196 bank branches. The Canadian banking insurers with approximately $413 billion in industry contributes approximately 3 assets under administration.3 percent of total gross domestic product directly, or approximately $33 billion Background annually. Domestically, it employs some The current Canadian financial regulatory 250,000 people, about 1.5 percent of structure, which developed in response total employment. Within this sector, six to bank failures in the 1980s, can be Canadian banks dominate—the Royal described as an integrated and functional Bank of Canada, the Canadian Imperial hybrid, because it has characteristics of Bank of Commerce, the TD Bank Financial both integrated and functional systems. Group, The Bank of Nova Scotia, The Bank The legislative and regulatory framework of Montreal, and the National Bank of for banks is entirely federal. The federal Canada. At the end of fiscal 2007, these six government, through the Department of banks combined represented $2.25 trillion Finance, is responsible for the legislative in assets. framework, the Office of the Superin- The mutual fund sector, with approxi- tendent of Financial Institutions (OSFI) mately $700 billion in assets in 2007, is the prudential supervisor, the Canada consists of the manufacturers of mutual Deposit Insurance Corporation (CDIC) is funds and the distributors, with a number the deposit insurer, the Bank of Canada is of mutual fund companies involved in both the lender of last resort, and the Financial segments of the business, notably those Consumer Agency of Canada (FCAC) is owned by the banks and the credit unions responsible for adherence to consumer pro- (caisses populaires). tection provisions in the Bank Act. The fed- The Canadian securities sector is made eral Competition Bureau, an independent up of integrated, institutional, and retail agency, plays a major role in determining firms. The number of firms participating whether mergers among financial institu- in the Canadian securities industry has tions can proceed. The OSFI and the Minis- risen significantly over the years. Although ter of Finance also have a role. The federal there are approximately 207 securities Financial Transactions Reports Analysis firms operating in Canada, the six larg- Centre of Canada is responsible for anti- est integrated securities firms, which are money laundering and anti-terrorist financ- owned by the big six domestic banks, ing, which, in the case of federal financial continue to account for the largest share of institutions, it has delegated to OSFI.

1 All dollar amounts are in Canadian dollars. 2 Trust and loan companies offer similar services to banks but administer estates, trusts, pension plans, and agency contracts. (While banks are not permitted to undertake these activities directly, the largest trust companies are subsidiaries of the major banks.) 3 Assets under administration usually represent assets beneficially owned by clients but administered by a company.

126 Profile: canada

The Bank of Canada is the nation’s companies, trust and loan companies, and central bank. In the early 1930s, a gather- pension plans, and to provide actuarial ing depression and mounting criticism of services to the government. The OIGB was the country’s existing financial structure established in the mid-1920s as a result of coincided with a concern over the lack of the failure of the Home Bank, with the a direct means in Canada for settling inter- mandate to regulate Canada’s chartered national accounts. In 1933, a royal commis- banks. At that time, the notion of a govern- sion was set up to study the organization ment inspection system for banks was not and working of the entire banking and widely embraced—there were concerns monetary system and to consider the argu- about cost, efficiency, and duplication of ments for and against a central banking work being performed by internal and institution. The arguments “for” won, and external auditors. In response, the new reg- in 1934 the Bank of Canada was founded ulatory system was patterned on the one in as a privately owned corporation. In 1938, use in the United Kingdom, which did not it became a Crown corporation belonging include on-site examinations and placed a to the federal government. great deal of reliance on self-regulation. From 1980 through 1986, 22 deposit-tak- The 1980 Bank Act allowed banks to ing institutions, most of which were trust have subsidiaries in different sectors such companies, failed in Canada, many as a as venture capital and mortgage loans, result of aggressive growth strategies. The which led to the creation or purchase of Office of the Superintendent of Financial mortgage loan companies by the banks. Institutions (OSFI) was formed in 1987 as a In 1987, Canadian banks were permitted result of these failures. OSFI is responsible to invest in corporate securities and to for supervising the operations of banks and distribute government bonds. All major federally regulated financial institutions, banks made substantial investments in the including insurance companies and private securities business, and purchased control pension plans. Prior to the establishment of most of the existing large investment of OSFI, a Department of Insurance, an dealers. In 1992, banks were given the Office of the Inspector General of Banks, right to enter the trust business through and the Canada Deposit Insurance Corpo- the establishment or acquisition of trust ration (CDIC), together were responsible companies. for overseeing the insurance and banking The regulation of the Canadian securi- sectors of the industry. ties industry is carried out by the provinces OSFI, established in 1987, was created and territories, each having its own through the merger of the Department securities regulator. Following the lead of of Insurance (DOI) and the Office of the a number of states in the United States Inspector General of Banks (OIGB). The almost a century ago to enact their own DOI (formerly called the Office of the securities law, that is, the Blue-Sky Law, Superintendent of Insurance) was estab- Canadian provinces began passing their lished at the beginning of the 20th century own securities legislation shortly thereafter. in response to problems experienced in The 13 provincial and territorial regulators the industry. The role of the DOI was to collaborate through the Canadian Securi- oversee federally licensed life insurance ties Administrators (CSA), whose goal is to and property and casualty insurance develop a national system of simplified and

127 The Integrated Approach

harmonized securities regulation, policy, The 2007 amendment to the Bank Act and practices while retaining regional resulted in a number of changes to acts flexibility. governing financial institutions, including In the past, the Bank Act prohibited the Bank Act, the Cooperative Credit Associa- Canadian banks from selling most types tions Act, the Insurance Companies Act, and of insurance either directly or indirectly the Trust and Loan Companies Act. through subsidiaries; banks were restricted The Insurance Companies Act (1991) is to selling a limited selection of insurance designed to help protect insurance pur- products viewed as incidental to the busi- chasers by setting out guidelines for insur- ness of banking. Legislative reforms in ance companies. The Act provides details 1987 and 1992 increased the potential for regarding insurance and its applicability competition among financial institutions with incorporation, continuance and dis- by enabling federal financial institutions continuance, capital structure, corporate to develop into financial conglomerates. governance, ownership, business and pow- The 1992 reforms extended the ability to ers, investments, and other relevant topics. own insurance subsidiaries. The issue of The Trust and Loan Companies Act (1991) banks retailing insurance products in their outlined the rules regulating trust and loan branches emerged as a dominant subject companies in Canada. of early debate during consultations for the The Canada Deposit Insurance Corporation 1997 review of federal financial institutions Act (1967) established the CDIC to protect legislation. Current federal legislation depositors and to promote the stability allows limited retailing of insurance by of the financial system in Canada. The banks but prohibits the complete integra- Corporation reports to Parliament through tion of banking and insurance in Canada. the Minister of Finance, and its objectives The federal and provincial governments are to provide insurance against the loss of share regulation of the life- and health- part or all of deposits and to promote and insurance sector, with the main federal otherwise contribute to the stability of the regulator being OSFI. financial system in Canada. The Cooperative Credit Association Act Statutory Framework (1970) established the rules regulating The Bank Act (1871) regulates Canada’s Cooperative Credit Associations. These banks. The Act divides banks into two associations are organized and operated on groups—Schedule I and Schedule II banks. cooperative principles, with one of its prin- Schedule I banks, for the most part domesti- cipal purposes being to provide financial cally owned, are widely held (no single services to its members. owner may control more than 10 percent The Canadian Payments Act (1980) estab- of the banks’ voting stock). Schedule II lished the Canadian Payments Association banks are closely held; many are owned by as a regulated public-purpose organization, their foreign parent financial institutions. with a mandate to establish and operate a The Act allows the government to control national clearings and settlement system the size of Schedule II banks, except for and to plan the evolution of the national U.S.-owned Schedule II banks, which are payments system. In June 2001, the Act was exempt, in keeping with the provisions of revised to update and refine the Canadian the North American Free Trade Agreement. Payments Association’s mandate, expanded

128 Profile: canada

the membership, and added new gover- Mutual Fund Dealers Association . nance features. of Canada (MFDA) The Financial Consumer Agency of Canada The MFDA was established in 1998 by the Act (2001), established the FCAC as an Canadian Securities Administrators and agency responsible for strengthening the is an SRO that regulates the operations, oversight of consumer protection measures standards of practice, and business conduct in the federally regulated financial sector. of its members and their representatives, The federally regulated Canadian financial with a mandate to enhance investor protec- services sector includes all banks and tion and strengthen public confidence in all federally incorporated or registered the Canadian mutual fund industry. The insurance, trust and loan companies, and MFDA is recognized as an SRO by the cooperative credit associations. The Act majority of the provinces and is responsible outlines FCAC’s functions, administration, for the distribution side of the mutual fund and enforcement powers. industry. The Office of the Superintendent of Finan- The MFDA Investor Protection Corpora- cial Institutions Act (OSFI) (1987) created tion (IPC) is a not-for-profit corporation a single regulatory agency responsible and is a separate legal entity from the for the regulation and supervision of all MFDA. The MFDA IPC provides protection federally chartered, licensed, or registered to eligible customers of MFDA Members banks, insurance companies, trust and loan on a discretionary basis to prescribed lim- companies, cooperative credit associations, its, if securities, cash, and other property and fraternal benefit societies. In addition, held by any such member are unavailable it established the Financial Institutions as a result of the member’s insolvency. Supervisory Committee (FISC), composed Responsibility for regulation of the funds of the Superintendent of Financial Institu- or the fund manufacturers remains with tions, the Governor of the Bank of Canada, the securities commissions. the Deputy Minister of Finance, the The IDA, TSX Group, and the Montreal Chairperson of the CDIC, and the Com- Exchange sponsor the Canadian Investor missioner of the FCAC. FISC was created Protection Fund, a trust fund that was to simplify and enhance the confidential established in 1969 to protect investor exchange of information among its mem- assets in the event of the insolvency of an bers on all matters related to the supervi- SRO member firm. sion of financial institutions. Investment Dealers Association (IDA) Nonstatutory Elements The IDA is the national SRO of the securi- Provincial securities regulators delegate ties industry, whose members include more certain aspects of securities regulation to than 200 investment dealers. The IDA self-regulatory organizations (SROs), such regulates the activities of investment deal- as the Investment Dealers Association of ers in terms of both their capital adequacy Canada (IDA), the Mutual Fund Dealers and conduct of business. Association of Canada (MFDA), and Mar- In 2007, member firms of the IDA voted ket Regulation Services, Inc. for a merger with RS Market Regulation

129 The Integrated Approach

Services, Inc., and a new SRO, provision- responsibilities for Canada’s monetary ally, New Regco,4 was formed. policy, bank notes, financial system, and funds management. Institutional Structure The Bank regulates financial markets of the Regulators largely through its influence on interest As mentioned, the current Canadian finan- rates, and acts as a lender of last resort cial regulatory structure can be described (LOLR). The Bank of Canada has rarely as an integrated and functional hybrid, had to extend Emergency Lending Assis- because it has characteristics of both inte- tance (ELA) as the LOLR to financial grated and functional systems. institutions.5 The Bank of Canada is under the man- Department of Finance agement of a Board of Directors composed The Department of Finance drafts legisla- of a Governor, a Deputy Governor, and tion governing federal financial institutions 12 directors appointed by the Minister of to ensure they are safe and sound, and Finance. The Governor and Deputy Gov- determines the regulatory framework for ernor are appointed by the directors with banking and other financial services. Estab- the approval of the Governor in Council lished under the Financial Administration (the Governor General of Canada acting Act, it is led by the Minister of Finance, who by and with the advice and consent of the is appointed by the Prime Minister. The Queen’s Privy Council for Canada). They Department receives most of its funding are appointed to seven-year terms. Direc- through annual Parliamentary appropria- tors are appointed to three-year terms and tions. Parliament approves resources to may be reappointed. The Deputy Minister the Department, including voting on of Finance sits on the Board as a nonvoting appropriations and statutory authorities for member. both budgetary and non-budgetary items. The majority of the Bank’s revenue is The Department of Finance participates in investment income earned on its portfolio the Financial Institutions Supervisory Com- of government securities. Most of this rev- mittee (FISC). enue is paid to the Government of Canada; a small portion is used each year to finance Bank of Canada the Bank’s general operating expenses. The Bank of Canada was founded in 1934 as a privately owned corporation. In 1938, Office of the Superintendent . it became a Crown corporation belonging of Financial Institutions (OSFI) to the federal government. The Bank of OSFI was established in 1987 and reports Canada is the nation’s central bank, with to the Minister of Finance. OSFI is the

4 This merger has not been approved as yet by the Canadian Securities Administrators. 5 In the last 30 years, there have been a small number of examples of ELA to federal chartered banks in Canada. The first involved Unity Bank of Canada and occurred in 1977. In that case, the Bank of Canada provided ELA over a three-month period. Unity Bank was merged with the Provincial Bank of Canada. The second case involved two banks, the Canadian Commercial Bank and the Northland Bank, and occurred in 1985. These two small regional banks were supplied with ELA over a six-month period, at the end of which authorities concluded that neither bank was viable and they were liquidated. A number of other small regional banks also received ELA in the aftermath of the closure of the two banks.

130 Profile: canada

primary supervisor of federally chartered The CDIC’s Board of Directors consists financial institutions and federally admin- of a Chairperson, five ex officio directors, istered pension plans. It is an independent and five private sector directors. The Chair- institution, and although it reports to the person of the CDIC is appointed by the Minister of Finance, on certain key matters Governor in Council to serve for a defined OSFI retains sole responsibility for its judg- term pursuant to the CDIC Act, unlike the ments and actions, notably decisions and other private sector directors who serve actions related to prudential supervision. pursuant to the provisions of the Financial This leading role in prudential supervision Administration Act. The ex officio direc- is underscored by the Superintendent’s tors consist of officials from the Bank of position as Chair of the Financial Stability Canada, the Department of Finance, OFSI, Committee. and the FCAC. The Superintendent of Financial Insti- Membership in the CDIC is limited to tutions is appointed by the Governor in banks, federally incorporated trust and Council to a seven-year term. The Super- loan companies, provincially incorporated intendent is responsible for exercising the trust and loan companies, and retail asso- authorities under the financial legislation, ciations within the meaning of regulations and is required to report to the Minister of promulgated under the Cooperative Credit Finance on the administration of the finan- Associations Act. The CDIC automatically cial institutions’ legislation. OSFI is funded insures deposits in federal institutions that mainly through asset-based, premium- are authorized to take retail deposits. based, or membership-based assessments The CDIC is funded by premiums that on the financial services industry and are assessed on the insured deposits of related fees for selected services. A small member institutions. The CDIC does not portion of OSFI’s revenue is derived from receive federal tax dollars to carry out its the Government of Canada, primarily for operations. actuarial services relating to Canadian pension programs and public sector pension Securities Regulators and benefit plans. The 10 provinces and three territories in Canada are responsible for securities regu- Canada Deposit Insurance . lations. Securities regulators from each Corporation (CDIC) province and territory form the Canadian The CDIC is a federal Crown corporation Securities Administrators (CSA). The CSA created by Parliament in 1967. Its mandate is primarily responsible for developing a is to protect depositors and to promote harmonized approach to securities regula- and otherwise contribute to the stability of tion across the country. In recent years, the the financial system in Canada. CDIC mem- CSA has developed a system that designates ber institutions pay premiums to CDIC to one securities regulator as the lead agency cover the cost of insuring deposits. In the when it comes to reviewing applications or event of a failure, CDIC pays depositors disclosure documents from companies that the amount of their insured savings—up to report to more than one jurisdiction. The $100,000 in each of six categories of CDIC purpose of this system is to increase market deposit insurance coverage. efficiency by streamlining the process and

131 The Integrated Approach

Figure 8. The Financial Services System Regulatory Structure, Canada

Department of Finance Financial Institutions Supervisory Committee (FISC)

Office of the Superintendent Canada Deposit Financial Consumer Agency Federal Level Bank of Canada of Financial Institutions (OSFI) Insurance Corporation (CDIC) of Canada (FCAC)

Prudential Supervisor Consumer Protection

BANKING

INSURANCE

PENSION PLANS

Canada Securities State Level Administrators (CSA)

SECURITIES

Note: Dotted lines indicate a cooperative relationship.

reducing the number of regulatory agen- instability of a financial institution. There cies with which a given company must deal. are four stages of intervention: (1) when While the CSA coordinates initiatives deficiencies are first detected, that is, early on a cross-Canada basis, provincial or ter- warning; (2) when there is a risk to viability ritorial regulators handle all complaints or solvency of the institution; (3) when regarding securities violations in their viability or solvency of an institution is in respective jurisdictions. Enforcement of serious doubt; and (4) and when nonviabil- securities regulations for individual firms ity or insolvency is imminent. Each stage is also done on an individual basis by each is associated with an increasing level of province or territory. intervention that can be undertaken by the Figure 8 provides a graphic depiction OSFI. Interventions taken at each stage are of the relationship among the above-men- coordinated with CDIC, and other agencies tioned institutions. are kept informed via the FISC. OSFI’s level of intervention gradually Enforcement escalates in severity and can include formal The OSFI and the CDIC have numerous notification to management, meeting with mechanisms by which they can inter- management, or monitoring an institution vene in the case of a failing institution. on an escalating basis; requiring the institu- These are laid out by the OSFI and the tion to increase capital; requiring a special CDIC in a Guide to Intervention for Federal audit; restricting the institution’s business; Financial Institutions. The Guide provides seeking a possible buyer; taking control; a framework for responding effectively or after taking control, OSFI can seek to circumstances that could lead to the a winding-up order by a court, at which

132 Profile: canada

point a liquidator, which is not OSFI, can tutions. It is also a forum for consultation be appointed. and information exchange on supervisory After reports of major corporate fraud matters that have implications for solvency, and misconduct in the United States in last-resort lending, and the risk of deposit- 2001/2002, actions were taken in Canada insurance payout. The FISC is intended by governments, regulators, and industry to give the Superintendent of OSFI, who to foster investor confidence in capital is responsible for judgments pertaining to markets. The federal government adopted the viability and solvency of federal finan- a coordinated national enforcement cial institutions, the full benefit of views of approach to strengthen the investigation the deposit insurer and the lender of last and prosecution of serious corporate fraud resort when making supervisory decisions. and market illegality, which included the The FISC also serves as a forum to coor- creation of integrated market enforcement dinate strategies of its member agencies teams (IMETs) with the Royal Canadian when dealing with troubled institutions. Mounted Police in Canada’s major finan- The Bank of Canada has the ability to cial centers. Six IMETs are currently opera- inject liquidity in its role as LOLR and via tional in Canada. its emergency lending role. It can inject As a regulatory agency, the Financial liquidity into a broad range of financial Consumer Agency of Canada (FCAC) can institutions if the Governor, in consultation exercise its enforcement powers to ensure with FISC colleagues, determines it is nec- that financial institutions comply with the essary to ensure the safety and soundness consumer provisions of the various federal of Canada’s financial system. However, in acts relating to financial services. In cases of recent years the Bank of Canada has not contravention or noncompliance, it notifies had to exercise this ELA role. the financial institution of a violation. It The FISC provides the principal forum may also, depending on the severity and fre- in which issues related to financial stability quency of the problem, seek a commitment and possible bank failures are discussed. Its from the financial institution to remedy membership includes the leaders of all the the issue within a short time frame, impose key supervisory agencies: the Department a monetary penalty, impose criminal sanc- of Finance, the Bank of Canada, the OSFI, tions, or take other actions as necessary. the CDIC, and the FCAC. The Superinten- dent of OSFI chairs the FISC. Framework for Domestic Coordination The FISC meets regularly to address The Financial Institutions Supervisory financial stability, supervision, and LOLR Committee (FISC) was established in 1987 matters. The FISC met daily during recent pursuant to the Office of the Superintendent turmoil in the asset-backed commercial of Financial Institutions Act. Its membership paper market in Canada. Much of the consists of the Superintendent of Financial debate in the FISC is, by necessity, initially Institutions (who acts as chair), the Deputy not disclosed to the public. Minister of Finance, the Governor of the Canadian regulators do not have a Bank of Canada, the chairperson of the formal Memorandum of Understanding CDIC, and the Commissioner of the FCAC. (MoU) with respect to the intervention of The FISC meets regularly to discuss matters financial institutions; however, the OSFI and related to the supervision of financial insti- the CDIC have the Guide to Intervention for

133 The Integrated Approach

Federal Financial Institutions, which provides Current Issues a framework for coordination. Supervisors Debate continues in Canada over the also have the Senior Advisory Committee reform of the current regulatory frame- (SAC), a body that provides a forum from work for Canadian securities markets. In within which broader questions of overall 2003, the Wise Persons’ Committee was system policy development and implementa- established by the Minister of Finance of tion can be debated. The SAC is led by the Canada to undertake an independent, Department of Finance, and its membership objective review of the current securities is the same as the FISC. regulatory framework. The committee Regulators coordinate on combating recommended that a single regulator built money laundering and terrorist financing. on joint federal-provincial participation The OSFI and others have signed an MoU replace the current system of provincial with the Financial Transactions Reports regulation. This has yet to be imple- Analysis Centre of Canada. mented. In 2005, the Crawford Panel The Joint Forum of Financial Market recommended a Canadian Securities Regulators, founded in 1999 by the Cana- Commission. dian Council of Insurance Regulators, the Another structural and supervisory Canadian Securities Administrators (CSA), issue that is being debated concerns the and the Canadian Association of Pension drafting of legislation that would permit Supervisory Authorities, and including the creation of a bridge bank by the CDIC. representation from the Canadian Insur- A bridge bank is a temporary banking ance Services Regulatory Organizations, structure put in place and maintained by was established as a mechanism through the government, designed to take over which pension, securities, and insurance the operations of a failing bank in order regulators could coordinate, harmonize, to maintain services to its customers.6 The and streamline the regulation of financial CDIC and its supporters believe that such products and services in Canada. a facility would provide further assurance to depositors after the closure of a failed International Coordination institution. Please refer to the chart of international coordination activities and organizational participation on page 234.

6 Nicholas J. Ketcha, Jr., “Deposit Insurance System Design and Considerations,” Bank for International Settle- ments, Basel, November 1999, www.bis.org/publ/plcy07o.pdf.

134 Profile: canada

Acronyms and Abbreviations

CDIC Canada Deposit Insurance Corporation CSA Canadian Securities Administrators DOI Department of Insurance ELA Emergency Lending Assistance FCAC Financial Consumer Agency of Canada FISC Financial Institutions Supervisory Committee IDA Investment Dealers Association IMETs Integrated market enforcement teams IPC Investor Protection Corporation LOLR Lender of last resort MFDA Mutual Fund Dealers Association of Canada MFDA IPC MFDA Investor Protection Corporation MoU Memorandum of Understanding OIGB Office of the Inspector General of Banks OSFI Office of the Superintendent of Financial Institutions SAC Senior Advisory Committee SRO Self-regulatory organization

135 germany The Integrated Approach

Market Description of the fact that Germany had adopted the The Deutsche Bundesbank and the euro, thereby reducing the powers of the German Financial Supervisory Authority Landeszentralbanken (state central banks) (BaFin) currently supervise approximately in the central banking system. At the same 2,079 banking institutions and 718 financial time, the government reevaluated the services institutions, 633 insurance under- institutional nature of the banking supervi- takings, 26 pension funds, 6,000 investment sion system since it no longer suited the funds, and 78 investment companies. The evolving financial services market. Growing supervised banks are categorized into four integration of the financial sector had led large groups: lending banks, savings banks, to blurred boundaries across financial cooperative banks, and other (building services sectors and an overlap in products, societies, mortgage banks, securities trading services, and supervisory functions. banks, and both the federal and state hous- A key part of the reform was restructuring promotion banks).1 ing supervision under one institution—the The German banking system has the newly created integrated supervisor, the lowest level of concentration, or level Bundesbank and the German Federal of market share held by a small number Financial Supervisory Authority (BaFin)— of financial institutions, in Europe. The which replaced the three institutional traditional three-tier banking system in the supervisors, the BaKred, the BaWe, and Federal Republic of Germany, consisting the BAV. However, the Bundesbank is of private, public-sector, and co-opera- assigned most of the operational tasks in tive banks, is slowly being transformed. banking supervision. To avoid duplication Further changes are likely as a result of the of work, the Bundesbank and the BaFin elimination of the Landesbanken’s public have spelled out the details of their respec- guarantees (Gewährträgerhaftung) and the tive roles in day-to-day supervision in an modification to maintenance obligation agreement. (Anstaltslast) in 2005. After World War II, the military governments of the Western Allies assigned regu- Background latory powers to the newly created Bundes- The German regulatory structure is länder (the individual Federal States characterized as an integrated regula- within Germany’s new federal system). The tory structure. Prior to 2002, Germany’s Federal States performed the functions of financial regulatory system was institutional banking supervision, together with their in its approach. The Federal Banking respective Federal-State central banks Supervisory Office (BaKred) regulated (Landeszentralbanken). To coordinate banking, the Federal Securities Supervisory their activities, in 1949 the Landesregier- Office (BaWe) was in charge of securities, ungen (governments of the Bundesländer) the Federal Insurance Supervisory Office established a Special Banking Supervision (BAV) regulated insurance, and state Committee, bringing together representa- regulators supervised stock exchanges. tives of all banking supervisory authorities, In 2002, the Bundesbank Act (the central including Federal ministry representatives. bank act) was amended, to take account The Bundesbank was established in 1957

1 www.bafin.de

138 Profile: germany

as the sole successor to the two-tier central of Germany’s financial sector, enhancing bank system, composed of Bank Deutscher its ability to compete within the interna- Länder and the Landeszentralbanken, for- tional arena. One of the key elements mer legally independent bodies. Together, of the reform was the establishment of these institutions bore responsibility for the Federal Securities Supervisory Office the German currency from June 1948, (BaWe) in 1995.2 Almost all provisions of when the Deutsche Mark was introduced, Germany’s Securities Trading Act are based until the Bundesbank was founded. on European directives.3 Throughout the 1950s, discussions With the end of World War II, unified continued to address problems relating to insurance supervision collapsed. The Reich legal and jurisdictional ambiguity. In 1961, Insurance Supervisory Office ceased to the Banking Act was passed, creating the exist, and the Occupying Powers assumed legal basis for the establishment of the Fed- responsibility for insurance supervision. eral Banking Supervisory Office (BaKred). However, by the end of 1945, attempts were During 1962–2002, the BaKred saw the being made to reestablish insurance super- number of supervised credit institutions vision. The fragmentation of insurance decrease from approximately 13,000 to supervisory activities in postwar Germany 2,600, while the number of branches was also considered to be counterproduc- expanded from 18,000 to 51,000. tive. Those involved in the debate sur- The BaKred’s powers increased as a rounding a general overhaul of legislation result of a banking crisis in 1974, when a agreed that the Insurance Supervision Act Cologne-based bank, Herstatt, failed. The of 1901 should remain intact. However, banking law was amended to authorize the there were differing views as to whether BaKred to issue a temporary moratorium on public insurers should also be subject to a bank in financial difficulties or to conduct official supervision. In 1951, the BAV was special audits without particular cause. The established, paving the way for the creation changes also included more stringent provi- of a federal office for the supervision of the sions concerning large exposures and the insurance sector and of building and loan introduction of the principle of dual control associations.4 The BAV was responsible for for senior management or directors. the supervision of both private and public Federal securities supervision was insurance undertakings engaged in com- created as a result of the Second Financial petitive business operating in more than Market Promotion Act, adopted in 1994. one region of the country.5 This legislation provided a federal body to supervise securities markets and prompted Statutory Framework a far-reaching reform of Germany’s securi- The Banking Act is the primary legal basis ties markets regulation. The main goal of for the supervision of banks, and has been the reform was to bolster the efficiency amended on a number of occasions since it

2 Germany’s Securities Trading Act of 1995. 3 “History of Securities Supervision,” www.bafin.de. 4 In 1973, supervision of building and loan associations came under the jurisdiction of the BaKred, following the adoption of the Building and Loan Associations Act. 5 “History of Insurance Supervision,” www.bafin.de.

139 The Integrated Approach

first came into effect in 1962. A number of Nonstatutory Elements specific acts further define the supervisory In Germany, industry associations exist environment, such as the Mortgage Bonds in every sector of the finance business. Act, the Securities Deposit Act, the Building and They represent and promote the interests Loan Associations Act, and the Savings Banks of their members in all matters relating Acts of the Federal States. In 1985, the Third to financial policy. The associations also Amendment to the Banking Act was passed. provide best practice rules that apply to Various amendments followed, seeking to all their members, and additional volun- align German law with other European tary deposit protection schemes for the Union (EU) directives. banking sector. The voluntary protection In 1998, the Sixth Amendment to the schemes of the associations enhance the Banking Act implemented additional EU guarantee on customer deposits beyond directives. It also empowered the BaKred statutory requirements. Industry associa- with the necessary regulatory tools to com- tions include: bat unauthorized banking business and financial services as part of its extended 8 The Association of German Banks; scope of supervision. In mid-2002, bank- 8 The Association of German Public ing supervision had become a directorate Sector Banks; within the newly established BaFin. 8 The German Savings Banks The legislation relating to the supervi- Association; sion of securities includes the Securities 8 The Association of German Coopera- Trading Act, the Securities Acquisition and tive Banks ; Takeover Act, the Securities Prospectus Act, and 8 The German Investment and Asset the Prospectus Act. For asset management, Management Association; and the BaFin supervises the financial services 8 The German Insurance Association. institutions and investment companies on the basis of the Banking Act and the Invest- Institutional Structure of the ment Act. Regulators The Third Financial Market Promotion Act The German regulatory structure is of 1998 granted additional broad powers to characterized as an integrated regulatory obtain information relative to insider trad- structure. ing, and extended the notification requirements for shareholders in exchange-listed Ministry of Finance enterprises. In 2002, the BaWe was BaFin is subject to the legal and techni- assigned the task of monitoring corporate cal oversight of the Federal Ministry of takeovers, in line with the newly enacted Finance, which monitors BaFin’s admin- Securities Acquisition and Takeover Act. The istrative actions for legality and fitness of Fourth Financial Market Promotion Act of purpose. 2002 further realigned the scope of supervision, and the BaFin is now responsible for Financial Supervisory Authority (BaFin) monitoring the prohibition on price and The BaFin was established in 2002 as the market manipulation. integrated financial supervisor in Germany

140 Profile: germany

for the supervision of credit institutions subject to unlimited insurance supervision and financial services providers, insurance by the BaFin. Social insurance institutions undertakings, and securities trading. (that is, statutory health insurance funds, Its primary objective is to guarantee the the statutory pension insurance fund, proper functioning, stability, and integrity statutory accident insurance, and unem- of the German financial system. ployment insurance) are not subject to The BaFin’s mission is to counteract supervision by the BaFin, but are regulated undesirable developments in the bank- by other government agencies. ing and financial services sector that may BaFin is an independent body governed endanger the safety of the assets entrusted by public law. Its Administrative Council to institutions or that might impair the oversees management and is responsible proper conduct of banking business, for deciding the BaFin’s budget. The provision of financial services, or involve Administrative Council is composed of 21 serious disadvantages for the national members, chaired by the Federal Ministry economy. Through its securities supervi- of Finance, and includes representatives sion, the BaFin also enforces standards of from the Federal Ministry of Finance and professional conduct that aim to preserve other ministries, the Bundestag, credit investor trust in the financial markets. institutions, and insurance and investment The BaFin also has an investor protection companies.6 In 2008, the management role and seeks to prevent unauthorized structure for day-to-day operations was financial activities. Operators of exchange- changed from having authority rest solely like trading systems are subject to the with the President of the BaFin to a Board same solvency supervision by the BaFin as of Directors, consisting of the President credit institutions and financial services and four Chief Executive Directors. institutions. An Advisory Council, which meets The two primary objectives of insur- twice a year, also aids the BaFin in general ance supervision are to ensure that the matters related to its further development interests of policyholders are adequately of supervisory law. The 24 members of safeguarded and that the obligations aris- the council are drawn from academia, ing under insurance contracts can be met the supervised undertakings, consumer at all times. The BaFin supervises private protection associations, and the Deutsche insurance undertakings of material eco- Bundesbank. nomic significance, and public insurance Separate organizational units were undertakings engaging in open competi- created for supervision of banking, insur- tion that operate across the border of any ance, and securities/asset management. Federal State. The Federal States mainly There is cross-sectoral coordination across supervise public insurers whose activities functional areas necessitated by develop- are limited to the Federal State in question ments in the financial markets, carried out and to those private insurance undertak- by several cross-sectoral departments that ings of lesser economic significance. Since are organizationally separated from the 2004, domestic undertakings engaging in traditional supervisory functions. The tasks the reinsurance business have also been

6 BaFin Annual Report 2006, p. 227.

141 The Integrated Approach

of these departments include coordination the President, the Vice-President, and four of the work in international supervisory other members (due to a transition period, forums, risk analysis and financial market there are currently five other members). studies, consumer and investor protection, Its mandate is to govern and manage and the fight against money laundering the Bundesbank. The members of the across all sectors. Board are appointed by the President of In 2006, the BaFin employed approxi- the Federal Republic. The President, the mately 1,600 people. It does not receive Vice-President, and one other member are any funding from the federal budget; nominated by the German Federal Govern- rather, it is financed by cost allocation payment, and the other three members are ments (2006 estimate: €106 million) and nominated by the Bundesrat (the upper fees, including separate reimbursements house of Parliament) in agreement with (2006 estimate: €18.9 million) from the the Federal Government. At the end of companies subject to supervision.7 2007, the Bundesbank had approximately 11,600 employees.9 The Deutsche Bundesbank The Bundesbank is the central bank of the Deposit Insurance Federal Republic of Germany, and it plays Germany has a statutory deposit protection an important role in virtually all areas of system for deposits with any credit institu- banking supervision.8 The Bundesbank tion with a registered office in the Federal is responsible for ongoing supervision Republic of Germany. The amount of the (evaluations of bank reports, annual claim to compensation is limited to 90 per- accounts and auditor reports, interviews, cent of the non-fulfilled claim and a maxi- onsite examinations, and so forth), with mum of €20,000 for each depositor. All the exception of (sovereign) individual deposit-taking credit institutions must by regulatory measures vis-à-vis institutions, law join a statutory compensation scheme. which are reserved for the BaFin, pru- In addition to the statutory protection, dential audits, and international coopera- there are also private protection schemes tion/coordination in the prudential field. run by the respective banking associations, In addition, the Bundesbank plays an which offer protection in excess of the important role in crisis management. In statutorily prescribed degree of protection. exercising its powers, the Bundesbank is independent of and not subject to instruc- Bundesländer tions from the Federal Government. The The authorities of the Federal States Bundesbank advises the Federal Govern- (Bundesländer) supervise the individual ment on monetary policy issues of major stock exchanges, including the orderly importance. conduct of trading on these exchanges, in The Bundesbank’s decision-making accordance with the provisions of the Stock body is the Executive Board. It comprises Exchanges Act. The BaFin cooperates with

7 Jahresbericht, BaFin Annual Report 2006. 8 www.bundesbank.de/bankenaufsicht/bankenaufsicht_bafin.en.php. 9 www.bundesbank.de.

142 Profile: germany

Figure 9. The Financial Services System Regulatory Structure, Germany

Ministry of Finance European Union (EU)

Federal Financial Supervisory Deutsche Bundesbank Authorithy (BaFin) Federal Level Administrative Council BANKING BANKING

SECURITIES Advisory Councils INSURANCE

CROSS SECTOR

Bundesländer supervise State Level stock exchanges

Note: Dotted lines indicate a cooperative relationship. the stock exchange supervisory authorities management and/or the institution’s in fulfilling the functions of stock exchange Board of Directors. regulator at the international level. Figure 9 provides a graphic depiction Framework for Domestic Coordination of the relationship among the above-men- The Deutsche Bundesbank cooperates tioned institutions. with the BaFin in ongoing banking supervision, as stipulated by section 7 of Enforcement the Banking Act. Both organizations spelled The BaFin has wide-ranging powers of out the details of their respective roles in investigation and intervention, and has day-to-day supervision in a February 2008 extensive powers to enforce the immediate updated Supervisory Guideline (Guideline cessation and closure of unauthorized on the execution and quality assurance business activities. Under the Insurance of the ongoing supervision of credit Supervision Act, the BaFin may issue any and financial services institutions by the instructions that may be “appropriate and Deutsche Bundesbank). Under this agree- necessary” to prevent or eliminate undesir- ment, the Bundesbank is assigned most of able developments that threaten to harm the operational tasks in banking supervi- the interests of policyholders. sion. In the ongoing monitoring process, To address serious supervisory weak- the Bundesbank’s responsibilities include nesses in institutions, the BaFin can initiate evaluating the documents, reports, annual consultations, order a special audit, impose accounts, and auditors’ reports submitted higher capital requirements, freeze the by the institutions, and regular audits of institution, revoke licenses, and replace banking operations. It holds both routine

143 The Integrated Approach

and ad hoc prudential discussions with the mind that each financial crisis will be dif- institutions. The BaFin, on the other hand, ferent, the arrangements are flexible. is responsible for all sovereign measures. Since unauthorized businesses are The Deutsche Bundesbank, the BaFin, becoming increasingly international, the and the Federal Ministry of Finance meet BaFin cooperates not only with the Federal regularly in the Forum for Financial Mar- Office of Criminal Investigation and its ket Supervision with the aim of coordinat- Bundesländer counterparts, but also with ing the supervision of enterprises operat- the regulatory and criminal prosecution ing in the financial markets and enhancing authorities of other countries. existing concepts of supervision, in particular against the backdrop of current market International Coordination developments. Formal discussions among Please refer to the chart of international the three institutions are supplemented by coordination activities and organizational information exchange. participation on page 234, and to the Euro- In addition, Germany has established pean Union profile for an explanation of a Domestic Standing Group for financial coordinating activities within the EU. market stability and crisis management. This body has developed a general frame- Current Issues work for crisis management; however, this No current issues have been noted. framework is not made public. Bearing in

Acronyms and Abbreviations

BaFin Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht) BaKred Federal Banking Supervisory Office (Bundesaufsichtsamt für das Kreditwesen) BAV Federal Insurance Supervisory Office (Bundesaufsichtsamt für das Versicherungswesen) BaWe Federal Securities Supervisory Office (Bundesaufsichtsamt für den Wertpapierhandel) EU European Union

144 japan The Integrated Approach

Market Description There are five city banks, four of which The Japanese financial system is notable (Mizuho Bank, Mizuho Corporate Bank, for the large role that deposit-taking Sumitomo Mitsui Banking Corporation, institutions continue to play in financial and Bank of Tokyo-Mitsubishi UFJ) have intermediation. In the 1980s, bank loans a combined total banking asset share of constituted more than 30 percent of all around 35 percent. The total assets within corporate liabilities.1 Although the percent- banking were approximately ¥761 trillion age has declined since then, reflecting the (Japanese yen). The Japan Post Bank is still shift to direct fundraising from the market, undergoing privatization, which is planned bank loans still constitute 18 percent of all to be achieved by 2017. Among non-bank liabilities. The large role of deposit-taking financial institutions, the market for mon- institutions in financial intermediation is eylenders registered with the Financial also reflected in the size of their assets and Services Agency (FSA) is classified broadly liabilities, which constitute more than 50 into 12 categories, by type of operations.4 percent of the sum of assets and liabilities In 2006, there were 9,066 such companies. of all financial intermediaries.2 As of March The market size of the non-bank business, 2007, there were 618 financial institutions particularly the consumer credit business, is insured by the Deposit Insurance System, generally measured based on the loan bal- including 147 banks and 455 cooperative- ance, which was about ¥41 trillion in 2006.5 type deposit-taking institutions (includ- Historically, securities companies in ing 287 Shinkin banks and 168 credit Japan operate mainly as dealers (including cooperatives).3 retail stock subscriptions and trades). They

1 Flow of Funds statistic base. 2 Ibid. 3 Shinkin Banks: Shinkin banks are cooperative financial institutions whose membership is composed of local residents and small and medium-sized companies. Shinkin banks’ distinctive characteristics are (a) they are close and convenient, (b) they have fine-tuned and personalized services, and (c) they have a strong relationship of mutual trust with their customers and communities. Shinkin banks limit their lending, in principle, to members; however, their functions are almost the same as those of commercial banks, and they also deal with many people who are not members, accepting deposits, providing exchange services, accepting various payments including those for public utilities, and engaging in over-the-counter sales of public bonds, investment trusts, and insurance. Credit Cooperatives: Credit cooperatives are not-for-profit cooperative financial institutions owned and managed by their members, and they offer various financial services (such as commercial banks) for their members. Originally, credit cooperatives were founded for the purpose of mutual financial aid among their own communities. Generally, credit cooperatives are divided into three groups, each having members that share common bonds in membership: (a) residency, (b) type of business, or (c) occupation (workplace). Labor Banks: Labor Banks are organized and managed under the Labor Bank Law, enacted in 1953, which states: “The objectives of this law are to establish a Labor bank system jointly organized by trade unions, consumers’ livelihood cooperatives, and other worker’s organizations, to plan smooth financing of the welfare and mutual-aid activities of such organizations, thereby contributing to their healthy growth, as well as to improve the economic status of workers.” 4 These types of operations are as follows: (a) consumer unsecured loan companies (major companies with a loan balance of more than ¥50 billion, and others); (b) consumer secured loan companies; (c) consumer residential loan companies; (d) business loan companies; (e) bill dealers; (f) credit card companies; (g) credit loan companies; (h) retail distributor/manufacturer-affiliated loan companies; (i) construction companies and realty dealers; (j) pawnbrokers; (k) leasing companies; and (l) “Nippu” loan companies (dealing with short-term loans for small, self-employed business owners). 5 “Statistical Data Related to Moneylending Business — Movement of the Loan Balance by Type of Operations/ Business Condition of Moneylenders by Type of Operations,” www.fsa.go.jp/en/index.html.

146 Profile: japan

are generally not engaged in investment controlled about 90 percent of total assets banking activities. The three major securi- in 2006. ties companies (Nomura Securities Co., Ltd., Daiwa Securities Co., Ltd., and Nikko Background Citigroup Limited) do engage in some Japan is characterized as having an inte- investment banking activities as a part of grated regulatory structure. The reform their operations, but they engage in far of the previous supervisory system into more dealer activities for personal securi- an integrated system was a reaction to ties trades. perceived weaknesses in the traditional The life insurance industry has 41 life inspection and supervisory practices of the insurance companies that currently oper- Ministry of Finance (MOF), which empha- ate in Japan. Of the 41 companies, 12 are sized consultation and administrative foreign-affiliated companies and 4 are guidance, often called the “convoy system.” foreign branches. The total assets were Regulatory reform was spurred by eco- ¥220 trillion in 2006.6 The market in Japan nomic events, namely the gradual deflation is broadly shared by the so-called “Big of the economic boom of the late 1980s, Ten”7 and 31 other companies. The Big which by the 1990s had resulted in stagfla- Ten companies had a combined industry tion, and saw the collapse of a number of total asset share of around 80 percent for banks. Hokkaido Takushoku Bank, one of the past three years. The share of the Big the city banks in Japan, went bankrupt in Ten is decreasing while that of the 31 other 1997. Yamaichi Securities Co., Ltd., one of companies has been gradually expanding. the Japanese Big Four securities companies The publicly owned Japan Post Insurance, at that time, closed its business, and in as mentioned, continues to undergo 1998, the Long-Term Credit Bank of Japan gradual privatization, which is expected to and The Nippon Credit Bank, Ltd. failed. be achieved by 2017. Policymakers from the Diet felt that a new With regard to the property and casualty supervisory structure and approach was insurance industry, the total assets8 held needed to ensure that individual bank’s by the 23 domestic companies (excluding problems did not develop into a broader companies specialized in reinsurance busi- systemic or financial crisis. ness) were approximately ¥35 trillion in To consolidate the supervisory system 2006. The six largest property and casualty into a more effective one and to deal with companies, referred to as the “Big Six,”9 the banking crisis, various institutional

6 Based on data from “Insurance for 2007—Statistics of Life Insurance Business in Japan, 2006,” published by the Insurance Research Institute. 7 The Big Ten are (a) Nippon Life Insurance Co., (b) Meiji Yasuda Life Insurance Co., (c) Dai-ichi Mutual Life Insurance Co., (d) Sumitomo Life Insurance Co., (e) Mitsui Life Insurance Co., (f) Daido Life Insurance Co., (g) Asahi Mutual Life Insurance Co., (h) Fukoku Mutual Life Insurance Co., (i) AXA Life Insurance Co., Ltd., and (j) Taiyo Life Insurance Co. 8 The market share analysis for the general insurance industry is generally made based on the “premium income.” The analysis here is based on the “total assets” for the comparison with other industries. 9 These companies are (a) Tokio Marine & Nichido Fire Insurance Co., Ltd., (b) Sompo Japan Insurance Inc., (c) Mitsui Sumitomo Insurance Co., Ltd., (d) Aioi Insurance Co., Ltd., (e) NIPPONKOA Insurance Co., Ltd., and (f) Nissay Dowa General Insurance Co., Ltd.

147 The Integrated Approach

changes were implemented. The Financial changed its name to Financial Services System Reform in the late 1990s involved Agency (FSA). After the creation of the a big shift in the regulatory approach FSA, the Bank of Japan retained its bank- from ex ante regulation (limiting entry of ing supervisory role via its private contracts financial intermediaries, restricting the with depositors. types of financial services or products that Prior to the Japanese Big Bang in 1992, could be provided) to ex post regulation the Securities and Exchange Surveillance (liberalizing entry while adopting measures Commission (SESC) was established to to enhance transparency of financial trans- supervise securities transactions. Today the actions, investor protection rules). Many SESC is a semi-independent body under changes took place during this period of the FSA. It conducts market surveillance rapid reformation. There was liberalization and on-site inspections but does not have of the entry into the various industries powers to impose administrative actions. within the financial services arena. In 1996, the Prime Minister directed the Minister Statutory Framework of Finance and the Minister of Justice to The experience in dealing with the Japa- commence the “Japanese Big Bang,” the nese financial crisis in the late 1990s led overall reform of the financial system. The to the clarification of the role of financial Japanese Big Bang was based on three authorities in case of a financial crisis. principles—“free, fair and global”—aiming The Ministry of Finance Law outlines the to increase the competitiveness of the Japa- duties of the MOF. nese financial market. The Bank of Japan Law, (Act No. 89 of In 1998, a new integrated supervisor, 1997), defines the responsibility of the the Financial Supervisory Agency10 (FSA1), Bank of Japan for on-site examination took over from the MOF the authority to and for providing lender-of-last-resort inspect deposit-taking institutions (banks, functions. Shinkin banks, credit cooperatives, and The FSA Law established the FSA and so forth), securities firms, and insurance the SESC. It outlines the Agency’s and the companies. From 1998 to 2001, the Finan- Commission’s responsibilities and func- cial Reconstruction Commission (FRC) tions regarding supervision and inspection played a central role in the planning of of financial institutions, surveillance of the failure resolution of, and capital injection securities markets, licensing, and other to, financial institutions, and the FSA1 regulatory activities. was positioned below the FRC. In 2001, The Deposit Insurance Law protects the FRC was abolished and its functions depositors and provides assistance in merg- were transferred to the FSA1, resulting in ers or other transactions involving failed the present framework in which the FSA1 institutions. Notwithstanding the provisions is the sole integrated regulator. In 2000, of the Law Concerning Limitation of Public the authority for policy planning and Financial Assistance to Corporate Entities, the implementation regarding the financial government may provide guarantees for system was transferred from the MOF to liabilities with respect to funds borrowed the Financial Supervisory Agency, which by the Deposit Insurance Corporation of

10 The MOF kept the function of managing the financial system during this time frame.

148 Profile: japan

Japan (DICJ) or bonds issued by the DICJ, Insurance Policyholders Protection Corpo- within the limits approved by a resolution ration of Japan, for property and casualty of the Diet. insurance, was established. In addition, the The Financial Instruments and Exchange Investors Protection Fund was established Law of 2007 (FIEL) is a broadly revised to protect investors from losses incurred version of the former Securities and Exchange due to a failure of a securities firm. Law.11 The FIEL presents a uniform legal infrastructure for financial market trans- Institutional Structure of the actions. Securities-related businesses by Regulators deposit-taking institutions and insurance The Japanese financial regulatory structure companies are regulated under the FIEL is characterized as an integrated approach based on the Banking Law and the Insur- led by the Financial Services Agency, with ance Business Law. the Ministry of Finance and the Bank of Japan continuing to retain an important Nonstatutory Elements role. The Deposit Insurance Corporation There are various self-regulatory com- of Japan is responsible for implementing ponents adopted by industry groups practical measures such as reimbursement (voluntary associations), such as the of insured deposits and financial assistance Japanese Bankers Association, the Regional to reorganize failed banks. Banks Association of Japan, the National Association of Shinkin Banks, the Life Ministry of Finance (MOF) Insurance Association of Japan, the Gen- The MOF is responsible for managing the eral Insurance Association of Japan, the government’s budget and maintaining Japan Securities Dealers Association, the the credibility of Japanese currency and Commodity Futures Association of Japan, the stability of foreign exchange markets. the Japan Financial Services Association, The MOF’s supervisory role is limited as and the Japan Securities Investment Advis- a result of the establishment of the FSA, ers Association. These industry groups although it retains a role within the crisis were established to enhance the position management council. In addition, the of each industry in the economy and to MOF is responsible for the budgets of all of protect their own interests through politi- the country’s public entities, including the cal lobbying. FSA. The MOF has approximately 70,000 In 1998, the Insurance Policyholders employees. Protection Corporation of Japan, for life insurance, was established to support Bank of Japan (BOJ) policyholders, in the event of the failure of The objective of the BOJ, as the central life insurance companies, for the transfer bank, is to issue currency and to carry of insurance policies, and for the payment out monetary policy. In addition, the of covered claims. All of the life insurance BOJ is responsible for financial stability companies in Japan are currently members to ensure effective settlement of funds. of this organization. Also in 1998, the BOJ’s principal supervisory role, the use

11 Many securities-related laws are integrated with the FIEL, such as the Law on Investment Trust and the Invest- ment Advisor Law.

149 The Integrated Approach

of on-site examinations, enables it to fulfill Financial Services Agency (FSA) its financial stability responsibility. These The FSA is part of the Cabinet Office. The examinations are based on contractual FSA is responsible for ensuring stability of relationships with all institutions that the financial system; protection of deposi- maintain deposits at the central bank. The tors, insurance policyholders, and securi- institutions agree to on-site examinations ties investors; and smooth finance, through by the BOJ. Such examinations allow the such measures as planning and policymak- BOJ to maintain a detailed understanding ing concerning the financial system; and of the day-to-day health of financial institu- inspection and supervision of private sector tions, providing necessary information for financial institutions. the BOJ to conduct its lender-of-last resort The FSA is headed by a commissioner functions. appointed by the Minister for Financial The Board of the BOJ is composed of Services based on approval of the Cabinet. nine members, each with a five-year term: The Minister for Financial Services, the six Members of the Policy Board, the Senior Vice-Minister, and the Parliamen- Bank of Japan’s Governor, and two Deputy tary Secretary, who are appointed by the Governors. The Governor and Deputy Prime Minister, are assigned to oversee Governors are appointed by the Cabinet, the FSA’s operations. Approximately 1,300 subject to the consent of the House of Rep- people are employed by the FSA. resentatives and the House of Councilors. The Members of the Policy Board are also Securities and Exchange Surveillance Com- appointed by the Cabinet, subject to the mission (SESC) consent of the House of Representatives The SESC is a commission under the FSA and the House of Councilors. The Gov- and conducts market surveillance and ernor appoints the BOJ’s staff. The BOJ on-site inspections of securities companies. reports semiannually to the Diet. The SESC is authorized to carry out

Figure 10. The Financial Services System Regulatory Structure, Japan

Office of the Prime Financial Crisis Minister Management Council

Ministry of Finance Financial Services Agency (FSA) Bank of Japan (BOJ) (MOF)

BANKING

SECURITIES

INSURANCE

Deposit Insurance Corporation of Japan (DICJ)

Note: Dotted lines indicate a cooperative relationship.

150 Profile: japan

inspections but not to take administrative other than deposits for payment and actions such as penalties. The FSA imposes settlement purposes, which are protected penalties based on the advice of the SESC. in full. The DICJ’s wholly owned subsidiary, The FSA has the authority to supervise the Resolution and Collection Corpora- securities companies while the SESC has tion, handles management and disposal the authority to inspect them. The SESC is of assets purchased from failed financial governed by a chairman and two commis- institutions. sioners, who are appointed to a three-year Figure 10 provides a graphic depiction term by the Prime Minister, with the con- of the relationship among the above-men- sent of both Houses. As of 2007, the SESC tioned institutions. had a staff of approximately 600. All SESC operations are funded within the budget Enforcement allocated to the FSA. In 1998, “Prompt Corrective Action” (PCA), a framework that provides for the Deposit Insurance Corporation . FSA to issue administrative orders to finan- of Japan (DICJ) cial institutions based on capital adequacy The DICJ is a quasi-autonomous govern- requirements, was introduced. In addition mental organization established in 1971 to the PCA, FSA has an “Early Warning for the purpose of operating the deposit System,” including in-depth interviews, insurance system. It consists of one requests for reports, and administrative Governor, four Deputy Governors, and an orders to improve a financial institution’s Auditor (part-time). Officers are appointed handing of credit risk, market risk, and by the Prime Minister with the consent of liquidity risk. FSA also has a PCA and an both Houses of the Diet. The Policy Board Early Warning System for securities and within the DICJ is composed of not more insurance activities. than eight members, in addition to the The FSA can take various actions when Governor and the Deputy Governors of the faced with an institution in trouble. It can DICJ. Subject to the approval of the Prime issue administrative orders requiring vari- Minister and the Minister of Finance, the ous measures including: alterations to a Governor of the DICJ appoints members firm’s business plan; a reduction in assets, to the Policy Board to a one-year term, and a prohibition against entering into new they can be reappointed. The executives business; a halt to deposits; an increase in of the DICJ, who serve a two-year term, capital; and the merger or closure of an include one Governor, no more than institution. four Deputy Governors, and one Auditor, who are appointed by the Prime Minister Framework for Domestic Coordination subject to the approval of both Houses of Japan has a specific crisis management the Diet. As of 2007, the DICJ had a staff of mechanism—the Financial System Manage- approximately 360. ment Council (FSMC)12—that is triggered The DICJ may provide for the payment when government intervention in a of deposit insurance claims for the princi- troubled financial institution is necessary. pal amount of ¥10 million per depositor The FSMC consists of the Prime Minister

12 See Deposit Insurance Law, Article 102.

151 The Integrated Approach

(chair), the Chief Cabinet Secretary, the cial System Council, which conducts wide- Minister for Financial Services, the Minister ranging deliberations on the financial sys- of Finance, the Commissioner of Financial tem in response to requests from the Prime Services, and the Governor of the BOJ. The Minister, the Commissioner of the FSA, or body meets when convened by the Prime the Minister of Finance. The Council has Minister, to take decisions when a financial conducted deliberations on matters that institution or institutions face serious call for improvements of the financial sys- liquidity or solvency issues. If necessary, tem involving legislative measures, and has the BOJ could provide uncollateralized presented reports on the financial system loans to an insolvent financial institution from medium- and long-term perspectives. upon request of the Prime Minister and the Minister of Finance, via a decision of International Coordination the FSMC. Since its creation, the FSMC has Japan participates in various international been used only twice, and since the blanket organizations. Please refer to the chart of guarantee was lifted, the general bank reso- international coordination activities and lution measure of providing partial deposi- organizational participation on page 234. tor protection has never been applied. There is currently no explicit Memoran- Current Issues dum of Understanding among authorities. No current issues were noted. Finally, general advice regarding the financial system is provided via the Finan-

Acronyms and Abbreviations

BOJ Bank of Japan DICJ Deposit Insurance Corporation of Japan FIEL Instruments and Exchange Law FRC Financial Reconstruction Commission FSA1 Financial Supervisory Agency (1998–2000) FSA Financial Services Agency (2000–present) FSMC Financial System Management Council MOF Ministry of Finance PCA Prompt and corrective action SESC Securities and Exchange Surveillance Commission ¥ Yen

152 qatar The Integrated Approach

Market Description regulator, the Qatar Financial Centre Current Qatar gross domestic product Regulatory Authority (QFCRA), tasked (GDP) is approximately US$60 billion. with overseeing supervision and regulation GDP grew by 10 percent in 2006 and of firms operating in the Qatar Financial is estimated to grow 12 percent a year Centre. The parallel system was created in through 2012. The country’s per capita response to a perceived need to attract new GDP is over US$70,000, placing Qatar financial institutions into the country and among the wealthiest countries in the to create a legal and supervisory structure world. Oil and gas account for more than that would achieve that goal. After review- 60 percent of GDP, which is roughly 85 ing the success of the QFCRA, the Qatari percent of export earnings and 70 percent government decided to move to a single, of government revenues.1 integrated regulator. Qatar has approximately 26 banks, There is also an ongoing consolidation insurance firms, and brokerage houses. in the securities market. In 2005, the Qatar There are 17 commercial banks, includ- Financial Markets Authority (QFMA) was ing 9 Qatari banks (6 commercial and created to supervise the Doha Securities 3 Islamic banks), and 7 subsidiaries of Market (created in 1995). The QFMA is foreign banks. The three largest banks, expected to merge with the QFCRA within Qatar National Bank, the Commercial the framework of the new single regulator. Bank of Qatar, and Doha Bank, accounted The Qatari legal system is a historically for 70 percent of the market share by the complex hybrid of English common law end of 2006.2 There are 9 insurance com- (drawn from Sudan, at the time a British panies, 5 of which are national, and 4 of protectorate), Napoleonic Code (via Egypt), which are agencies or branches of foreign and civil law. Upon becoming independent companies.3 The local exchange, the Doha in 1971, Qatar established the Qatar Mon- Securities Market, had 40 listed companies etary Agency (QMA) to maintain currency as of 2007. stability (pegging the Qatari Riyal to the U.S. dollar). In 1993, the Qatar Central Background Bank (QCB) was established and functions The Qatari financial regulatory system is as the central bank, replacing the QMA. undergoing a rapid evolution into a single Notwithstanding the aforementioned integrated regulator. These changes were changes, the Qatari financial services regu- triggered after a government-led analysis latory environment was unable to keep of the existing structure indicated the up with the demands of a fast-growing need for modernization of the supervisory economy. By 2004, its legal and regula- system. Authorities decided to adopt an tory structure was perceived as having onshore parallel system of financial super- become out-of-date. At that time, the QCB vision, with the Qatar Central Bank (QCB) exercised limited banking supervision over retaining supervisory powers over existing approximately 20 institutions (15 banks banking institutions, and an integrated and second-tier financial institutions). The

1 International Monetary Fund Country Report No. 08/5, January 2008. 2 Rankings and Market Share of all Qatar banks, www.qcb.gov.qa/Publications. 3 Ministry of Foreign Affairs, Qatar, www.english.mofa.gov.qa.

154 Profile: qatar

QCB required banks to have high levels of supervision of an international standard capital, and prohibited high-risk business desired by new entrants. activities. Insurance was essentially unregu- Banks and financial firms could choose lated (and outside of the QFCRA regime, the system under which they would be still is), with licenses being granted by regulated. The system was expected to be Authorities. There has been no specific observed and reviewed during its initial prudential regime for such domestic years of operation. The creation of a insurers. The powers of the QCB were parallel system was not only a supervisory enhanced in 2006, when it was granted change, but also a regulatory and legal additional prudential supervisory powers, change, with new laws being adopted by licensing, and enforcement mechanisms the government creating the QFCRA, for existing banks.4 based on international best practices. If Despite rapid economic growth, there were any conflicts with local Qatari international banks and financial firms law, the laws, rules, and regulations of the appeared to avoid Qatar for a number of QFC would prevail in respect of the institu- reasons, including an unclear regulatory tions licensed by the QFCRA. framework, an inability to secure banking licenses, a lack of legal certainty, and con- Statutory Framework cerns related to the quality of the judicial In 1993, Amiri Decree No. 15 (amended in system. In 2005, the Qatar government 1997) established the Qatar Central Bank sought to modernize its regulatory infra- (QCB) as the monetary authority in the structure in line with the best international State of Qatar. The QCB was mandated to practices. The government created a formulate monetary, banking, and credit supervisory system that would allow exist- policies to achieve certain financial and ing banks to remain under the supervision economic objectives. The powers of the of the QCB, while allowing new entrants QCB were enhanced in 2006, when it took the option of supervision as part of a new on prudential regulation powers, licensing, Qatar Financial Centre (QFC), with its own and enforcement mechanisms. legal, regulatory, and supervisory system. Law No. 7 of 2005 established the Qatar To date, over 80 firms have been licensed Financial Centre (QFC), consisting of by the QFCRA, with approximately 60 per- the QFC Authority, the QFCRA, the QFC cent of firms being licensed to undertake Appeals Body (renamed the QFC Regula- financial services activities, and the bal- tory Tribunal in 2007), the QFC Tribunal ance licensed to conduct related ancillary (renamed the QFC Civil and Commercial services (such as providing legal, auditing, Court in 2007), and the QFC Companies or compliance services). This “one country- Registration Office. The Doha Securities two systems” model sought not to disturb Market is governed by Law No. 14, effec- the existing regulatory arrangements tive in 1997. QFMA was established under and to provide a familiar supervisory and Law No. 33 in 2005 as amended by Decree regulatory framework for existing banks Law No. 14 in 2007 as an independent and while encouraging competition by offering empowered regulatory authority for the

4 History of the Qatar Central Bank, www.qcb.gov.qa/Historical%20Perspective.asp.

155 The Integrated Approach

domestic capital market. Its primary mis- of the QCB board and the approval of the sion is to implement a modern and robust Council of Ministers. It now holds over regulatory framework for the securities US$5.48 billion in assets, based on net markets and conduct effective and respon- international reserves.5 sible market oversight and supervision. Qatar Financial Centre Authority (QFC) Nonstatutory Elements The QFC was established in 2005 and No nonstatutory elements have been consists of the QFC Authority, the QFC noted. Regulatory Authority (QFCRA), the QFC Civil and Commercial Court, the Institutional Structure of the Regulators QFC Regulatory Tribunal, and the QFC The Qatari regulatory system is moving Companies Registration Office (CRO). It toward an integrated structure. provides a distinct business legal system with administration and dispute resolution Qatari Council of Ministers procedures. The QFC is led by a commer- The Qatari Council of Ministers is the cial authority and a regulator—the QFC highest executive authority in the country. Authority and the QFC Regulatory Author- All the laws must be approved by the Emir ity, respectively—which are independent of before they enter into force. The Emir, each other. who is the Head of State, holds legislative The Chairman of the QFC Authority, in power and issues the laws, proposed by the his capacity as Minister of Economy and Council of Ministers, after consulting with Commerce, determines the regulations the Advisory Council. The latter consists of that are applicable in the QFC. Regulations five permanent committees, including one affecting the duties, functions, and powers on Financial and Economic Affairs. of the regulatory bodies (including the Tribunal and Court) must be consented to Qatar Central Bank (QCB) by the Qatari Council of Ministers. The QCB is responsible for prudential regulation, licensing, and banking supervi- Qatar Financial Centre Regulatory . sion. Its supervisory role will be replaced Authority (QFCRA) by that of the new integrated regulator, The QFCRA is an integrated regulator and currently being referred to as the Financial provides the model for the new integrated Regulatory Authority (FRA). The QCB will regulator (the FRA) announced in 2007. remain in charge of monetary policy and It has been closely modeled on the UK’s issues related to financial stability, such as Financial Services Authority. The QFCRA evaluation of new financial products. The is in charge of licensing and supervision QCB is governed by a Board of Directors of all forms of financial services (banking, and a Governor. insurance, asset management, financial The original capital of the bank was advisory services, securities, and derivatives 50 million Qatari Riyals, fully paid by dealing). The QFCRA’s main objectives the government. The capital has been are financial stability and reduction of increased as needed on recommendation systemic risk, and promoting efficiency,

5 uk.reuters.com/article/marketsNewsUS/idUKL1959707220071120.

156 Profile: qatar

transparency, integrity, and confidence in and regulation to ensure fostering investor the financial market. confidence, creation and strengthening The QFCRA is an independent body, the market institutions, conducting proper governed by a Board, is composed of up to market surveillance and formulating an six members (including a majority of inter- adequate supervision framework, stream- national non-Qatari supervisory experts). lining market processes and reducing The Board is appointed by the Qatar financial risks, and improving investor Council of Ministers and reports directly to awareness and protection.7 the Council. The Minister of Economy and Com- The QFRCA is financed in large part merce is currently the Chairman of by appropriations from the Government QFMA’s Board, and the Deputy Governor of Qatar, supplemented by fees paid by of the QCB serves as the Deputy Chairman the regulated entities. In 2006, the total of the QFMA. The activities of QFMA will expenses of the QFCRA were US$14.167 be subsumed into the FRA when that body million.6 becomes active. Other judicial and regulatory functions are carried out by the QFC Civil and Doha Securities Market (DSM) Commercial Court (formerly the QFC The DSM is responsible for the regulation Tribunal), the QFC Regulatory Tribunal and supervision of the issuance of and (formerly the Appeals Body), and the QFC dealing in securities for purchase and sale. Companies Registration Office. The DSM is considered an independent legal entity. It is managed by the Market Qatar Financial Markets Authority (QFMA) Committee, which consists of two repre- The QFMA was established in 2005 as the sentatives of the Ministry of Economy and regulatory supervising authority of the Commerce (one who is the President), domestic capital markets. It is the listing the Director of the DSM, a representative and licensing authority for the securities of the QCB, a representative of the Qatar industry and relevant activities. It also Chamber of Commerce and Industry, two has the responsibility to ensure market securities brokers, two representatives of integrity and transparency by enforcing the the Qatari joint-stock companies, and two market rules and regulations on market experienced and qualified persons, each participants, and conducting the necessary for a three-year term. It is expected that surveillance and supervision activities. The this oversight structure will also be over- QFMA has begun to implement a new hauled at the time the FRA takes on its full regulatory infrastructure for the capital responsibilities. markets and the securities industry based on the International Organization of Financial Regulatory Authority . Securities Commissions requirements and (FRA) (future structure) recommendations. Positive feedback from market participants The objectives of the QFMA include and an improved financial services regula- developing an adequate market structure tory environment prompted the Qatari

6 QFCRA Annual Report 2006; www.qfcra.com. 7 www.complinet.com/gccsummit/sponsors/about.html.

157 The Integrated Approach

Figure 11. The Financial Services System Regulatory Structure, Qatar

Council of Ministers

Qatar Central Bank (QCB) Qatar Financial Centre (QFC) Qatar Financial Markets Authority (QFMA)

BANKING SECURITIES

Doha Securities Market Qatar Financial Centre (DSM) Regulatory Authority (QFCRA)

BANKING QFC Civil and Commercial Court SECURITIES

INSURANCE QFC Regulatory Tribunal

Note: Dotted lines indicate a cooperative relationship.

government to propose to move the Enforcement entire system toward a single integrated The QFCRA, and in due course the FRA, regulator (based closely on the United can take enforcement or disciplinary Kingdom [UK] model) ahead of expecta- action for noncompliance with applicable tions, with an initial announcement of the laws and rules. The powers of the other government’s intentions in July 2007. legacy regulatory bodies are relatively The unified independent financial limited. regulatory body, known at present as the FRA, will bring together the QFCRA, the Framework for Domestic Coordination QCB’s banking supervision department, The reorganized structure of the Qatari and the Qatar Financial Markets Author- regulatory system will ensure coordination ity (QFMA). It will have broad powers to is inherent in its design. Supervisory roles authorize, supervise, and discipline finan- will be defined and will continue to be cial market participants. monitored over time. Figure 11 provides a graphic depiction of the relationship among the above-men- International Coordination tioned institutions. Coordination within the region remains rather weak. Debate continues over the

158 Profile: qatar

necessity of sharing supervisory responsi- of Understanding, outlining the respective bilities in normal periods and during peri- roles of these parties upon the creation ods of financial volatility. Qatar is publicly of the FRA. The Ministry of Finance will committed to joining the Gulf Cooperation likely have the key role of the lender of last Council monetary union by 2010. resort in the tripartite structure. Please refer to the chart of international To promote deeper cooperation and coordination activities and organizational coordination among the agencies, cross- participation on page 234 to understand membership of boards of the FRA and the Qatar’s participation in international regu- QCB is being considered. Mechanisms for latory activities. coordination among less senior staff are also being addressed. Current Issues The government seeks to attract inter- The Ministry of Finance, the QCB, and the national financial services firms to Qatar as QFCRA are studying current developments competition is growing from other Middle in the UK and, specifically, the UK’s reform East and North African regional financial of their existing tripartite arrangement centers. Human resources recruitment and among the government, the FSA, and the retaining of staff is a constant task, since Bank of England, in light of the issues obtaining adequate numbers and quality of raised by the failure of Northern Rock. personnel resources can be problematic in The Qatari government, the QCB, and the the region. QFCRA (in anticipation of the FRA) are A deposit guarantee insurance scheme is in the process of drafting a Memorandum being considered but is not yet in place.

Acronyms and Abbreviations

DSM Doha Securities Market FRA Financial Regulatory Authority GDP Gross domestic product QCB Qatar Central Bank QFC Qatar Financial Centre QFCRA Qatar Financial Centre Regulatory Authority QFMA Qatar Financial Markets Authority QMA Qatar Monetary Agency UK United Kingdom

159 singapore The Integrated Approach

Market Description banking and monetary environment neces- The Singapore financial services sector sitated streamlining functions to facilitate constitutes 11 percent1 of Singapore’s the development of a more dynamic and gross domestic product, which, in 2006, coherent policy on monetary matters. was S$132.16 billion (Singaporean dol- In 1977, in a continuing effort to lars).2 The Singapore market is heavily streamline the various financial sectors, influenced by foreign investment. There the government decided to bring the are 113 commercial banks including six regulation of the insurance industry under local banks, 107 foreign banks,3 and 49 the control of the MAS. The regulatory merchant banks in the regulated financial functions under the Securities Industry Act, services market. There are 285 entities in which was enacted in 1973, were also trans- the capital markets sector, consisting of ferred to the MAS in 1984. In 1986, the fund management firms, stockbrokerages, Futures Trading Act was implemented, and is financial advisers, and futures brokers. The administered by the MAS. insurance sector comprises 217 insurance In 2002, Singapore’s Board of Commis- companies and brokers. The remainder of sioners of Currency merged with the MAS the market comprises finance companies to rationalize common functions and real- and trust companies. ize efficiency gains, transforming the MAS into a central bank. Background Singapore has been a republic since 1965. Statutory Framework Prior to that time, it was a Crown Colony of The Monetary Authority of Singapore Act Great Britain. In 1959, Singapore attained (1970) defined the functions of the MAS, self-government rule. In 1963, it joined with which are to: (a) act as the central bank of Malaya to form the Federation of Malaysia, Singapore, which includes the conduct of but withdrew from the Federation in 1965, monetary policy, the issuance of currency, at which time it proclaimed itself a republic. the oversight of payment systems, and to Singapore has an integrated financial serve as banker to, and financial agent of, regulatory structure, under which the the government; (b) conduct integrated Monetary Authority of Singapore (MAS) supervision of financial services and finan- has the authority to regulate the bank- cial stability surveillance; (c) manage the ing, securities, futures, and insurance official foreign reserves of Singapore; and industries in the nation-state. The MAS (d) develop Singapore as an international is Singapore’s central bank, created by financial center. an Act of Parliament in 1970. Before the Amendments to the Act in 2007 establishment of the MAS, monetary func- addressed, among other issues, the tions were performed by various govern- following: ment departments and agencies. However, the demands of an increasingly complex

1 http://financeconnectsingapore.com/financesector.php?PHPSESSID=76893c9ddb46dbc977f2f6d11cf3819. 2 http://ddp-ext.worldbank.org/ext/ddpreports/ViewSharedReport?&CF=1&REPORT_ID=9147&REQUEST_ TYPE=VIEWADVANCED&HF=N&WSP=N. 3 www.mas.gov.sg/fi_directory/index.html.

162 Profile: singapore

8 Improvement of accountability and similar investment products, namely life governance of the MAS through clari- insurance policies and collective invest- fication of its role as an integrated ment schemes.4 The Act consolidated financial services supervisor and previous legislation governing financial central bank managing Singapore’s advisory services in respect to securities, official foreign reserves; futures, and life insurance products. 8 Revision of the scope of the MAS’s The Deposit Insurance Act (2005) requires powers to address emerging issues; all full banks5 and finance companies in and Singapore to be members of the Deposit 8 Consolidating requirements previ- Insurance Scheme. In the event a member ously imposed under various Acts fails, the MAS may compensate insured on money laundering and terrorism depositors out of the Deposit Insurance financing and enabling the MAS to Fund built up from premiums paid by issue regulations or directions for scheme members, and notify the Singapore that purpose. Deposit Insurance Corporation (SDIC), which is responsible for making the payout. The 2007 amendments to the Banking The Insurance Act (1967) provides the Act of 1970 affected policies and measures regulatory framework for engaging in the to strengthen prudential safeguards, facili- insurance business and for acting as insur- tate risk-based supervision, and provide ance intermediaries in Singapore. As part banks with greater operational flexibility. of an ongoing effort to bring the regula- Some key changes were strengthening tory framework for the insurance sector up prudential safeguards; enhancing the to international best practice standards, MAS’s role in bank resolutions; and the the Act was amended in 2003 to provide extension of the MAS’s regulatory scope to for a risk-based capital framework for life all credit card issuers targeting the Singa- and non-life insurance companies. pore market, not just banks and financial The Trust Companies Act, which was institutions. substantially amended and reauthorized The Securities and Futures Act (2001) in 2005, requires the mandatory licensing created the existing framework for autho- of trust companies. Prior to reauthoriza- rization of markets and licensing of inter- tion, trust companies were regulated by mediaries, the scope of regulated activities, the Accounting & Corporate Regulatory and an enforcement mechanism to enable Authority, and registration of trust compa- MAS to carry out its enforcement function nies was voluntary. The framework for the more efficiently. regulation of trust companies set out in the The Financial Advisers Act (2001) regu- Act also makes provision for the MAS to lates financial advisory activities in respect issue notices to counter money laundering to investment products, and the distribu- and financing of terrorism. tion or marketing of specific functionally

4 Collective investment schemes are similar to mutual funds. A collective investment scheme is an arrangement where money from investors is pooled together. The scheme may invest in various types of assets such as financial, real estate, precious metals, or commodities. 5 Full banks refer to banks holding a license granted by the MAS under the Banking Act (Cap. 19), which permits the bank to conduct the full range of banking business.

163 The Integrated Approach

The Accounting Standards Act (ASA) was Regulation division of SGX addresses issuer enacted in 2007. With the coming into regulation, member supervision, market force of the ASA, the Accounting Standards surveillance, enforcement, risk manage- Council (ASC) assumed the task of prescrib- ment, and regulatory policy. ing accounting standards from the Council As in all other developed economies, on Corporate Disclosure and Governance. there are numerous industry associations MAS and the Singapore Exchange Limited within the financial services sector. These (SGX) have taken over the purview of include the Securities Association of disclosure practices and the corporate gov- Singapore, the Life Insurance Association, ernance framework of listed companies. the Singapore Reinsurers Association, and the General Insurance Association of Nonstatutory Elements Singapore. Association of Banks in Singapore (ABS) Created in 1973, the ABS’s role is to Institutional Framework represent and further the interest of its Singapore has an integrated financial members, set standards of good practice, regulatory structure, under which the MAS and upgrade their expertise. It aims to has the authority to regulate the banking, achieve this through regular dialogue and securities, futures, and insurance industries consultation with the MAS to discuss indus- in Singapore. try issues and promote a sound financial system in Singapore. Ministry of Finance (MOF) The emphasis of the MOF’s regulatory Investment Management . policy is on economic development; the Association of Singapore ministry does not have a role as a financial The Association was formed in 1997 and supervisor. The MOF actively reviews its is a representative body of investment rules to ensure they remain relevant to the managers spearheading the development business and financial environment. This and growth of the industry in Singapore. is done in close consultation with industry By establishing high standards and industry experts and key stakeholders. practices among members, the association seeks to set the benchmark for the invest- Monetary Authority of Singapore (MAS) ment and fund management industry in The MAS, as Singapore’s central bank, Singapore. It also serves as a forum for is authorized to act as a banker to, and member discussions, and as a collective financial agent of, the government. It voice where representation is needed on has a responsibility to promote monetary behalf of the investment management stability and credit and exchange policies industry. conducive to the growth of the economy. As the integrated supervisor of the Singapore Exchange Limited (SGX) financial services sector, the MAS conducts SGX was inaugurated in December 1999, risk-based supervision of financial institu- following the merger of two financial insti- tions. This includes authorization or tutions, the Stock Exchange of Singapore licensing of financial institutions to offer and the Singapore International Monetary financial services, setting regulatory rules Exchange. The Risk Management and and standards, and taking actions against

164 Profile: singapore

Figure 12. The Financial Services System Regulatory Structure, Singapore

Singapore Deposit Monetary Authority of Singapore Ministry of Finance Insurance Corporation (MAS) (MOF) (SDIC)

BANKING

SECURITIES

INSURANCE

Monetary Policy Development & External Currency & Corporation Prudential Supervision Marketing Conduct Investmant & Research Relations Resources

Note: Dotted lines indicate a cooperative relationship. institutions and individuals for regula- official of any financial institution licensed tory breaches. The MAS also monitors or approved by the MAS. A managing direc- the financial system to identify emerging tor, appointed by the President from one of trends and potential vulnerabilities in the current directors, is responsible for the order to guide and support its regulatory day-to-day administration of the MAS. activities. The Board is responsible for the policy The MAS has the authority to make and general administration of the affairs loans and advances to any financial institu- and business of the MAS. It informs the tion under the Monetary Authority of Singa- government of the regulatory, supervisory, pore Act if it thinks this action is necessary and monetary policies of the MAS. The to safeguard the stability of the financial MAS has operational autonomy, although system or public confidence in the finan- the board remains accountable to the cial system. The MAS may issue regulations Parliament through the minister in charge and directions to financial institutions, of the MAS. which include all entities approved, autho- The MAS receives its income from its rized, licensed, registered, or otherwise investment activities. regulated by MAS. The MAS Board of Directors is com- Singapore Deposit Insurance . posed of a Chairman and at least four, Corporation (SDIC) but no more than nine, directors. The The SDIC, which was established in 2006, Chairman is appointed by the President of is a company limited by guarantee,6 and Singapore, on the recommendation of the is not part of the government. However, Cabinet. The directors are appointed by the SDIC was established by an act of the President. No one may be appointed as Parliament and has been designated to a MAS director who is a director or salaried be the Deposit Insurance Agency. The

6 A public company limited by guarantee is one that carries out nonprofit activities that have some basis of national or public interest.

165 The Integrated Approach

board of the SDIC is also accountable to Appeals can be made to the Minister in the minister in charge of the MAS. In the charge of the MAS against certain deci- event an SDIC member fails, the SDIC will sions made by the MAS. make reimbursements from the annual In case of a banking failure, the MAS insurance premiums members pay under has the power to: (a) require the bank the Deposit Insurance Scheme. concerned to take immediate actions that The annual premiums levied on mem- it considers necessary; (b) appoint statu- ber institutions are differentiated accord- tory advisers to advise the bank on proper ing to the risk they pose to the Fund. management of the bank’s business; and These risk-based premiums are charged (c) assume control and management of to member institutions as a percentage of the bank, or appoint statutory managers the amount of insured deposits they hold. to do so. In the event a member fails, all the eligible accounts with that member, except for Framework for Domestic Coordination deposits under the Central Provident Fund The MAS maintains a close relationship (CPF) Investment Scheme,7 are aggregated with the Ministry of Finance (MOF). and insured up to S$20,000, net of the However, MOF’s role is limited with regard liabilities to the member, such as loans. to the regulation of banks and financial Moneys held in bank deposits under the institutions, as all supervisory powers are CPF Investment Scheme (CPFIS) are sepa- vested in the MAS. As an integrated regula- rately insured up to S$20,000.8 tor, many of the coordination functions The Fund invests in liquid assets such as needed in other systems are internal to Singapore Government Securities, deposits the MAS organization. The MAS conducts with the MAS, and other assets approved by stress testing to assess its ability to handle the minister in charge of the MAS. financial crises and bank failures. The MAS Figure 12 provides a graphic depiction works with the MOF to assess the need for, of the relationship among the above-men- and appropriateness of, measures to main- tioned institutions. tain financial stability in times of crisis.

Enforcement International Coordination Enforcement is handled by the MAS and The MAS maintains a close working the Police’s Commercial Affairs Depart- relationship and communication with ment. MAS’s actions can include a repri- foreign regulators on supervision of both mand, issuance of directions to a regulated foreign and local financial institutions entity, imposition of a fee on a regulated in Singapore. Please refer to the chart of entity suspected of committing an offense, international coordination activities and taking civil penalty action against market organizational participation on page 234. misconduct, referral of the matter to the Commercial Affairs Department for Current Issues criminal investigations and prosecution, or Currently, there is no significant debate on in serious cases, the revocation of licenses. regulatory structure.

7 The CPF is a comprehensive social security savings plan. 8 www.sdic.org.sg.

166 Profile: singapore

Acronyms and Abbreviations

ABS Association of Banks in Singapore ASA Accounting Standards Act ASC Accounting Standards Council CPF Central Provident Fund CPFIS Central Provident Fund Investment Scheme MAS Monetary Authority of Singapore MOF Ministry of Finance SDIC Singapore Deposit Insurance Corporation SGX Singapore Exchange Limited

167 switzerland The Integrated Approach

Market Description Banking supervision was introduced The Swiss financial markets sector is one of in Switzerland by the Federal Act on Banks the largest sectors in the national economy. and Savings Institutions of 1934 in response Banks, insurance companies, securities to the banking crisis of the 1930s. The firms, and other financial intermediaries Act established the SFBC as the regula- account for approximately 12 percent of tory body for banking organizations. The the country’s gross national product, 6 per- Swiss definition of banking is the public cent of employment, and 10 percent of the announcement to accept deposits, which, tax basis in the country.1 The Swiss market according to Swiss law, only a bank may is dominated by two large banks, UBS AG do. Some activities warranting a bank- and Credit Suisse Group, which account ing license in other countries, such as for more than one-third of the domestic equity-financed lending, foreign currency financial services market. There are 24 exchange, or (until 1998, see securities Cantonal banks2 in the Swiss Confedera- section) brokering, could be performed tion, which, with 76 of the regional banks, without a banking license in Switzerland. account for almost another third of the Provisions for federal supervision of number of banks operating in Switzerland. insurance activities were included in the Swiss banks are predominantly universal Federal Constitution of 1874; however, banks, that is, they offer deposit taking the FOPI was not created until 1885. In (which defines them as a bank), lending, 2006, the revised Insurance Supervision securities, and insurance services to the Act was adopted, to secure the long-term public. stability of the insurance companies and to improve the protection of insured parties. Background The Swiss regulatory system is moving from Statutory Framework a functional toward an integrated regula- The 1934 Federal Act on Banks and Savings tory structure. In January 2009, the Swiss Institutions (BA) defined regulated banking Federal Banking Commission (SFBC), the activities and established requirements Federal Office of Private Insurance (FOPI), pertaining to capital adequacy and liquid- and the Anti-Money Laundering Control ity, accounting, and audit. It established Authority will be merged into the Federal the SFBC as the supervisory authority and Financial Markets Supervisory Authority delineated its authority over the proceed- (FINMA). The merger is required by the ings for the restructuring and bankruptcy Act Concerning Swiss Financial Markets Super- of banks. It defined several crimes, includ- vision (FMSA), which establishes FINMA as ing the violation of bank secrecy. a federal authority. The 1995 Stock Exchanges and Securi- Switzerland is not a member of the ties Traders Act (SESTA) provisions are European Union (EU); however, it has further delineated by a 1996 ordinance adopted many EU Directives to ensure of the Federal Council.3 The Investment Swiss banks a level playing field with their Funds Act (IFA) of 1966 was amended in mainly European competitors. 1994 to allow the creation of investment

1 Federal Department of Finance, “Figures on Switzerland as a Location for Financial Services,” 2008. 2 Cantonal banks are semi-government owned, as a portion of the capital is held by the Cantons of Switzerland. 3 The Swiss Federal Council is a seven-member executive council that serves as the collective head of state.

170 Profile: switzerland

funds in Switzerland, which comply with but must be respected as the minimum the requirements of the EU Directive, standard by all industry participants. Undertakings for the Common Investment in The mandate of the Swiss Bankers Transferable Securities. In 2006, the Collective Association is to maintain and promote the Investment Schemes Act replaced the IFA. The Swiss financial services industry. The Asso- new act expands the number of legal forms ciation works with the regulatory agencies in which a collective investment can be to develop further self-regulation arrange- undertaken and removes some restrictions ments within the industry. for qualified investors. The 2006 Insurance Supervision Act (ISA) Institutional Structure is the legal foundation for supervision of of the Regulators conglomerates, expanding supervisory The regulatory system in Switzerland is responsibilities in the areas of corporate moving from a functional toward an inte- governance, transparency, and consumer grated structure. protection. In particular, the disclosure requirements of insurers have been Swiss National Bank (SNB) increased considerably. Reinsurers are The SNB, founded in 1906, conducts the subject to the same solvency supervision as country’s monetary policy as an independ- direct insurers. ent central bank. In addition, the SNB The FMSA will be fully implemented in contributes to financial stability by regu- 2009, and provides the underpinning for larly analyzing and monitoring conditions the integrated regulatory structure. Some and developments in the financial system. of its provisions have already been imple- It oversees the systemically important pay- mented to allow for the organizational ment and securities settlement systems and structure of FINMA to be built to ensure a contributes to the regulatory framework smooth transition from the former regula- of the financial sector. The SNB is also tory structure. The FMSA will not replace the lender of last resort. It is governed by the current legislation for the individual an 11-member Bank Council, a Govern- financial sectors. The BA, ISA, and SESTA, ing Board, and an Audit Board, and has including all regulations issued interpret- approximately 675 employees. ing these Acts, will remain in force. Only the parts relating to the supervisory author- Swiss Federal Banking Commission (SFBC) ities, their duties, and their organization The SFBC is an independent agency and will be replaced by the FMSA. not part of the central government. Admin- istratively, however, it is integrated within Nonstatutory Elements the Federal Department of Finance. The The SFBC recognizes some aspects of SFBC is the supervisory authority of both self-regulation as a minimum standard, as institutions and markets. It focuses on the established by a professional organization maintenance of liquidity and solvency of a (such as the Swiss Bankers Association or particular institution, the transparency of the Swiss Funds Association). As a result of ownership of listed companies and market this recognition, the minimum standards activities, and the protection of minority no longer apply only to the members of shareholders. the respective self-regulatory organization,

171 The Integrated Approach

Swiss banking supervision is based on intermediary supervision, life insurance, a division of tasks between the SFBC and group supervision, health insurance, and a number of audit firms that are specially reinsurance. authorized for supervisory tasks. The The members and the Director of authorized audit firms conduct on-site the FOPI are appointed by the Federal audits, while the SFBC retains responsibil- Council upon nomination by the Head ity for overall supervision and enforcement of the Department of Finance. The FOPI measures. The auditors act, in some sense, has approximately 90 staff members.4 It is as an extension of the SFBC, exercising financed by the institutions it supervises direct supervision through regular audit through the levy of fees and general checks of their clients. They must report charges, which depend at least partially on immediately to or notify the SFBC of the the size of the supervised institution. results of their audits if significant findings have been made. All costs of the audits are Federal Financial Markets Supervisory assumed by the institutions being audited. Authority (FINMA) (future structure) Also, to ensure the robustness of the super- Within the future structure, FINMA will be visory system, it carries out quality control the integrated regulator and will assume checks on the authorized audit firms and, the responsibilities of the SFBC and the on occasion, may directly monitor their FOPI, and responsibility for anti-money audit procedures at banks or securities laundering oversight. FINMA will have dealers. The SFBC was given sole responsi- an Administrative Board headed by a bility for bankruptcy proceedings of banks. President, and an executive management The SFBC is appointed by the Federal headed by a Director, appointed by the Council after nomination by the Head of Federal Council upon proposal of the the Department of Finance. The SFBC is Head of the Department of Finance. financed by fees and general charges levied FINMA will report annually to the Federal on the institutions it supervises. It consists Council to discuss strategy matters and cur- of seven individuals, a full-time president, rent issues. In 2008, the Federal Council and six part-time members. To fulfill its appointed seven of the future nine mem- duties, the SFBC employs approximately bers of FINMA’s Administrative Board. Six 160 people, who make the day-to-day are members of the SFBC, including its decisions. current president, who was also appointed The deposit protection scheme covers president of the Board, and a former Chief “privileged deposits” of up to 30,000 Swiss Risk Officer of a major reinsurance com- francs per depositor. pany. FINMA will continue to be financed similarly to SFBC and FOPI, through the Federal Office of Private Insurance (FOPI) levy of fees and general charges. The FOPI is a federal office under the full Figure 13 provides a graphic depiction authority, including specific directives, of of the current financial system regulatory the Federal Department of Finance. It has structure. divisions responsible for non-life insurance,

4 www.bpv.admin.ch.

172 Profile: switzerland

Figure 13. The Financial Services System Regulatory Structure, Switzerland

Swiss Federal Banking Federal Department Swiss National Bank Commission (SFBC) of Finance (FDF) (SNB) BANKING Federal Office of Private SECURITIES Insurance (FOPI)

INSURANCE

Note: Dotted lines indicate a cooperative relationship.

Enforcement strengthened cooperation in the future. The SFBC has broad powers and can take The MoU includes a clear division of the enforcement or disciplinary action for individual responsibilities of the two insti- noncompliance with applicable laws and tutions. In particular, the MoU governs the rules. When the SFBC finds evidence that way in which information is exchanged and crimes have been committed, it informs opinions shared, and the manner in which the Federal Department of Finance or the the two authorities cooperate in regulatory responsible cantonal offices. matters. FINMA will also have these enforcement powers. In addition, it will have the ability International Coordination to prohibit individuals from employment As a non-member of the EU, Switzerland in the financial sector for up to five years is not subject to any formal commitments; and to confiscate profits arising from however, as noted, it has adopted a number unlawful behavior. of EU directives. Please refer to the chart of international and European organiza- Framework for Domestic Coordination tions for further details, on page 234. In 2007, the SFBC and the SNB signed a Memorandum of Understanding (MoU) Current Issues regarding financial stability. The MoU The main issue under discussion is the defines the relationship between the two implementation of the new regulatory institutions and sets out the framework for framework.

173 The Integrated Approach

Acronyms and Abbreviations

BA Federal Act on Banks and Savings Institutions of 1934 EU European Union FINMA Federal Financial Markets Supervisory Authority FMSA Act Concerning Swiss Financial Markets Supervision FOPI Federal Office of Private Insurance IFA Investment Funds Act ISA Insurance Supervision Act MoU Memorandum of Understanding SESTA Stock Exchanges and Securities Traders Act of 1995 SFBC Swiss Federal Banking Commission SNB Swiss National Bank

174 United Kingdom The Integrated Approach

Market Description statutes principally concerned with con- The Financial Services Authority (FSA) in sumer protection. the United Kingdom (UK) licenses and The Bank of England (BoE) exercised regulates around 22,350 financial services informal oversight of the banking sector firms. An additional 5,980 financial services based on its operational involvement in firms operating in the United Kingdom markets and its access to a broad range (UK) are licensed elsewhere in the of “market intelligence.” It also had a European Economic Area.1 Approximately general power, under the Bank of England 400 of these firms are banks or building Act 1946 and subject to the approval of Her societies, and almost 1,100 are insurance Majesty’s Treasury (HMT), to give “direc- companies. tions to bankers.” This power was never The financial services sector accounted used, but its existence may have helped for nearly 10 percent of UK gross domestic support the informal guidance that from product in 2006. In individual markets, time to time the BoE gave to banks. Most recent Bank for International Settlements securities business, at least until the birth survey data suggest that the UK accounts of the eurobond market, took place on the for 34 percent of global foreign exchange London Stock Exchange, and was subject turnover and 43 percent of global over- to the Exchange’s nonstatutory rules. the-counter derivative turnover. It also There were statutory provisions concerned accounts for 20 percent of international with the fraudulent offering of or deal- bank lending, and is a major investment ing in securities. For insurance, the main management center, with £3.5 trillion in statutory requirement involved the “audit” assets under management in 2005. by actuaries in a government department (later the Department of Trade and Indus- Background try) of insurance companies’ reserves. The regulatory structure in the UK is During the 1970s, a number of serious characterized as an integrated structure, problems arose with “fringe banks,” the but this has not always been the case. Until nature of whose business made them less the late 1970s, financial regulation in the visible to the BoE than those involved in UK operated on a largely nonstatutory mainstream banking business. At the end basis under rules that were often enshrined of 1973, the BoE was called upon to orches- in contracts between firms and individuals trate a “lifeboat” operation in conjunction on the one side, and trade and profes- with the major commercial banks to coun- sional bodies on the other. In some areas, ter what was perceived as a potential threat regulation was “informal” in the sense that to the stability of the banking system. rules were enforced by moral suasion or Subsequently, a formal statutory regime for peer pressure. Banks operated within an banking supervision (under the Banking extensive body of case law built up over Act 1979) was introduced, with the BoE many years, but which mainly focused on taking the role of supervisor. This role was the nature and enforceability of banking reinforced by a new Banking Act 1987, in contracts. In addition, provision of credit, the aftermath of further problems among by banks and others, was subject to various small banks involved in property lending,

1 FSA Annual Report 2006/07.

176 Profile: United kingdom

and the regime remained in place until the services regulation in the UK and the cre- major reorganization of regulation in 1997. ation of a new regulator. In October 1997, Problems in the retail securities sector the Securities and Investments Board was during the early 1980s, together with the renamed the Financial Services Authority, recasting of the market as a result of the with responsibility for banking supervi- 1986 “Big Bang” (which removed the sion transferred to the FSA from the BoE previous single-capacity restrictions on in mid-1998. In 2000, the FSA took over securities firms in the UK), prompted an the role of UK Listing Authority from the overhaul of regulation with the Financial London Stock Exchange. Services Act 1986. The new regime is based on the Finan- During the 1990s, it became increasingly cial Services and Markets Act 2000 (FSMA), clear that the fragmented nature of the which came fully into effect at the end regulatory regime in the UK, particularly of 2001, when most remaining financial in relation to securities business, was incon- regulatory responsibilities were formally sistent with the way major financial firms transferred to the FSA.2 were developing as integrated “full service” groups. This evolution of financial service Statutory Framework firms was one of the main motives for mov- The statutory framework for regulation ing to an integrated regulator in 1997. in the UK is set out in the FSMA, which The new Labour Government elected replaced a plethora of previous legislation, in 1997 had determined to give the BoE and set out the statutory objectives for the operational independence in relation FSA and the principles for regulation. to monetary policy. It also decided that The FSA undertakes both prudential assigning the further role of integrated and conduct-of-business regulation. It financial regulator to the BoE, in a finan- has the power to make rules to meet its cial center as large as London, would statutory objectives, subject to specific involve an undue concentration of power, and extensive requirements on consulta- as the BoE was only indirectly politically tion.3 In many areas, the substance of the accountable. This, combined with a num- supervisory regime is determined by EU ber of additional considerations (such legislation, negotiations on which are the as potential conflicts of interest and of responsibility of HMT. There are also inter- priorities, and the increasingly divergent relationships with the competition authori- staffing requirements of the monetary ties, notably the Office of Fair Trading and policy and regulatory functions) led to the the Financial Ombudsman. The FSA also conclusion that a free-standing, integrated exercises various powers under the Building regulator, should be established. Conse- Societies Act 1986, the Friendly Societies Acts quently, the Chancellor of the Exchequer 1974 and 1992, and the Industrial and Provi- announced a major reform of financial dent Societies Act 1965.

2 In 2001, the FSA took over the responsibilities of the Building Societies Commission, HMT (in respect of insurance supervision), the Friendly Societies Commission, the Investment Management Regulatory Organi- zation, the Personal Investment Authority, the Register of Friendly Societies, and the Securities and Futures Authority. In 2004, the FSA was given responsibility for mortgage regulation, and in 2005, it was also tasked with the regulation of general insurance. 3 www.fsa.gov.uk/Pages/About/Who/Accountability/legal/index.shtml on the legal framework.

177 The Integrated Approach

As noted, under the Bank of England Act Her Majesty’s Treasury (HMT) 1946, the BoE has the general power to The Chancellor of the Exchequer and give “directions to bankers” subject to the HMT are responsible for determining the approval of HMT. statutory framework for financial regula- The conduct of takeover bids in the UK tion. In addition, the Chancellor, as Chair is governed by a Code,4 which, since 1968, of the Tripartite Committee, has a key role has been overseen by the Takeover Panel. in decision making in times of banking Under the EU Directive on Takeover Bids failures and financial crisis management. (2004/25/EC), the Panel is designated the In the case of a bank failure where public supervisory authority for certain regulatory funds are to be committed, the Chancellor functions, but the substance of the Code has the final say. itself is not described in the statute. Bank of England (BoE) Nonstatutory Elements The BoE relinquished its responsibilities The main area of financial regulation fall- for banking supervision in 1997, but it ing outside the FSA’s purview is corporate retains financial stability as one of its two reporting and governance. This is the core purposes. It carries out this task not responsibility of the Financial Reporting only through its monetary policy role, but Council, under which are six operational also through its oversight of systemically units covering accounting standards, important payments systems, by maintain- auditing practices, actuarial standards, ing a broad overview of the system as a professional oversight of audit firms, review whole, and by providing liquidity to the of financial reporting, and professional banking system, which, in exceptional discipline in accountancy. The Council circumstances, can involve acting as lender itself maintains the so-called Combined of last resort. The government recently (corporate governance) Code. proposed changes to the law to formalize Several important aspects of banking the BoE’s financial stability role, and to conduct are governed by the nonstatutory give it a role in implementing the special Banking Code, overseen by the Banking resolution regime for failing banks, if this Code Standards Board, which is sponsored is triggered by the FSA. by the British Bankers Association, the Building Societies Association, and APACS Financial Services Authority (FSA) (the UK Payments Association), but with a The FSA was established as a private majority of independent directors on the company limited by guarantee with four 10-person board. statutory objectives: maintaining market confidence, promoting public awareness Institutional Structure (on financial matters), protecting consum- of the Regulators ers, and reducing financial crime. The The UK structure is characterized as FSA is also required to respect a set of an integrated regulatory structure and “principles of good regulation”: efficiency involves the following institutions. and economy, the role of management,

4 www.thetakeoverpanel.org.uk/new/codesars/DATA/code.pdf.

178 Profile: United kingdom

Figure 14. The Financial Services System Regulatory Structure, United Kingdom

European Union

Tripartite Committee (HMT, BoE, FSA)

Her Majesty’s Treasury (HMT) Bank of England (BoE) Financial Services Authority (FSA)

BANKING FINANCIAL STABILITY BANKING

INSURANCE

SECURITIES

Other Authorities Operations Retail Markets Wholesale (e.g., competition) and Institutional

Note: Dotted lines indicate a cooperative relationship.

proportionality, innovation, the interna- of the BoE. The Board has overall respon- tional character of financial services, and sibility for running the FSA, and besides competition. Internally, the FSA is divided general matters of policy, is concerned into three main areas, operations, retail especially with internal management, markets, and wholesale and institutional including issues relating to budgets and markets, each headed by a Managing staff remuneration. The FSA is required to Director, plus a group of central services report to Parliament annually.5 reporting to the Chairman or Chief Execu- The FSA employs about 2,800 staff. tive Officer. It is financed by fees levied on the firms The FSA operates under a Board with supervised, receives no public funds, and 14 members, all appointed by HMT. borrows from the private sector if necessary The Board is headed by a non-executive via a revolving credit facility with a major Chairman and four executive members, UK bank. The FSA’s Board oversees and the Chief Executive and three Managing approves the budget. Directors. The remaining nine members Figure 14 provides a graphic depiction are non-executive and include, ex officio, of the relationship among the above-men- the Deputy Governor (Financial Stability) tioned institutions.

5 www.fsa.gov.uk/Pages/About/Who/Accountability/Relations/index.shtml.

179 The Integrated Approach

Enforcement among HMT, the BoE, and the FSA, set- The FSA has broad powers of investiga- ting out their respective responsibilities, tion, enforcement, and civil and criminal and arrangements to ensure coordination prosecution. The FSMA contains provi- of their activities.8 One element of these sions for a Complaints Commissioner to arrangements was the creation of a Tri- hear complaints against the FSA,6 and a partite Standing Committee9 comprising Financial Services and Markets Tribunal, to representatives of HMT, the BoE, and the review disputes between the FSA and indi- FSA. The representatives are the Chancel- viduals or firms. The Tribunal can make lor of the Exchequer, the Governor of the binding rulings in these cases.7 The FSA BoE, and the Chairman of the FSA, but in seeks to avoid duplication of enforcement practice, the Committee has often met at actions taken by other agencies, including the deputies level. An HMT representa- those responsible for law enforcement, and tive chairs the Committee, which seeks to will generally defer to the other agencies ensure timely and effective exchange of where they have the principal statutory information among the three institutions. responsibility. The Tripartite Committee meets on a monthly basis to discuss individual cases Framework for Domestic Coordination of significance and other developments Her Majesty’s Treasury (HMT) is respon- relevant to financial stability. Meetings sible for determining the statutory frame- may occur at other times if there appears work for financial regulation and, in rela- to be an issue that needs urgent attention. tion to financial crises, deciding whether Each authority has representatives who public funds should be used to mitigate its meet, at short notice, in times of crisis. effects. The BoE, in addition to monetary In these circumstances, the BoE and the policy, contributes to financial stability FSA are each to assess, from the perspec- through its market operations, its oversight tive of their distinct responsibilities and of key payments systems, and its access to expertise, the seriousness of the crisis and market intelligence, and, in a crisis, may its potential implications for the stability of undertake official financial operations to the financial system. Ultimate responsibil- limit potential market impact. The FSA ity for authorization of support operations regulates individual firms and markets in exceptional circumstances rests with the using the FSMA, and, in a crisis, would Chancellor. explore the potential for private sector Until recently, the coordination frame- solutions. work established by the MoU had not been The new institutional structure, intro- tested by a major financial crisis. Following duced in 1997, was documented in a recent events in the UK, the authorities Memorandum of Understanding (MoU) suggested10 changes to the framework to:

6 www.fsa.gov.uk/Pages/About/Who/Accountability/CC/index.shtml. 7 www.fsa.gov.uk/Pages/About/Who/Accountability/FSAMT/index.shtml. 8 www.fsa.gov.uk/pubs/mou/fsa_hmt_boe.pdf. 9 The full name of the committee is The Standing Committee on Financial Stability. 10 “Financial Stability and Depositor Protection: Strengthening the Framework,” January 2008.

180 Profile: United kingdom

8 Make a clearer distinction between ance (in the EU) and accounting “normal” and “crisis” arrangements; standards. 8 Improve external communications, 8 Greater reliance on a lead regula- where such communications are tor—typically the home supervisor judged necessary; of the group. The issue here is that 8 Ensure that the Authorities have suf- since a subsidiary has capital of its ficient resources available to deliver own, local supervisors are inter- the arrangements; ested in the distribution of capital 8 Authorize increased BoE involvement within the group, and in its overall with individual firms if emergency adequacy. Within insurance, there assistance is likely to be needed; and are proposals to address these issues 8 Clarify responsibilities for decisions through the draft Solvency 2 direc- to provide support to firms, both to tive, due to come into force in the ensure that the terms of any emer- EU in 2012. One possibility is that gency lending are discussed among each subsidiary would be expected to the Authorities, and that the respon- meet the minimum capital require- sibilities for the provision of general ment, rather than the (higher) liquidity are clarified. solvency capital requirement, which would be set only on a group-wide International Coordination basis. This would allow firms some The UK participates in both interna- benefit from the diversification of tional and European financial services risks across a group, and may reduce organizations. Please refer to the chart of the amount of subsidiary-specific international coordination activities and review that is required. organizational participation on page 234, 8 Related to this, the more frequent and to the European Union profile for use of regulatory colleges, to share an explanation of coordinating activities information and reduce duplication. within the EU. There are practical limitations on how large such colleges can be. Current Issues 8 Agreement that group-wide pruden- There is an active debate about how to tial assessments or group-wide system make international cooperation in regula- and control reviews, need not be tion more efficient and effective in the replicated for every subsidiary in the future. Some of this debate, which began group. before the recent disruptions in financial 8 Attempts to bring about greater markets, is focused on arrangements within alignment of standard regulatory Europe, but for global firms the issues reporting. are broader. Possible solutions proposed include: Recent events have heightened concerns about the complex potential interactions in 8 Greater international convergence these cases among different sets of national of rules, most obviously in banking legislation (for instance on insolvency, or supervision, but also now in insur- deposit protection). There are also issues

181 The Integrated Approach

in the context of crisis resolution with 8 The appropriate level of disclosure: the interaction with EU rules on state aid where there have been calls for addi- (and competition rules more generally); tional transparency in areas such as transparency (under legislation designed structured products, but for greater to combat market abuse); and the Euro- discretion in areas such as emergency pean Convention on Human Rights, to the lending by the official sector. extent that it relates to directors, creditors, 8 Improvements to risk management, and shareholders of a failing firm. particularly to sharpen the under- Finally, in light of recent experiences, standing of the “tails” of the distribu- a number of existing questions have been tion, and to take account of systemic sharpened, and some new ones added. The shocks. issues identified for further work include: 8 Appropriateness of sales practices, both for subprime mortgages and for 8 Liquidity, about which the FSA issued certain structured products. a discussion paper at the end of 2007. 8 A reassessment of some of the details In the UK, there has been some debate of the Basel II capital rules. over the supervisory structure following the 8 Deposit protection arrangements and problems at Northern Rock, and criticism other means to resolve failing institu- of each of the Tripartite Authorities (the tions smoothly, which were discussed FSA, the BoE, and HMT). These ideas have in the papers from the Tripartite been fed into the review being undertaken Authorities in January and July 2008. by the Authorities, who have not proposed On deposit protection, the key issues a major restructuring of responsibilities, are the level of cover, the extent to but are examining ways in which it can be which the scheme is prefunded, and made to work more effectively. the speed with which payment is As noted, there has been a more general made. The papers also look at tools interest in reforms to the deposit insurance that might allow the Authorities scheme, and in how failing banks can be more easily to achieve an orderly resolved more effectively and efficiently. resolution of a failing bank. These issues are currently under consider- 8 To reexamine the approach to valua- ation by policymakers, with further consul- tion when markets freeze up, so that tation promised on the details. positions are evaluated on the basis of realistic and prudent assumptions.

182 Profile: United kingdom

Acronyms and Abbreviations

BoE Bank of England EU European Union FSA Financial Services Authority FSMA Financial Services and Markets Act 2000 HMT Her Majesty’s Treasury £ British pound sterling MoU Memorandum of Understanding UK United Kingdom

183 the twin peaks approach

The twin peaks approach, a form of regulation by objective, is one in which there is a separation of regulatory functions between two regulators: one that performs the safety and soundness supervision function and the other that focuses on conduct-of-business regulation.

Australia · The Netherlands

Australia The Twin Peaks Approach

Market Description In 2006/07, the financial services indus- Banking services in Australia are provided try accounted for 7.3 percent of Australia’s by Authorized Deposit-Taking Institutions gross domestic product.3 (ADIs), which include banks, building societies, and credit unions. As of September Background 2007, there were 58 banks, including 14 The current Australian structure can be domestic banks, 10 locally incorporated described as a twin peaks system, and is the foreign banks, and 34 foreign bank result of a specific series of reforms that branches.1 Four banks (the “Big Four”) took place in the late 1990s. In the early dominate the local market: the Australia 1980s, Australia deregulated its financial and New Zealand Banking Group Limited, services in response to the perception that Commonwealth Bank of Australia, the the existing financial system had outdated National Australia Bank Limited, and regulatory structures.4 In 1997, the Wallis Westpac Banking Corporation. These Committee was charged with looking at banks control around 67 percent of total the results of deregulation since the early domestic banking assets. 1980s, with a focus on realigning and Following reforms introduced in 1992, streamlining regulation to make it more there have been no restrictions on the efficient and effective.5 number of foreign banks operating in Following a review of the results of Australia. Foreign financial companies financial deregulation, including the are substantial competitors in investment regulation of financial institutions, and the banking and securities and brokerage, credit laws and fair trading laws that affect and foreign banks represent 11 percent of financial institutions, the Committee put domestic credit. forward a recommendation that financial The remainder of the ADI sector is system regulation should be organized made up of building societies and credit on a twin peaks basis with two principal unions, which specialize in providing authorities: personal finance for residential and other domestic purposes. As of September 2007, 1. The Australian Prudential Regula- there were 132 credit unions and 12 build- tion Authority (APRA), responsible ing societies. Insurance services are pro- for prudential supervision of ADIs vided by direct insurers and reinsurance (banks, building societies, credit firms with about A$90 billion in assets. unions), insurers, and most of the Superannuation (pensions) has been superannuation industry; and the fastest-growing sector of the financial 2. The Australian Securities and services industry in Australia, with assets Investments Commission (ASIC), accounting for over a quarter of the total an expanded version of the old 2 assets of the financial system. Australian Securities Commission

1 Australian Prudential Regulation Authority website, www.apra.gov.au. Figures are current as of June 2008. 2 International Monetary Fund Country Report No. 06/372, October 2006. 3 Department of Foreign Affairs and Trade website, www.dfat.gov.au/facts/global_economy.html. 4 Jeffrey Carmichael, Some Reflections on Where We Have Been and Where We are Heading, APRA, August 8, 1998. www.apra.gov.au/Speeches/98.05.cfm?RenderForPrint=1. 5 Ibid.

188 Profile: australia

(ASC), responsible for market con- 8 Holds Australia’s foreign exchange duct relative to financial services and reserves; general corporate and business legal 8 Operates Australia’s main high-value standards. payments system; 8 Provides banking services to the gov- The Reserve Bank of Australia (RBA) ernment; and continues to be responsible for financial 8 Designs, produces, and issues Austra- stability, monetary policy, and payment sys- lia’s banknotes. tems. Two other agencies impact financial services providers: the Australian Competi- While the RBA has not had any respon- tion and Consumer Commission (ACCC), sibility for the prudential supervision of which is responsible for market conduct banks since 1998, it has a general responsi- for nonfinancial institutions and a range of bility to promote stability in the Australian general consumer protection and antitrust financial system. In 1998, theReserve Bank issues and vets most substantial finan- Act 1959 was amended to establish the Pay- cial sector mergers; and the Australian ments System Board (PSB) within the RBA Transaction Reports and Analysis Center to promote the safety and efficiency of the (AUSTRAC), which regulates anti-money Australian payments system. New legisla- laundering and counterterrorism financing tion—the Payment Systems (Regulation) Act for financial and nonfinancial institutions. 1998 and the Payment Systems and Netting Act 1998—was introduced, giving the Bank Statutory Framework relevant powers in this area.6 The legislation granting authority to APRA, The Australian Prudential Regulation ASIC, and RBA includes the Australian Authority Act 1998 established APRA as the Prudential Regulation Authority Act 1998, the prudential regulator of regulated financial Australian Securities and Investments Commis- institutions and sets out the framework sion Act 2001, the Reserve Bank Act 1959, the for APRA’s operation. APRA is required Banking Act 1959, and the Financial Sector to balance financial safety and efficiency, (Collection of Data) Act 2001. and competition, and to promote financial The Banking Act 1959 regulates bank- system stability. (Reflecting the fact that ing and contains provisions relating to Australian banks control 90 percent of the licensing of ADIs; the protection New Zealand banking assets, APRA is also of depositors; APRA’s powers to obtain required to avoid actions that could have information from ADIs; APRA’s powers to a detrimental effect on financial system issue directions to, or take control of, an stability in New Zealand.) ADI; and mergers and restructures of ADIs. The Insurance Act 1973 and the Life The Reserve Bank Act 1959 established Insurance Act 1995 charge APRA with a the RBA as Australia’s central bank and duty to protect insurance policyholders. empowers it to conduct monetary policy in The General Insurance Reform Act 2001 line with the objectives set out in Section amended the Insurance Act 1973, and 10(2) of the Act. In addition to the con- supports APRA’s prudential supervision duct of monetary policy, the Reserve Bank: framework for general insurance, and gives

6 Reserve Bank of Australia website, www.rba.gov.au/AboutTheRBA/History/history_of_the_rba.html.

189 The Twin Peaks Approach

it increased flexibility for establishing and to issue Prudential Standards, which set out enforcing more stringent standards on APRA’s prudential requirements for all capital adequacy, liability valuation, risk ADIs and life and general insurers, and management, and reinsurance. Prudential Practice Guides, which provide The Australian Securities and Investments guidance and elaboration in relation to Commission Act 2001 established ASIC’s role how regulated institutions may comply with of monitoring the market conduct of cor- the associated standard. ASIC interprets porations registered under the Act, which the laws through issuance of guidelines, includes all banks. Some Acts administered preferred practices, regulatory guides by the former Insurance and Superannua- (formerly known as policy statements), and tion Commission, which contained both approval of codes of conduct. prudential and market integrity and dis- The Financial Transaction Reports Act closure requirements, were split between 1988 (FTR Act) established the Australian APRA and ASIC. The Financial Services Transaction Reports and Analysis Centre Reform Act 2001, administered by ASIC, (AUSTRAC), Australia’s anti-money laun- provides for streamlined regulation of dering and counterterrorism financing financial products, operation of financial regulator and specialist financial intel- markets, clearing and settlement, financial ligence unit. The Anti-Money Laundering service provision, and disclosure. and Counter-Terrorism Financing Act 2006 The Financial Sector (Collection of Data) (AML) superseded the FTR Act. The AML Act 2001 shifted responsibility for the implements a risk-based approach to registration of financial corporations from regulation; that is, reporting entities will the RBA to APRA. The Act applies to determine the way in which they meet their financial corporations not already covered obligations based on their assessment of by the Banking Act 1959. Financial corpora- the risk of whether providing a designated tions include a wide range of financial service to a customer may facilitate money intermediaries, including money market laundering or terrorism financing.7 corporations, finance companies, general financiers, and pastoral finance companies Nonstatutory Elements (rural lenders), which are required to Australian Competition and . register with APRA for statistical purposes. Consumer Commission (ACCC) However, it does not empower APRA to The ACCC oversees competition in the supervise the activities of registered finan- financial system, including scrutinizing cial corporations (RFCs), and registration bank and insurance company takeovers does not imply any kind of guarantee or and mergers and preventing anticompeti- supervision of the firms. tive conduct by banks and other financial Since 2001, ASIC and the financial institutions. services industry have been implementing numerous changes mandated by the Finan- Financial Sector Advisory Council (FSAC) cial Services Reform Act 2001. APRA, ASIC, The government established the FSAC and RBA have the authority to issue stan- as part of the financial sector reforms dards and guides. APRA has the authority responding to the 1997 Financial System

7 www.austrac.gov.au/aml_ctf.html.

190 Profile: australia

Inquiry. The FSAC is a resource for elicit- Reserve Bank of Australia (RBA) ing and distilling the views of both industry The stability of the financial system, the and regulators. The FSAC is recognized safety and reliability of the payments by regulators and industry representatives system, and monetary policy are the as an important part of the framework, responsibility of the RBA. The RBA is the and provides independent advice to the sole currency-issuing authority and acts as government. banker to the federal government. The RBA is responsible for overall financial The Australian Stock Exchange (ASX) and system stability and is lender of last resort the Sydney Futures Exchange (SFE) to ADIs. The RBA implements financial The ASX and SFE monitor market par- stability standards for central counterpar- ticipant and company compliance with ties and securities settlement facilities. their business and listing rules. This role These standards seek to ensure that clear- is supported by ASIC, which has overall ing and settlement facilities identify and regulatory responsibility for securities and properly control risks associated with their futures markets. operations. The RBA is formally responsible for ensuring that licensed facilities for Institutional Structure the clearing and settlement of securities of the Regulators and derivatives conduct their affairs in a The current Australian structure can be way that is consistent with financial system described as a twin peaks system, with stability. APRA taking responsibility for prudential The RBA has two boards with comple- regulation and ASIC responsibility for mentary responsibilities, the Reserve Bank market conduct. Board and the Payments System Board (PSB), both accountable to the Australian Commonwealth Treasury Parliament. The Reserve Bank Board is Treasury coordinates with a variety of agen- responsible for monetary policy and overall cies to promote sound economic policy. financial system stability. The PSB has It is a member of the Council of Financial specific responsibility for the safety and Regulators, the coordinating body of efficiency of the payments system. The Australia’s main financial regulatory agen- Governor of the Reserve Bank chairs the cies. The Governor-General, on the recom- PSB, and other Board members include mendation of the Treasurer, is responsible one other RBA representative, one repre- for the appointment of directors to the sentative from APRA, and up to five other RBA (including the Governor and Deputy members who are usually drawn from the Governor) and the Members/Commission- financial markets community. ers of APRA and ASIC. The Treasurer has The Reserve Bank Board is composed of power to direct APRA on matters of policy nine members: three ex officio members— and operational priorities, if needed. This the Governor (who is Chairman), the Dep- power has not been exercised, and the uty Governor (who is Deputy Chairman), expectation is that it will not be exercised and the Secretary to the Treasury—and other than in extraordinary circumstances. six external members, all of whom are

191 The Twin Peaks Approach

appointed by the Governor‑General on the of the fund are regulated by the Australian recommendation of the Treasurer. Mem- Taxation Office. bers of the Board may not be a director, APRA is responsible for dealing with officer, or an employee of an ADI. institutions that are unable to meet their The RBA earns the bulk of its income prudential obligations. With respect to from the portfolio of financial assets that it ADIs, it undertakes this action in close holds primarily to conduct monetary policy. cooperation with the RBA but, as with all institutional types under its responsibility, Australian Prudential Regulation . it is required to directly inform the rel- Authority (APRA) evant Minister when an entity is in serious APRA is the prudential regulator of banks difficulty. The RBA retains its existing role and other deposit-taking institutions, in providing liquidity support to financial life (including friendly societies) and institutions if such assistance is required. general insurance companies, and most Operational effectiveness of the “deposi- of the superannuation industry. APRA tor protection” provisions overseen by has the dual role of regulating bodies in APRA provides for early intervention the financial sector and developing the in a financially troubled institution and administrative practices and procedures to makes clear that the regulator can close be applied in performing that regulatory an insolvent entity. APRA was also given role, including the making of prudential enhanced powers to take action in the case standards. of financial difficulties experienced by APRA collects statistical data from all its life and general insurance companies and regulated entities and a range of financial superannuation funds. In the event of fail- intermediaries and providers under the ure of an ADI, depositors are protected by Financial Sector (Collection of Data) Act 2001. means of a first priority claim against the The Act, as it relates to registered financial assets of the ADI. In addition, the govern- corporations (RFCs),8 requires a wide ment recently announced the introduction range of non-ADI financial intermediaries of a Financial Claims Scheme to provide to register with, and provide statistics to, depositors with early access to their funds APRA. APRA does not supervise the activi- (up to A$20,000) in a failed ADI. The ties of these RFCs. Scheme is to be administered by APRA. Superannuation funds operating APRA is accountable to the government through a third party trust structure, where and the Parliament. It is, however, subject trustees hold the superannuation assets on to an overriding policy determination behalf of members, are regulated by APRA. power of the Treasurer in the rare event These funds may draw together many of an unreconciled disagreement with the members from a company or industry or government (although such an event has may offer superannuation products to the not occurred in APRA’s history). APRA’s public on a commercial basis. (Small funds full-time Executive Group is composed of where the trustees are the only members three to five members who are appointed

8 RFCs are defined as such if their assets are over A$5 million, their principal business in Australia is the borrowing of money and provision of finance, and they are not already covered by theBanking Act 1959.

192 Profile: australia

by the Governor-General on the recom- and Investments Commission (ASIC), the mendation of the Treasurer. The Gover- regulator responsible for market integrity nor‑General appoints a full-time APRA and consumer protection across the member as Chair and may appoint another financial system. ASIC regulates financial full-time APRA member as Deputy Chair of markets, financial services organizations, APRA. At least three of the APRA members and professionals who deal with and are appointed as full-time members, and advise about investments, superannuation, each of the other APRA members (if any) insurance, deposit taking, and credit. may be appointed as a full-time or part- ASIC regulates venture capital funds and time member. APRA’s Executive Group is private equity firms, although it regulates responsible and accountable for the opera- some aspects of money market corporation tion and performance of the organization. operations (such as compliance with the The Group’s responsibilities include the fundraising and securities licensing provi- development of regulatory and supervisory sions of the Corporations Law). ASIC does policies relating to the performance of its not undertake prudential supervision. role as prudential regulator. ASIC may interpret the laws through APRA is largely financed by fees issuance of guidelines, preferred practices, imposed on the financial sector entities it regulatory guides, and approval of codes of supervises as determined and collected by conduct. ASIC has undertaken a number the Australian government—as a levy on of Better Regulation Initiatives that aim to supervised entities. achieve better and more transparent regulation and to reduce burdens on business. Australian Securities and . The Ministers responsible for ASIC Investments Commission (ASIC) are the Treasurer and the Minister for ASIC began operating in 1991 as the Aus- Superannuation and Corporate Law. ASIC tralian Securities Commission (ASC), and operates under the direction of three in 1998 became the Australian Securities full-time Commissioners appointed by the

Figure 15. The Financial Services System Regulatory Structure, Australia

Council of Federal Regulators (CFR)

Reserve Bank of Australia Australia Prudential Regulatory Australia Securities and Commonwealth Treasury (RBA) Authority (APRA) Investmant Commission (ASIC)

Financial System Prudential Regulations Conduct-of-Business Stability

BANKING BANKING

SECURITIES SECURITIES

INSURANCE INSURANCE

PENSION FUNDS PENSION FUNDS

Note: Dotted lines indicate a cooperative relationship.

193 The Twin Peaks Approach

Governor-General on the nomination of remedies available to ASIC for violations of the Treasurer. The Commissioners report the law. It is an administrative settlement to the Ministers through their annual and may be accepted as an alternative to report, and through briefings, submissions, court action or certain other administra- and meetings with the Treasurer or Parlia- tive actions. It can apply to the Courts for mentary Secretary. action to be taken against breaches. Funding for ASIC comes from allo- cations within the annual budget of Framework for Domestic Coordination Parliament. The Council of Financial Regulators (CFR) Figure 15 provides a graphic depiction is the coordinating body for Australia’s of the relationship among the above-men- main financial regulatory agencies. Its tioned institutions. membership is composed of the RBA, which chairs the Council, APRA, ASIC, and Enforcement the Australian Treasury. The CFR provides APRA’s prudential framework is largely a forum to address emerging trends and principles based. Implementation is policy issues. The Council contributes to based on an ongoing dialogue between the efficiency and effectiveness of financial supervisors and regulated entities. Where regulation by providing a high-level forum significant difficulties arise, intervention by for cooperation and collaboration among APRA is proportionate to the seriousness its members. It operates as an informal of the problem and the level of risk to body in which members are able to share depositors, policyholders, and the financial information and views, discuss regulatory system. APRA has a broad range of supervi- reforms or issues where responsibilities sory powers that escalate from preventive, overlap and, if the need arises, coordinate to corrective, to failure management. responses to potential threats to financial APRA has the authority to establish stability. In the event of a crisis, the CFR standards on prudential matters in relation would serve as the key coordinating body to ADIs and insurers; however, it does not for developing an official response. have standards‑making powers in superan- The Council advises the government on nuation. APRA implements its prudential the adequacy of Australia’s financial system standards pursuant to its ongoing super- architecture in light of ongoing develop- visory activities, usually without resorting ments. The Council is nonstatutory and to its legal powers. However, APRA has has no regulatory functions separate from power to issue a “direction” to a licensed those of its members. Given the important institution requiring it to comply with a role played by each of these entities in the prudential standard or regulation, or to formulation of financial institutions policy, otherwise act in the interests of depositors in interacting with foreign counterparts, or policyholders. and in monitoring and evaluating trends The government is not legally obligated in domestic and international markets, the to consult ASIC in its legislative and CFR is an important forum for the Austra- policy formulation, and there is no formal lian financial sector. mechanism for such consultation. ASIC APRA has Memoranda of Understand- does have enforcement powers. “Enforce- ing (MoUs) with the ACCC, ASIC, the able undertakings” are one of a number of RBA, the Australian Taxation Office,

194 Profile: australia

the Commissioner for Fair Trading, the marking the commencement of the Trans- Department of Commerce, the Financial Tasman Mutual Recognition of Securities Reporting Council, the Office of Fair Trad- Offering Regime, which will allow a single ing, and the Treasury. It also has MoUs disclosure document to be used in both with a number of offshore prudential Australia and New Zealand. supervisors. The TTC recommended legisla- The APRA/RBA MoU addresses cooper- tive changes to lay the foundation for ation and coordination in instances involv- enhanced cooperation between APRA and ing threats to the financial system’s stabil- the Reserve Bank of New Zealand, and ity, participation by the RBA in prudential these changes have been implemented. consultations, and the establishment of The two regulators are required to sup- a coordination committee to ensure that port each other in fulfilling their statutory appropriate arrangements are in place objectives and, where feasible, to avoid to respond to threats to system stability actions that could have a detrimental effect and for coordinating information shar- on financial system stability in the other ing. The APRA/Treasury MoU addresses country. It provides for APRA to support information sharing, advising on emerging the Reserve Bank of New Zealand in the developments in the financial system, and performance of its statutory responsibilities informing the Treasurer of situations that relating to financial system stability and can cause financial distress or instability. prudential regulation in New Zealand. APRA and AUSTRAC have signed an MoU The future TTC work program includes to facilitate cooperation and the exchange improving cooperation in crisis manage- of information between the two regulators. ment, which would build on work currently underway in both countries. International Coordination Under the Australia-Indonesia Partner- The high interdependence of the Austra- ship for Reconstruction and Development, lian and New Zealand banking systems ASIC helped strengthen the Indonesian led to the formation, in 2005, of the capital markets supervisory agency, Bape- Trans-Tasman Council on Banking Supervi- pam-LK, in enforcement and surveillance. sion (TTC). The goals of the TTC are to This is a pilot for broader ASIC assistance enhance information sharing, promote a to promote financial stability in the region. coordinated response to financial crises, APRA also provides technical and strategic and guide policy advice to the governments advice to Bapepam‑LK on risk‑based superin relation to banking supervision. An vision and related matters. MoU between ASIC and the New Zealand Please refer to the chart of international Companies Office was signed in 2006, coordination activities and organizational moving the regulatory alignment closer. participation on page 234. To promote more consistent regulation between Australia and New Zealand, ASIC Current Issues signed a new MoU with the New Zealand Australian Authorities are pursuing initia- Securities Commission and an MoU with tives to develop a formal process to man- the New Zealand Registrar of Companies. age the failure of individual institutions The governments of Australia and New and more widespread crises. Historically, Zealand also recently exchanged letters failures of financial institutions in Australia

195 The Twin Peaks Approach

are rare. As a result, responses to troubled ning for crisis management. Government institutions have tended to be ad hoc intervention to compensate policyholders, rather than based on the remedial powers coupled with the history of arranged merg- of the Banking Act or insurance legislation. ers and state government support for fail- This history, in which there have been ing banks, has contributed to the expecta- no losses borne by depositors in a failed tion that the government would guarantee bank since the Banking Act was introduced or bail out policyholders or depositors in in 1945, has led to a widespread public a failed ADI. The government has recently perception that the government will be announced the introduction of a Financial compelled to intervene to bail out deposi- Claims Scheme to provide compensa- tors in failed ADIs. tion to policyholders of a failed general The current institutional arrangements insurer and to provide depositors with for financial stability have not been tested. timely access to their funds in a failed ADI. The failure in 2001 of a large insurance The Scheme forms part of an enhanced entity highlighted the need for improved framework for failure resolution and crisis arrangements to manage the failure of management. financial institutions and contingency plan-

Acronyms and Abbreviations

A$ Australian dollars ACCC Australian Competition and Consumer Commission ADIs Authorized Deposit-Taking Institutions AML Anti-Money Laundering and Counter-Terrorism Financing Act 2006 APRA Australian Prudential Regulation Authority ASC Australian Securities Commission ASIC Australian Securities and Investments Commission ASX Australian Stock Exchange CFR Council of Financial Regulators FSAC Financial Sector Advisory Council FTR Act Financial Transaction Reports Act 1988 MoUs Memoranda of Understanding PSB Payments System Board RBA Reserve Bank of Australia RFCs Registered financial corporations SFE Sydney Futures Exchange TTC Trans-Tasman Council on Banking Supervision

196 The Netherlands The Twin Peaks Approach

Market Description Until the late 1990s, financial supervi- The Netherlands has approximately 1,800 sion in the Netherlands was sector based, licensed financial institutions, with total with DNB responsible for the supervision assets of approximately €5 trillion (euros).1 of banks, collective investment entities, However, as the Dutch financial market and exchange offices. The Securities Board has undergone a process of consolidation (STE), predecessor of the AFM, supervised in recent decades, a small number of all the participants in the securities trade. financial conglomerates providing bank- The Pension and Insurance Supervisor ing and insurance services have come to (PVK) exercised prudential supervision dominate the market. At present, foreign over insurers and pension funds. With banks play only a limited role in the Dutch the increased diversification and mergers retail market and are principally active in of financial sector institutions, DNB, the the wholesale market. The takeover of the STE, and the PVK created the Council of Dutch bank ABN AMRO by three foreign Financial Supervisors (RFT) in 1999, to banks, however, at end-2007, marked a cooperate on cross-sectoral issues. turning point in the domestic consolidation Soon after, however, the public authori- process. ties decided to abandon the sector-based The Dutch pension fund industry is approach and replace it with a division of significant, given the pension structure in duties into prudential and market conduct the Netherlands, and is composed of both supervision. The decision was taken in a small number of large pension funds and response to two clear trends: the consolida- numerous smaller pension funds. Consoli- tion of the Netherlands’ financial sector dation in the pension fund sector began a into one dominated by a few large compa- few years ago and is still in progress. nies conducting business across multiple product types and lines, and the develop- Background ment of complex financial products that The current Dutch financial regulatory have cross-sector elements. This funda- structure can be described as a twin peaks mental reform of the financial regulatory system. De Nederlandsche Bank (DNB), system into a twin peaks structure was in the Dutch central bank, is responsible place by 2004, including the PVK merger for prudential and systemic supervision with DNB. The key legislative changes were of all financial services. The Netherlands in place by 2007. Authority for the Financial Markets (AFM), Under the new regime, DNB assumed is responsible for the conduct-of-business responsibility for the prudential supervi- supervision in the Dutch financial markets. sion of all financial institutions and the The Ministry of Finance is politically financial system as a whole (that is, systemic responsible for the functioning of the supervision). The STE was transformed financial system, for the institutional struc- into the AFM and became market conduct ture of supervision, the legislation, and the supervisor, with a view, among others, to use of public funds in crisis situations. consumer protection.

1 De Nederlandsche Bank (DNB) Statistical bulletin.

198 Profile: the netherlands

Statutory Framework WFT clarifies and strengthens the frame- The role of DNB was defined in the 1948 work for financial sector supervision and Bank Act, under which DNB had joint sets out the requirements that financial responsibility with the Ministry of Finance services providers must meet. The WFT for the stability of the value of money. In replaced seven supervision acts, which 1952, the role of DNB as the supervisor of were structured along traditional sector the banking system was statutorily formal- lines. The WFT clearly delineates the tasks ized, and expanded in the following years between DNB—in the area of prudential to include all credit institutions. supervision—and the AFM—relating to The Act on the Supervision of the Credit market conduct or conduct-of-business System of 1952 “the Act” established the supervision. statutory basis for banking supervision. In addition to the WFT, there are a few The Act encompasses credit institutions, a acts that regulate specific segments of the collective term that includes general banks, financial sector. Pension funds are super- banking cooperatives, savings banks, securi- vised on the basis of the Pension Act (PW) ties banks, and capital market institutions, and the Obligatory Occupational Pension such as mortgage banks. Initially, the Act Schemes Act. The PW is a modernization and distinguished between monetary supervi- technical revision of the previous Pensions sion and prudential supervision. Monetary and Savings Fund Act, which entered into supervision empowered DNB to control force at the same time as the WFT, in Janu- lending by private banks. Under the Act ary 2007. DNB supervises trust offices and (and subsequent amendments), DNB’s money transaction offices on the basis of supervisory activities were again expanded, the Supervision of Trust Offices Act and the enabling it to target systemic risk. During Money Transaction Offices Act, which supervi- the 1980s and 1990s, DNB’s duties were sion focuses on integrity. The AFM super- further expanded to include supervision of vises audit firms on the basis of theAct collective investment entities and exchange on Supervision of Audit Firms and financial offices.2 reporting of listed Dutch companies on the DNB’s financial supervisory role was basis of the Act on the Supervision of Financial transformed in 2002, when it was given Reporting. Both DNB and AFM supervise responsibility for prudential supervision financial institutions on the basis of the of financial institutions and the soundness Identification (Financial Services) Act (WID) of the financial system. At the same time, and the Disclosure of Unusual Transactions market conduct supervision was entrusted (Financial Services) Act (Wet Mot). WID and to the AFM. Wet Mot will be integrated in 2008 into a The legal underpinning of the reform new Act on the Prevention of Money Launder- of the Netherlands’ financial supervisory ing and Financing of Terrorism. system was completed with the Financial Supervision Act (WFT), in January 2007, Nonstatutory Elements providing one main act along with various No nonstatutory elements have been decrees and regulations concerning the noted. supervision of the financial sector. The

2 The history of DNB is available at www.dnb.nl.

199 The Twin Peaks Approach

Institutional Structure account holder per institution (regardless of the Regulators of the number of accounts held). For each As mentioned, the financial regulatory account holder, the amount over €20,000 structure in the Netherlands can be is subject to a 10 percent account holder described as a twin peaks system. The fol- risk. The compensation under the scheme lowing institutions are involved. cannot be more than €38,000 per account holder. DNB will pay out compensation The Ministry of Finance under the Deposit Guarantee Scheme The Ministry of Finance has no supervisory and can subsequently apportion the total responsibilities, with one major exception. sum paid among the participating banks The Minister of Finance, with DNB, has to according to size.3 grant permission for a takeover or merger DNB’s day-to-day management rests with in which one of the five largest banks or the Governing Board, which consists of a insurers in the Netherlands is involved, President and up to five Executive Direc- as was the case with the takeover of ABN tors, appointed by the Crown to seven-year AMRO. terms. DNB also has a Supervisory Board and an advisory body, called the Bank De Nederlandsche Bank (DNB) Council. The Supervisory Board supervises DNB has a dual status, being both a member management of the DNB’s affairs and of the European System of Central Banks adopts the annual balance sheet and profit- (ESCB) as a central bank, and an indepen- and-loss account. One member of the dent public body, as a supervisory authority. Supervisory Board is appointed by the gov- DNB exercises prudential supervision of ernment. The Supervisory Board approves financial institutions (credit institutions, the budget, and then the portion of the insurers, collective investment schemes, budget applicable to DNB’s supervisory investment firms, and pension funds), and activities is submitted to the Ministers of of integrity-related supervision over money Finance and of Social Affairs and Employ- transactions offices and trust offices. ment for approval. The Bank Council DNB has established a specialized Finan- offers advice to the Governing Board. Two cial Stability Division, which analyzes the Supervisory Board members sit on the interplay between prudential supervision Bank Council, including the government- and systemic and monetary stability issues. appointed Supervisory Board member. The division examines the degree to which DNB’s supervision is partly funded by the the financial system can absorb shocks. financial institutions via contributions and This involves a continuous examination of the government. DNB has more than 1,600 potential risks and vulnerabilities, includ- employees (full-time equivalents), including concentration risk and the second- ing approximately 400 employees with a round effects of financial instability. primary focus on supervisory activities. In DNB executes a Deposit Guarantee 2007, DNB’s net operating costs were €276 Scheme, in case a bank fails, which million, and its net profit for the year was 4 guarantees balances up to €40,000 per €1.621 billion.

3 www.dnb.nl. 4 DNB Annual Report 2006, at www.dnb.nl.

200 Profile: the netherlands

The Netherlands Authority . The AFM has a five-member Supervisory for Financial Markets (AFM) Board, which is responsible for monitor- The AFM supervises market conduct ing whether the AFM’s tasks are carried and the provision of information by all out properly by the Executive Board. market participants in the Netherlands: The Minister of Finance has the power to savings, lending, investment, and insurance appoint and dismiss the members of the markets. The overall objective of the AFM Supervisory Board. The Supervisory Board is to promote an orderly and transparent is responsible for approving the AFM’s market process in the financial markets, annual plan, budget, and annual financial the integrity of relations among market statements. It also has to approve the Exec- players, and the protection of the con- utive Board’s resolutions of major strategic sumer. This overall objective is translated importance, such as to adopt or alter policy into three further objectives, which guide plans for the medium or long term, change the work of the agency: to promote access the organizational structure, appoint or to the market; to ensure the efficient, fair, dismiss the external auditor, amend the and orderly operation of the market; and statutes, or accept new tasks. to guarantee confidence in the market.

Figure 16. The Financial Services System Regulatory Structure, the Netherlands

European Union (EU)

Ministry of Finance

De Nederlandsche Bank (DNB) Netherlands Authority for Financial Markets (AFM)

Prudential Conduct-of-Business Supervisory Supervision Supervision Supervisory Board Board BANKING BANKING

SECURITIES SECURITIES Executive INSURANCE INSURANCE Board

PENSION FUNDS PENSION FUNDS

Deposit Guarantee Scheme

Note: Dotted lines indicate a cooperative relationship.

201 The Twin Peaks Approach

The Executive Board governs the AFM Framework for Domestic Coordination and has ultimate strategic responsibility. In their capacities as prudential supervisor The Directors, who report to the Board, and market conduct supervisor, respec- are responsible for day-to-day manage- tively, DNB and AFM work closely together. ment of the AFM. In contrast to the They have concluded the so-called Cov- Executive Board, the AFM Directors do enant, which outlines the procedures for not have joint responsibility; rather, each cooperation and coordination in regula- Director is responsible for only his or her tion and ongoing supervision. The latter individual mandates as established by the includes licensing and regular supervisory Executive Board. inspections, special measures, and other The AFM operates as an agency of the functions. Minister of Finance. The Minister appoints Also, representatives from DNB and the the members of the Supervisory Board and Ministry of Finance at all levels meet fre- the Executive Board, and approves the quently and regularly to discuss supervisory budget and any amendments to the AFM’s and financial stability issues, although gen- statutes. The AFM is funded jointly by the erally not concerning specific institutions, institutions it supervises and through the given the confidentiality of supervisory Dutch government budget. It employs information. The Ministry of Finance approximately 450 people and its operat- and DNB have had a Memorandum of ing costs for 2006 were €73.24 million.5 Understanding (MoU) since 2007, which Figure 16 provides a graphic depiction outlines the procedures for the manage- of the relationship among the above-men- ment of financial crises. The MoU sets out tioned institutions. principles of coordination, not operational details, as both the Ministry and DNB Enforcement agree that in a crisis, speed is of prime Both financial supervisors—DNB and importance. When faced with a possible the AFM—have similar broad powers of financial crisis or banking failure, DNB has enforcement, based on the above-men- the lead role, while the Ministry remains tioned Acts. They decide on the admission informed, if necessary, on specific institu- of financial undertakings to the financial tions, and will be involved if measures by markets and are empowered to withdraw the Minister are needed. The AFM does licenses. Firms cannot use the word “bank” not have a formal crisis management role in their title unless authorized by DNB. If under the MoU. However, the agency is the supervisors find violations of said Acts, informed of actions taken by DNB and the they can take various measures, including Ministry, according to the Convenant. issuing an instruction, appointing an administrator, or imposing sanctions like International Coordination cease and desist orders, under penalty Please refer to the chart of international or administrative fines. Moreover, the coordination activities and organizational supervisors can publicize a public warning participation on page 234, and to the Euro- or report a case to the Public Prosecutions pean Union profile for an explanation of Department (Openbaar Ministerie). coordinating activities within the EU.

5 AFM Annual Report 2006, at www.afm.nl.

202 Profile: the netherlands

Acronyms and Abbreviations

AFM Netherlands Authority for the Financial Markets (Autoriteit Financiële Markten) DNB De Nederlandsche Bank ESCB European System of Central Banks s Euro MoU Memorandum of Understanding PVK Pension and Insurance Supervisor (Pensioen- en Verzekeringskamer) PW Pension Act (Pensioenwet') RFT Council of Financial Supervisors (Raad voor de Financiële Toezichthouders) STE The Securities Board (Stichting Toezicht Effectenverkeer) Wet Mot Disclosure of Unusual Transactions (Financial Services) Act (Wet melding ongebruikelijke transacties) WFT Financial Supervision Act (Wet op het financieel toezicht) WID Identification (Financial Services) Act (Wet identificatie bij dienstverlening)

203 the exception

United States of America

United states of america The Exception

Market Description Background The U.S. financial services system accounts The structure of the U.S. financial services for approximately 8 percent of the regulatory regime is admittedly complex, country’s gross domestic product, and by and reflects such factors as the federalist assets is the largest financial system glob- nature of the United States, responses ally. There are more than 31,000 regulated to financial crises, solutions to specific financial services providers in the United problems, developments or regulatory States, providing banking, securities, invest- gaps, and efforts to modernize the finan- ment management, and insurance services. cial system over time. While successful in This includes approximately 9,000 banks the past, the credit and financial market and bank or financial holding companies, turmoil over the last year has focused atten- 8,000 credit unions, 7,600 insurance tion on the efficacy of the U.S. system in providers, 5,000 brokerage firms, 1,300 meeting the goals of financial supervision, thrifts and thrift holding companies, and including promoting safety and soundness 500 investment management firms. The of individual institutions, market integrity, complexity of the U.S. system is created, investor and customer protection, and in part, by the differences in the regula- financial stability. tory oversight of banking, securities, and The U.S. system of supervision and regu- insurance. In the United States, federal lation comprises both functional regulation and state agencies provide oversight and of activities (for example, banking, securi- guidance for banking and securities, but ties, commodities, insurance) and consoli- states supervise insurance. In addition, dif- dated supervision. The latter is a guiding ferent federal and state agencies regulate principle of bank and thrift supervision, as each sector. exercised by the Federal Reserve through The U.S. market also contains a sig- its bank and financial holding company nificant number of unregulated or lightly responsibilities, and by the Office of Thrift regulated financial services providers, Supervision (OTS) of thrift holding compa- including hedge funds, private equity and nies. In recent years, efforts by the Securi- other private pools of capital, mortgage ties and Exchange Commission (SEC), brokers, check cashers, money transmit- through the Consolidated Supervised Entity tal firms, and payday loan providers. program, have also extended the principle This segment of the market, (that is, the of consolidated supervision to some of the unregulated or lightly regulated segment), country’s largest securities firms. which ranges from relatively small entities A distinguishing feature of the U.S. operating in local markets to large global banking system is its dual nature, in which firms with investments or exposures that banks have a choice of state or national transcend national boundaries, poses charters. For a long period after the significant challenges to U.S. regulators. founding of the country, states played a The recent mortgage lending crisis in major role in chartering financial institu- the United States is focusing attention on tions, providing for their supervision, certain of these unregulated and lightly and establishing the earliest depositor regulated market activities. protection schemes. Indeed, the First and

208 Profile: united states of america

Second Banks of the United States were OTS (established by the Financial Institu- the only federally chartered institutions tions Reform, Recovery, and Enforcement Act in until passage of the National Currency and 1989) and the Commodity Futures Trading National Bank Acts in the 1860s. These Commission (CFTC) in 1974. laws provided for federally or nationally The formation of bank holding com- chartered banks and established the Office panies over time, in part to circumvent of the Comptroller of the Currency (OCC) restrictions on interstate and non-banking as the national bank supervisor. Since that activities, led to passage of the Bank Hold- time, competition in charter choice has ing Company Act in 1956, and the 1970 been viewed as an important source of Amendments, which gave the Federal innovation in, and development of, the Reserve authority to approve and supervise U.S. banking system. The creation of the such entities. Another key development Federal Reserve in 1913 provided for the in the structure of financial system over- supervision of member banks, extending sight in the United States was the Federal federal oversight to state-chartered institu- Deposit Insurance Corporation Improvement tions that were members of the Federal Act of 1991, which substantially increased Reserve. the federal role in the establishment and The stock market crash of 1929, fol- supervision of offices of foreign banks lowed by the Great Depression of the in the United States. Events, such as the 1930s, (and a decrease in the number of closing of the Bank of Credit and Com- banking institutions by approximately merce International (BCCI), a foreign 10,000, or roughly 40 percent), saw a bank operating in the U.S. without a home marked change in the structure of finan- country consolidated supervisor, pointed cial services regulation that would define to the need for tighter control over banks supervisory oversight for decades. The entering the United States; for comprehen- various regulatory agencies in operation sive, consolidated supervision by the home today, or their predecessors, were estab- country supervisor; and for enhanced lished during this turbulent period in supervision of foreign banks operating U.S. history. Key legislation of this period in the United States. The Foreign Bank created the Federal Deposit Insurance Supervision Enhancement Act (Title II of the Corporation (FDIC), which established the Act) established the Federal Reserve as the deposit insurance framework and provided umbrella supervisor for the U.S. operations for the supervision of state nonmember of foreign banking organizations. banks; separated commercial and invest- The Gramm-Leach-Bliley Act of 1999 ment banking under the Banking Act of (GLBA) repealed provisions of the Glass- 1933 (otherwise known as the Glass-Steagall Steagall Act that restricted the ability of Act); and established the SEC under the bank holding companies to affiliate with Securities Exchange Act to regulate the U.S. securities firms and insurance companies, securities markets in combination with and permitted the establishment of diversi- Self-Regulatory Organizations (SROs) that fied financial holding companies. The are subject to SEC oversight. This period GLBA’s intent was to modernize the finan- also saw the creation of the Federal Home cial services industry, rather than to be a Loan Bank Board and the Commodity response to crisis or scandal. The Federal Exchange Commission, predecessors to the Reserve serves as the umbrella or con-

209 The Exception

solidated supervisor of Financial Holding supervision and regulation. State supervi- Companies (FHCs), relying “to the fullest sors have also established coordinating extent possible” on functional regulators, bodies, such as the Conference of State and in its consolidated oversight, evaluates Bank Supervisors (CSBS) for bank supervi- the financial strength and stability of the sors, and the National Association of Insur- FHC, its consolidated risk management ance Commissioners (NAIC) for insurance and control processes, and overall capital supervisors. adequacy. The Federal Reserve may examine a functionally regulated non- Statutory Framework bank subsidiary of the FHC under certain The National Bank Act of 1863 was moti- conditions (for example, if the subsidiary is vated by the need to finance the Civil War. engaged in activities that present a material It provided for nationally chartered banks, risk to affiliated depository institutions). which would be supervised by the OCC, Banking and securities activities are a bureau of the U.S. Department of the generally regulated at both the state and Treasury. federal levels, insurance at the state level, The Federal Reserve Act of 1913 was and futures principally at the federal level. enacted in response to a series of financial Five federal agencies—the Federal Reserve, panics and economic problems in the the OCC, the FDIC, the OTS, and the late 19th and early 20th centuries. The National Credit Union Administration legislation created a means of ensuring the (NCUA)—oversee banking and thrift insti- availability of currency to meet emergency tutions and credit unions. State and federal needs. In addition, it provided for the banking agencies jointly oversee state-char- creation of the Federal Reserve System, tered banking institutions and thrifts. including the Board of Governors in The complex array of supervisory agen- Washington, D.C., and the Federal Reserve cies requires a high degree of coordina- Banks, and established the powers of the tion, and supervisors have worked out Federal Reserve, including the conduct of processes for limiting overlap and enhanc- open market operations, lending through ing resource efficiencies. These include the discount window, and the supervision arrangements between state and federal of state member banks. supervisors for state-chartered institutions, The Banking Act of 1933, also known between holding companies and federally as the Glass Steagall Act, was enacted to chartered bank subsidiaries, and between remedy some of the problems exposed by the OCC and the Federal Reserve and the the beginning of the Great Depression. It FDIC. At a broader level, in 1978, Congress created the FDIC and provided for federal established the Federal Financial Institu- deposit insurance, established procedures tions Examination Council (FFIEC), which for handling insolvent banks, established includes the executives of the five agencies, enforcement powers for bank regulators, as a forum for the various federal agencies and addressed perceived abuses in bank to discuss issues of common concern and securities underwriting activities, in part by to seek consistency in their approaches to

1 For more information, see www.ffiec.gov; www.csbs.org; and www.naic.org.

210 Profile: united states of america

prohibiting the banks from affiliating with mission became the Commodity Exchange firms engaged in such activities. Commission, which would eventually The Securities Act of 1933 was designed become the Commodity Futures Trad- to promote the availability of material ing Commission (CFTC) in 1974, when information to investors and to fight fraud. the Act was amended and extended the This Act focuses on the issuers of securities CFTC’s jurisdiction to futures trading in and requires the registration of securities, all commodities, not just those specifically unless an exception applies. enumerated in the 1936 Act. The Act The Securities Exchange Act of 1934 was makes the CFTC the regulator for certain enacted to form the basis for regulation of exchange-traded products and for certain financial markets and their participants, market participants, including futures including brokers, dealers, and clearing commission merchants and commodity entities. The Act created the SEC. pool operators. The CFTC’s mandate has The Home Owners’ Loan Act of 1934 was been renewed and expanded several times enacted to provide emergency relief for since then, most recently by the Commodity home mortgage debt, to refinance home Futures Modernization Act of 2000. mortgages, and to extend relief to the own- The Trust Indenture Act of 1939 applies to ers of homes occupied by them who are debt securities such as bonds, debentures, unable to amortize their debt elsewhere. and notes that are offered for public sale. The Act also amended the Federal Home Even though such securities may be reg- Loan Bank Act to increase the market for istered under the Securities Act, they may U.S. obligations and for other purposes. not be offered for sale to the public unless The Act was later amended, and trans- a formal agreement between the issuer of ferred the authority of the Federal Home bonds and the bondholder, known as the Loan Bank Board to the OTS as an agency trust indenture, conforms to the standards within the Treasury Department respon- of this Act. sible for supervising mortgage activities The Investment Company Act of 1940 conducted by savings and loan associations regulates the organization of companies, and their holding companies. including mutual funds, that engage pri- The Federal Credit Union Act of 1934 marily in investing, reinvesting, and trading authorized the formation of federally in securities, and whose own securities are chartered credit unions in all states. The offered to the investing public. The focus purpose of the federal law was to make of this Act is on disclosure of informa- credit available and promote thrift through tion about the fund and its investment a national system of nonprofit, cooperative objectives, and on investment company credit unions. In 1970, the National Credit structure and operations. The Act does not Union Administration (NCUA) was formed permit the SEC to directly supervise the as an independent federal agency to char- investment decisions or activities of these ter and supervise federal credit unions. companies or judge the merits of their The Commodity Exchange Act of 1936 investments. was enacted to replace the earlier Grain The Investment Advisers Act of 1940 Futures Act and extend federal regulation regulates investment advisers. With certain beyond grain to a wider enumerated list exceptions, this Act requires that firms or of commodities. The Grain Futures Com- sole practitioners compensated for advising

211 The Exception

others about securities investments must and bank supervisor enforcement powers, register with the SEC and conform to regu- among other supervisory subjects. lations designed to protect investors. Since The Bank Holding Company Act of 1956 the Act was amended in 1996, generally and the 1970 Amendments define what a only advisers who have at least US$25 mil- “bank holding company” is, control future lion of assets under management or advise expansion of bank holding companies, and a registered investment company must restrict the non-banking activities in which register with the Commission. bank holding companies can engage. The McCarran-Ferguson Act of 1945 The Federal Deposit Insurance Corporation permitted the states to continue regulating Improvement Act of 1991 was passed during the insurance business after the Supreme the savings and loan crisis. It introduced Court ruling declaring insurance to be a formal scheme for prompt corrective interstate commerce and therefore within action and it required the least-cost reso- Congress’s constitutional authority to regu- lution of failed depository institutions. late. Under the Act, insurance is exempt Notably, in response to the BCCI scandal, from some federal antitrust statutes to the it mandated comprehensive supervision on extent that it is regulated by the states. The a consolidated basis as a prerequisite for exemption primarily applies to gathering approval of many applications by foreign data in concert for the purpose of ratemak- banks for offices in the United States. ing. Otherwise, antitrust laws prohibit The Riegle-Neal Interstate Banking and insurers from boycotting, acting coercively, Branching Efficiency Act of 1994 allows restraining trade, or violating the Sherman interstate banking in the United States, Antitrust Act or the Clayton Antitrust Act. and permits banks to establish branches The Administrative Procedure Act of 1946 nationwide by eliminating all barriers to provides a basis for accountability to the interstate banking. Before this legislation public of financial regulators in the United went into effect, banks were required to States. The Act prescribes an agency’s establish separate subsidiaries in each state obligation to make public information to conduct business, and it was illegal for about its organization, procedures, and banks to accept deposits from customers substantive requirements, and to provide out of their home state. advanced notice of proposed rules. Inter- The Gramm-Leach-Bliley Act of 1999 ested parties must be given an opportunity provides a framework for the affiliation of to comment on the rulemaking process. banks and other financial services provid- The Act also defines general conditions for ers, most notably, insurance companies judicial review of agency decisions, provid- and securities firms. It allows the formal ing a check on regulatory powers. The affiliation of such companies under hold- procedural requirements of the Act have ing companies that were well capitalized been developed and refined by subsequent and well managed, in part by repealing the legislation. relevant sections of the Banking Act of 1933, The Federal Deposit Insurance Act of 1950 and by making amendments to the Bank contains the provisions of law regarding Holding Company Act of 1956. In addition, it the FDIC and deposit insurance, proce- provided that the Federal Reserve would be dures for the handling of insolvent banks, the umbrella supervisor of the new financial

212 Profile: united states of america

holding companies and that non-bank SROs play a significant role in the financial entities or subsidiaries of those overall U.S. regulatory regime. As with holding companies would be supervised by the FASB, the SEC delegates authority to their primary functional regulators. national and regional exchanges to enforce The Sarbanes-Oxley Act of 2002 mandates industry standards with respect to broker- a number of reforms to enhance corporate age and trading of securities. In particular, responsibility, enhance financial disclo- the SROs are responsible for oversight of sures, and combat corporate and account- the securities markets and their partici- ing fraud, and created the Public Company pants. This is implemented via standards Accounting Oversight Board (PCAOB), to which securities market participants are to oversee the activities of the auditing expected to adhere. SROs also monitor profession. The PCAOB is a private-sector, business conduct and bring disciplinary nonprofit corporation, with four primary actions against their members for violating responsibilities: applicable federal statutes, SEC rules, and their own rules. The SROs are overseen by 8 Registration of accounting firms that the SEC, which inspects their operations audit public companies in U.S. secu- and reviews their rule proposals. rities markets; SROs—including the numerous futures 8 Inspections of registered public exchanges and the National Futures accounting firms; Association—are also responsible for 8 Establishment of auditing and related overseeing the futures industry. Similar attestation, quality control, ethics, to their securities counterparts, futures and independence standards for reg- SROs establish and enforce rules govern- istered public accounting firms; and ing member conduct and trading, prevent 8 Investigation and discipline of reg- market manipulation via monitoring of istered public accounting firms and trading activity, and examine members for their associated persons for violations financial strength and other regulatory of specified laws or professional purposes. Futures SROs are also responsi- standards. ble for ensuring that industry professionals meet qualifications. The CFTC acts as an Nonstatutory Elements independent monitor of exchange trading In addition to the statutory elements of activity and market participants’ financial the U.S. system, there are various private conditions. These SROs are overseen by standard-setting organizations, including the SEC, which inspects their operations the Financial Accounting Standards Board and reviews their rule proposals. (FASB), the International Swaps and Derivatives Association (ISDA), and the Financial Accounting and . Securities Industry and Financial Markets Standards Board (FASB) Association (SIFMA). Self-regulatory Although not endowed with statutory organizations (SROs) have an underlying authority, the FASB serves as the leading statutory authority, but are discussed in private sector organization for the estab- more detail in this section. lishment and improvement of financial

2 For more on SROs, see www.finra.org/index.htm; www.cftc.gov/; and www.nfa.futures.org/.

213 The Exception

accounting and reporting standards. Financial Industry Regulatory . Its purpose in doing so is to guide and Authority (FINRA) educate the public, which includes issuers, In 2007, the SEC approved a merger of auditors, and users of financial informa- the enforcement arms of the New York tion. Statutory authority to establish Stock Exchange (NYSE) and the National financial accounting and reporting stan- Association of Securities Dealers (NASD), dards lies with the SEC, but the SEC has to form the Financial Industry Regulatory historically relied on the FASB, even going Authority (FINRA). FINRA is the largest so far as to recognize the FASB’s word as nongovernmental regulator of securities authoritative. firms doing business in the United States, and performs market regulation under International Swaps and . contract for the National Association of Derivatives Association (ISDA) Securities Dealers Automated Quotation The ISDA represents participants in the System (NASDAQ) Stock Market and vari- privately negotiated derivatives industry, ous national exchanges. and is the largest global financial trade association (by number of member firms). National Association of Insurance . The ISDA was chartered in 1985, and has Commissioners (NAIC) over 825 member institutions in 56 coun- The NAIC is an organization of insurance tries. These members include most of the regulators from the 50 states, the District of world’s major institutions that deal in pri- Columbia, and the five U.S. territories. The vately negotiated derivatives, as well as busi- NAIC provides a forum for the develop- nesses, governments, and other institutions ment of uniform policy when uniformity that rely on over-the-counter derivatives to is appropriate. It is a private association, manage financial market risks. The ISDA’s not a governmental organization. This primary purpose is to encourage the status carries two important implications. prudent and efficient development of the First, the NAIC has no power to compel privately negotiated derivatives business. the states or the industry; and second, the NAIC is completely self-governing, neither Securities Industry and Financial . accountable to voters nor subject to Markets Association (SIFMA) government oversight. Thus, although the The SIFMA was formed via a merger NAIC has assumed a central and national between the Securities Industry Association role in insurance regulation, it cannot and the Bond Market Association, and sanction regulators or insurers. The indus- represents more than 650 member firms try directly funds the NAIC. Each year the of all sizes, in all financial markets in the NAIC assesses insurance companies a fee, United States and around the world. Its based on premium volume, to file informa- objectives include ensuring the public’s tion in its centralized databases. trust in the securities industry and financial markets; encouraging retirement savings Conference of State . and investment; promoting effective and Bank Supervisors (CSBS) efficient regulation; and facilitating more The CSBS is a national organization dedi- open, competitive, and efficient global cated to advancing the U.S. dual banking capital markets. system. Through the CSBS, state bank

214 Profile: united states of america

regulatory agencies and state-chartered ety of system functions, including conduct- banks support a system that offers chartering and implementing monetary policy; ing and supervision options. As an associa- overseeing a nationwide payments system; tion, it works to optimize the authority of distributing the nation’s currency and coin; individual states to determine the activities supervising and regulating state member of their financial institutions; represent banks, bank holding companies, and finan- the interests of the state banking system to cial holding companies (approximately 95 federal and state legislative and regulatory percent of all commercial banking activi- agencies; enhance the professionalism of ties); chartering Edge Act corporations; and state banking departments and their per- serving as fiscal agent for the U.S. Treasury. sonnel; and ensure that all banks continue The 12 Reserve Banks are each responsible to have the choice and flexibility of the for a particular geographic area or district state charter in the new era of financial of the United States. Besides carrying out modernization. functions for the System as a whole, such as administering nationwide banking and North American Securities . credit policies, each Reserve Bank acts as a Administrators Association (NASAA) depository for the banks in its own district NASAA is a voluntary association whose and fulfills other district responsibilities. membership in the United States consists The Federal Reserve System is consid- of securities administrators in the 50 ered to be an independent central bank, states, the District of Columbia, Puerto because its decisions do not have to be rati- Rico, and the U.S. Virgin Islands. NASAA fied by the President of the United States is the voice of state securities agencies or anyone else in the executive or legisla- responsible for efficient capital forma- tive branches of government. The System tion and grass-roots investor protection. is, however, subject to oversight by the NASAA members license firms and their U.S. Congress. The Federal Reserve must agents, investigate violations of state and work within the framework of the overall provincial law, file enforcement actions objectives of economic and financial policy when appropriate, and educate the public established by Congress; therefore, the about investment fraud. description of the System as “independent within the government” is more accurate. Institutional Structure of the Regulators The Board of Governors of the Federal The U.S. financial services system is Reserve System is a federal government characterized as both a functional and a agency, composed of seven members who consolidated regulatory system, in which are appointed by the President of the the following institutions have a role. United States and confirmed by the U.S. Senate. The full term of a Board member Federal Reserve System is 14 years, and the appointments are stag- The Board of Governors in Washington, gered so that one term expires on January D.C. and a network of 12 Federal Reserve 31 of each even-numbered year. After Banks and their branches carry out a vari- serving a full term, a Board member may

3 Budget and staffing numbers obtained from the Federal Reserve 2007 Budget Review.

215 The Exception

not be reappointed. If a member leaves mately 2,600 people and has an annual the Board before his or her term expires, budget estimated at US$556 million. The however, the person appointed and con- major source of Federal Reserve Bank firmed to serve the remainder of the term income is earnings from the portfolio of may later be reappointed to a full term. U.S. government securities in the System The Chairman and the Vice Chairman of Open Market Account. Beginning with the the Board are also appointed by the Presi- 1998–99 budget, the Board of Governors dent and confirmed by the Senate. The has operated on a two-year budget cycle nominees to these posts must already be and a four-year planning cycle. Given their members of the Board or must be simulta- current business needs, the Federal Reserve neously appointed to the Board. The terms Banks maintain an annual budget cycle. for these positions are four years. A major component of the Federal Office of the Comptroller . Reserve System is the Federal Open Mar- of the Currency (OCC) ket Committee, which is made up of the The OCC is a bureau of the Department members of the Board of Governors, the of the Treasury. In addition to its national president of the Federal Reserve Bank of headquarters in Washington, D.C., the New York, and presidents of four other OCC maintains district and field offices. Federal Reserve Banks, who serve on a Although the national headquarters sets rotating basis. policy and direction and oversees bank Each Reserve Bank has a board of nine supervision, supervision of all but the larg- directors, chosen from outside the Bank, as est national banks is coordinated through provided by law. The boards of the Reserve four district offices and 48 field offices Banks are intended to represent a cross- located throughout the United States. section of banking, commercial, agricul- The OCC currently supervises more than tural, industrial, and public interests within 1,700 national banks and about 50 federal the Federal Reserve District. The directors, branches of foreign banks (approximately in turn, nominate a president and first vice two-thirds of all commercial banking president of the Reserve Bank, whose selec- assets). Legal and licensing staffs are based tion is subject to approval by the Board of at the national headquarters and in the Governors. Each branch of a Reserve Bank four district offices. has its own board of directors composed The OCC is led by the Comptroller, who of at least three and no more than seven is appointed by the President, with the members. A majority of these directors are advice and consent of the Senate, for a five- appointed by the branch’s Reserve Bank; year term. The Comptroller also serves as a the others are appointed by the Board of director of the Federal Deposit Insurance Governors. Corporation (FDIC). The bank supervision and regulation The OCC has approximately 3,000 function is by law the responsibility of employees and has an annual budget of the Board of Governors. The Board sets approximately US$637 million. The OCC is policy and direction and has delegated the a nonappropriated federal agency funded day-to-day conduct of on-site examination through assessments and fees paid by the and supervision to the Reserve Banks. The national banks it supervises. The OCC pub- supervision function employs approxi- lishes an assessment and fee schedule at

216 Profile: united states of america

least annually in a bulletin entitled, “Notice insure securities, mutual funds, or similar of Comptroller of the Currency Fees.” types of investments that banks and thrift institutions may offer. Office of Thrift Supervision (OTS) The FDIC is headquartered in Washing- The OTS is also a bureau of the Depart- ton, D.C., but conducts much of its business ment of Treasury. Its core mission is to in six regional offices and in field offices supervise U.S. thrift institutions and their around the country. It is managed by a five- holding companies and ensure proper person Board of Directors, all of whom are consumer protection. The OTS oversees appointed by the President and confirmed domestic and international activities of the by the Senate, with no more than three holding companies and affiliates that own being from the same political party. these thrift institutions. The FDIC employs approximately 3,900 The Director of the OTS is appointed by individuals and has an estimated annual the President and confirmed by the Senate budget of US$841 million. It receives no for a five-year term. The OTS Director also Congressional appropriations; it is funded serves as a member of the Board of Direc- by premiums that banks and thrift institu- tors of the FDIC. tions pay for deposit insurance coverage, The OTS has approximately 950 and from earnings on investments in U.S. employees and an estimated annual budget Treasury securities. With an insurance of US$233 million. It receives no appropri- fund totaling more than US$49 billion, the ations from Congress; its operating budget FDIC insures more than US$4.4 trillion of is funded by periodic assessments of the deposits in U.S. banks and thrifts. thrift industry. National Credit Union . Federal Deposit Insurance . Administration (NCUA) Corporation (FDIC) The National Credit Union Administra- The FDIC directly examines and supervises tion (NCUA) was formed to charter and about 5,250 banks and savings banks, more supervise federal credit unions, and the than half of the institutions in the banking National Credit Union Share Insurance system. It is the primary federal regulator Fund (NCUSIF) was formed to insure of banks that are chartered by the states credit union deposits. The NCUSIF was that do not join the Federal Reserve created without tax dollars and is capital- System. In addition, the FDIC has backup ized solely by credit unions. In 1979, a authority to examine the remaining three-member board replaced the NCUA insured banks and thrift institutions. administrator. That same year, Congress Under FDIC insurance, savings, check- created the Central Liquidity Facility, the ing, and other deposit accounts, when credit union lender of last resort. There combined, are generally insured up to are federal- and state-chartered credit US$100,000 per depositor in each bank unions. At the state level, most are feder- or thrift the FDIC insures. The FDIC ally insured by the NCUSIF; however, there generally provides separate coverage for are about 185 state-chartered credit unions retirement accounts, such as individual that are privately insured by American retirement accounts and Keoghs, insured Share Insurance. up to US$250,000. The FDIC does not

217 The Exception

Figure 17. The Financial Services System Regulatory Structure, United States

BANKING INSURANCE SECURITIES

President’s Working Group on Financial Markets (PWG)

SECURITIES

BANKING

United States Treasury

Office of the Comptroller Federal Level Federal Reserve Board (FRB) Office of Thrift Federal Deposit National Credit Union Securities and Exchange Commodity Futures of the Currency (OCC) Supervision (OTS) Insurance Corporation (FDIC) Association (NCUA) Commission (SEC) Trading Commission (CFTC)

STATE MEMBER BANKS, NATIONAL BANKS S&L NON-MEMBER CREDIT UNIONS SECURITIES FUTURES FHCs AND BHCs STATE BANKS S&L HCs DEPOSIT INSURER DEPOSIT INSURER

Federal Financial Instutions Examination Council (FFIEC)

State Level State Banking State Insurance State Securities Supervisors Supervisors Regulators

MEMBER STATE BANKS

NON-MEMBER STATE BANKS

BHC = Bank Holding Company. FHC = Financial Holding Company. S&L = Savings and Loan. S&L HC = Savings and Loan Holding Company. Note: Dotted lines indicate cooperative relationship.

218 Profile: united states of america

BANKING INSURANCE SECURITIES

President’s Working Group on Financial Markets (PWG)

SECURITIES

BANKING

United States Treasury

STATE MEMBER BANKS, NATIONAL BANKS S&L NON-MEMBER CREDIT UNIONS SECURITIES FUTURES FHCs AND BHCs STATE BANKS S&L HCs DEPOSIT INSURER DEPOSIT INSURER

Federal Financial Instutions Examination Council (FFIEC)

State Level State Banking State Insurance State Securities Supervisors Supervisors Regulators

MEMBER STATE BANKS

NON-MEMBER STATE BANKS

219 The Exception

The NCUA has a full-time, three-member the holding company or an unregulated board appointed by the President of the affiliate endangers a regulated entity or the United States and confirmed by the Senate. broader financial system. Like other con- No more than two board members can solidated supervisors overseeing interna- be from the same political party, and each tionally active institutions, the SEC requires member serves a staggered six-year term. CSEs to compute capital adequacy mea- The NCUA has approximately 900 sures consistent with the Basel Standard. employees and an estimated annual budget The SEC consists of five presidentially of US$142 million. It receives no operating appointed Commissioners, with staggered appropriations and is funded by federal five-year terms. One of them is designated credit union fees. The Central Liquidity by the President as Chairman of the Com- Facility is a government corporation man- mission. By law, no more than three of the aged by the NCUA and owned by member Commissioners may belong to the same credit unions. Created by Congress, the political party, ensuring nonpartisanship. liquidity facility serves as a backup lender, The Commission’s approximately 3,800 meeting member liquidity needs when staff are located in Washington, D.C. and funds are unavailable from a standard in 11 regional offices around the country. credit source. The Community Develop- The SEC has an estimated annual budget of ment Revolving Loan Fund is the only US$830 million. It is funded by the fees it appropriated funding NCUA receives. collects from the entities it regulates, subject to limits set by the congressional authoriza- Securities and Exchange Commission (SEC) tions and appropriations processes. The mission of the SEC is to protect investors; maintain fair, orderly, and efficient Commodity Futures . markets; and facilitate capital formation. It Trading Commission (CFTC) oversees the key participants in the securi- Congress created the Commodity Futures ties world, including securities exchanges, Trading Commission (CFTC) in 1974 as securities brokers and dealers, investment an independent agency with the mandate advisors, and mutual funds. The SEC is to regulate commodity futures and option concerned primarily with promoting the markets. The CFTC’s mission is to protect disclosure of important market-related market users and the public from fraud, information, maintaining fair dealing, and manipulation, and abusive practices protecting against fraud. related to the sale of commodity and The SEC supervises certain broker- financial futures and options, and to foster dealer holding companies on a consoli- open, competitive, and financially sound dated basis. In this capacity, supervision futures and option markets. extends beyond the registered broker- The CFTC organization consists of the dealer to the unregulated affiliates of the Commission, the offices of the Chairman, broker-dealer and the holding company and the agency’s operating units. The itself. In supervising these Consolidated Commission consists of five Commission- Supervised Entities (CSEs), the SEC ers appointed by the President, with the focuses on the financial and operational advice and consent of the Senate, to serve condition of the group. The aim is to staggered five-year terms. The President reduce the likelihood that weakness in designates one of the Commissioners as

220 Profile: united states of america

Chairman. No more than three Commis- insurers; to license companies, agents, and sioners at any one time may be from the brokers; and to monitor and regulate claims same political party. handling. Each state has a department The CFTC has approximately 450 within the executive branch to regulate employees and an estimated annual budget insurance. The head of the department is of US$130 million. It receives an appro- usually called the commissioner or director priation from the federal budget and must of insurance. A handful of states elect their submit an annual budgetary request for insurance commissioner. In the remain- such appropriation. ing states, the insurance commissioner is appointed by the governor and serves at Insurance — State Commissioners the governor’s pleasure. The insurance State legislatures set broad policy for the department typically has broad, legislatively regulation of insurance. They establish delegated powers to enforce state insurance and oversee state insurance departments, laws, promulgate rules and regulations, and regularly review and revise state insurance conduct hearings to resolve disputes. laws, and approve regulatory budgets. State Figure 17 provides a graphic depiction insurance departments, funded by each of the relationship among the above-men- state, employ 12,500 regulatory personnel. tioned institutions. Increases in staff and enhanced automation have allowed regulators to substantially Enforcement boost the quality and intensity of their The banking supervisory agencies have financial oversight of insurers and expand broad enforcement powers over the consumer protection activities. State regula- institutions they supervise and over institution of insurance provides a major source tion-affiliated parties. These may include of state revenue. In 2000, states collected actions in cases where institutions are more than US$10.4 billion in revenues from undercapitalized, under prompt corrective insurance sources. Of this amount, US$880 action guidelines, or where institutions million—roughly 8.4 percent—went to may be engaged in unsafe, unsound, or regulate the business of insurance, and illegal practices. Supervisory and enforce- the remaining US$9.6 billion went to state ment actions can take a number of forms, general funds for other purposes. including formal actions such as cease Insurance is unique among financial ser- and desist orders, and written agreements vices in that it is regulated by the states. The and informal steps such as MOUs, or goals of insurance regulation articulated by verbal agreements (not considered an most states include fair pricing of insurance, enforcement action), depending on the protecting insurance company solvency, pre- severity of the issues. Other actions include venting unfair practices by insurance compa- the removal, prohibition, or suspension nies, and ensuring availability of insurance of selected individuals, assessment of coverage. For example, all states have the civil money penalties, and termination power to approve insurance rates; to peri- of insurance coverage, appointment of odically conduct financial examinations of conservators, and divestment of activities.

4 For more information, see Section 5040.1 (Formal and Informal Corrective Actions) and 4133.1 (Prompt Corrective Action) of the Commercial Bank Examinations Manual, at www.federalreserve.gov/boarddocs/supmanual/cbem/200710/0710cbem.pdf; and Section 2110.0 of the Bank Holding Company Manual, at www. federalreserve.gov/boarddocs/supmanual/bhc/200707/bhc0707.pdf.

221 The Exception

All federal supervisory agencies, and many Examination Council (FFIEC) was estab- of the state supervisory departments, have lished in March 1979, to serve as a forum established ombudsman programs, which for the various federal agencies (and later allow banks a process to appeal examina- the Conference of State Bank Supervi- tion findings with which they disagree. sors [CSBS]) to discuss issues of common Among its enforcement powers, the concern and to seek consistency in their SEC may seek a court injunction against approaches to supervision and regulation. acts and practices that deceive consumers A formal interagency body, the FFIEC is or otherwise violate laws; suspend or revoke empowered to prescribe uniform principles, the registration or license of brokers, deal- standards, and report forms for the federal ers, investment companies, and advisers examination of financial institutions by that have violated laws; impose civil money federal supervisory agencies and to make penalties; issue cease and desist orders; refer recommendations to promote uniformity in persons to the Department of Justice for the supervision of financial institutions. criminal prosecution in situations involving The Financial Institutions Reform, Recovery criminal fraud or other willful violation of and Enforcement Act of 1989 (FIRREA) estab- laws; and bar attorneys, accountants, and lished the Appraisal Subcommittee within other professionals from practicing before the Examination Council. State supervisors the Commission. In addition, many of the have also established coordinating bod- supervisory agencies have various legal ies, such as the Conference of State Bank powers of their own, including the power to Supervisors (CSBS) for bank supervisors, subpoena witnesses, administer oaths, and and the National Association of Insurance compel the production of records anywhere Commissioners (NAIC) for insurance in the United States. supervisors. U.S. financial authorities have been active in both international and Framework for Domestic Coordination bilateral forums to improve emergency The complex array of U.S. financial ser- communications with financial authorities vices system supervisory agencies requires in other jurisdictions. a high degree of coordination, and U.S. regulators interact and cooperate supervisors have, over time, worked out with federal and state law enforcement in a processes for limiting overlap and enhanc- number of ways. In fact, the regulators and ing resource efficiencies. These include law enforcement frequently have overlap- arrangements between state and federal ping responsibility for investigations and supervisors of state-chartered institutions, enforcement actions on behalf of their between holding companies and federally respective agencies. In addition, referrals chartered bank subsidiaries, and between of matters are sometimes made from law the Office of the Comptroller of the Cur- enforcement to bank regulators, and vice- rency (OCC) and the Federal Reserve versa, as appropriate. System and the Federal Deposit Insurance Leaders from each of the federal regula- Corporation (FDIC). tory agencies are in regular contact with At a broader level, the congressionally policymakers in government. They fre- authorized Federal Financial Institutions quently testify before congressional com-

5 For further details on broad areas of SEC enforcement, see the 2007 Annual Report online at www.sec.gov/ about/secpar/secpar2007.pdf.

222 Profile: united states of america

mittees on the economy, monetary policy, responses at both the principal and staff banking supervision and regulation, con- levels in order to address potential financial sumer credit protection, financial markets, and operational disruptions. and other matters. They also have regular In addition, the PWG sponsors a contact with members of the President’s broader interagency group known as Council of Economic Advisers and other the Financial and Banking Information key economic officials. Infrastructure Committee (FBIIC), which The major crisis-coordinating mechanism consists of the PWG agencies plus 12 addi- in the United States is the President’s Work- tional federal and state financial regulatory ing Group on Financial Markets (PWG), agencies in the banking, securities, com- created in March 1988 following the Octo- modities, and insurance sectors. The FBIIC ber 1987 stock market crash. The PWG’s promotes interagency coordination in mandate is to enhance interagency commu- terms of preparations for and responses to nication and coordination with respect to natural and man-made threats to the U.S. financial crises—including significant opera- financial sector infrastructure. The FBIIC tional disruptions—in the U.S. financial has developed emergency communication system, and other areas where coordination protocols through a “duty officer” program may be appropriate. The PWG is chaired by and has established secure communication the Secretary of the Treasury and includes facilities for sharing classified information the Chairmen of the Board of Governors of concerning financial and operational the Federal Reserve System, the Securities disruptions. FBIIC agencies work with the and Exchange Commission, and the Com- Department of Homeland Security and modity Futures Trading Commission. The the National Communications System, as Secretary of the Treasury is a member of the appropriate, in a crisis. President’s cabinet and acts as a conduit for information sharing, as appropriate, and International Coordination includes the Office of the Comptroller of The U.S. participates in various interna- the Currency, the Federal Reserve Bank of tional organizations. Please refer to the New York, and other market regulators in chart of international coordination activi- projects as appropriate. The PWG principals ties and organizational participation on meet at least quarterly, and the agencies’ page 234. staffs work closely on a number of ongoing projects affecting the financial sector, Current Issues including preparedness for future financial The structure of U.S. financial services or operational disruptions. The PWG agen- oversight has been the subject of cies have established “duty officer” proce- significant debate and various analyses dures to share information and coordinate and proposals for many years, involving

6 The General Accountability Office, in particular, has published various reports on these issues, including: March 1994: “Bank Regulation: Consolidation of the Regulatory Agencies”; GAO/T-GGD-94-106. November 1996: “Bank Oversight Structure: U.S. and Foreign Experience May Offer Lessons for Modernizing U.S. Structure”; GAO/GGD-97-23. October 2004: “Financial Regulation: Industry Changes Prompt Need to Reconsider U.S. Regulatory Struc- ture”; GAO-05-61. March 2007: “Financial Market Regulation: Agencies Engaged in Consolidated Supervision Can Strengthen Performance Measurement and Collaboration”; GAO-07-154. October 2007: “Financial Regulation: Industry Trends Continue to Challenge the Federal Regulatory Struc- ture,” GAO-08-32.

223 The Exception

issues such as streamlining the number of contains short-, intermediate-, and long- banking and thrift institution regulators, term recommendations. possible merger of the Securities and The short-term recommendations Exchange Commission (SEC) and the include improvements in regulatory coordi- Commodity Futures Trading Commission nation and oversight. The Blueprint recom- (CFTC), creation of a federal insurance mends creating a new federal commission charter, and revised supervision of the Gov- for mortgage origination to better protect ernment-sponsored Enterprises (GSEs). consumers. Intermediate-term recom- The issues have come into renewed focus mendations focus on eliminating some of more recently in discussions of the poten- the duplication in the existing regulatory tial erosion of the competitiveness of U.S. system, and offer ways to modernize the financial markets, embodied in several regulatory structure for certain financial recent reports, which have broadened the services sectors, within the current frame- debate on structure to include such issues work. Recommendations include eliminat- as principles vs. rules, and supervision vs. ing the thrift charter, creating an optional enforcement. These issues will be the sub- federal charter for insurance, and unifying ject of further discussion in light of recent oversight for futures and securities. The experience regarding the credit crisis, the long-term recommendation is to create an distressed sale of Bear Stearns, the opening entirely new regulatory structure using an of the discount window to some securities objectives-based approach. The structure firms, and the government support legis- would consist of a market stability regulator, lated for the GSEs. a prudential regulator, a business conduct The U.S. Treasury Department last year regulator, with a focus on consumer protec- undertook a broad review of financial tion, and a corporate finance regulator, services regulation, and in March 2008, with a focus on corporate disclosure and issued its “Blueprint for a Modernized governance and accounting oversight. Financial Regulatory Structure,” setting While it is unlikely that major changes forth the Administration’s views on actions to the regulatory structure will be made by needed to update and modernize the U.S. Congress in the near term, the Treasury’s financial institutions’ regulatory frame- Blueprint is far-reaching. The fact that work. Treasury’s proposal is not designed Treasury has put these proposals on the principally to solve the current problems public agenda, together with the serious- in financial and credit markets. Rather, it ness of current conditions, suggests that is intended to ensure that the U.S. finan- there will be an active debate in the period cial regulatory structure keeps pace with ahead about the need for modifications changes that have taken place in the U.S. and enhancements to the U.S. financial and global financial systems. The proposal regulatory system.

7 GSEs are privately held corporations with public purposes created by the U.S. Congress to reduce the cost of capital for certain borrowing sectors of the economy. 8 These include reports from the Committee on Capital Markets Regulation, the U.S. Chamber of Commerce, the Financial Services Roundtable, and the Bloomberg/Schumer Report.

224 Profile: united states of america

The PWG’s “Policy Statement on Finan- ments, to mitigate risk management cial Market Developments” identified five weaknesses. principal underlying causes of the current financial markets turmoil and highlighted The Statement includes 40 recom- the need for infrastructure changes in the mendations to improve market transpar- OTC derivatives market to prevent prob- ency and disclosure, risk awareness and lems in this area. The five principal causes risk management, capital and regulatory identified were: policies, practices regarding, and use of, credit ratings, and market infrastructure 8 A breakdown in underwriting stan- for over-the-counter derivatives products. dards at the mortgage origination The PWG will report in late 2008 on the level; progress made toward implementation of 8 Erosion of market discipline by those the recommendations. involved in the securitization process; Another issue that is being debated 8 Flaws in credit rating agencies’ assess- is the applicability of certain laws and ments of securitized assets; regulations related to nonregulated or 8 Risk management weaknesses at lightly regulated financial services provid- some large U.S. and European finan- ers. In addition, the debate considers the cial institutions; and complexity of the U.S. regulatory structure 8 Failure of regulatory policies, includ- and the impact of the complexity on the ing capital and disclosure require- competitive status of U.S. financial entities.

225 The Exception

Acronyms and Abbreviations

BCCI Bank of Credit and Commerce International CFTC Commodity Futures Trading Commission CSBS Conference of State Bank Supervisors CSEs Consolidated Supervised Entities FASB Financial Accounting Standards Board FBIIC Financial and Banking Information Infrastructure Committee FDIC Federal Deposit Insurance Corporation FFIEC Federal Financial Institutions Examination Council FINRA Financial Industry Regulatory Authority GLBA Gramm-Leach-Bliley Act of 1999 GSE Government-sponsored Enterprise ISDA International Swaps and Derivatives Association NAIC National Association of Insurance Commissioners NASD National Association of Securities Dealers NASDAQ National Association of Securities Dealers Automated Quotation System NCUA National Credit Union Administration NCUSIF National Credit Union Share Insurance Fund NYSE New York Stock Exchange OCC Office of the Comptroller of the Currency OTS Office of Thrift Supervision PCAOB Public Company Accounting Oversight Board PWG President’s Working Group on Financial Markets SEC Securities and Exchange Commission SIFMA Securities Industry and Financial Markets Association SROs Self-Regulatory Organizations

226 financial crisis management mechanisms

The European Union

European union Financial Crisis Management Mechanisms

A number of crisis management mecha- The Legislative Framework nisms have been put in place by the Euro- Two EU directives,3 the Capital Require- pean Union (EU). Many of them were ments Directive (CRD) and the Financial implemented after the introduction of the Conglomerate Directive (FCD), which euro in January 1999, when EU policymak- were adopted as part of the EU’s Financial ers recognized that the advent of the euro Services Action Plan, address crisis man- significantly changed the landscape of the agement. The CRD (a) assigns a coordinat- European financial system. The linkages ing role to the authority responsible for among financial markets were strength- the supervision of banking groups on a ened, yet at the same time, the correspond- consolidated basis;4 and (b) strengthens ing channels through which adverse information-sharing requirements and financial market events on one market procedures among supervisory agencies might impact another also increased. Safe- dealing with banking groups.5 The FCD guards were needed to mitigate the impact specifies the tasks to be carried out by the of cross-border financial events spreading coordinating supervisor, including dis- rapidly throughout the EU. semination of information in normal (non- In 2000 and 2001, the Council of the crisis) times and emergency situations, to European Union’s1 Economic and Finan- other supervisors, national central banks, cial Committee (EFC)2 addressed the exist- and the European Central Bank. ing crisis management structures by recom- mending a series of changes: cross-border Memoranda of Understanding (MoUs) cooperation and coordination; oversight There are four principal MoUs address- of large financial groups and information ing financial crisis management in the exchange, both cross-border and cross-sec- European Union. The first MoU, adopted tor; and the development of agreements in 2001, addresses cooperation between among EU member nations. The following banking supervisors and central banks in are the main components of the EU finan- their capacity as payment systems overseers, cial crisis management system. dealing with the transmission of informa-

1 The Council of the European Union consists of ministers from the national governments of all the EU countries. Meetings are attended by ministers responsible for the items to be discussed, for example, foreign ministers, ministers of the economy and finance (known as ECOFIN), ministers for agriculture, and so on, as appropriate. 2 The EFC was established by the Treaty of Rome, signed in 1957, which created the European Community. The EFC advises the ECOFIN and the European Commission on financial stability matters. Membership in the EFC includes senior officials from the finance ministries, central banks, and supervisory committees of each EU country. 3 National legislatures must pass laws to implement EU directives. Disputes over their correct implementation are addressed in the courts, and the European Court of Justice is the ultimate arbiter. European Regulations have what is known as “direct effect” across the Community and need no implementing legislation to have the force of law in all 27 member states of the European Union. 4 Parent bank and parent supervisory authorities monitor the risk exposure of the banks or banking groups for which they are responsible and the adequacy of their capital on the basis of the totality of their business, wherever conducted. 5 On crisis management matters, the CRD requires (a) the consolidated supervisor to alert central banks and ministries of finance as soon as practical in the event of an emergency that threatens the stability of the financial system of a member state, and (b) the competent supervisory authorities to cooperate closely and to share essential information. (Note: The CRD’s provisions are being reviewed in light of the recent financial market turmoil. The European Commission, in fall 2008, may propose amendments to the CRD, including to the pertinent provisions on cooperation and exchange of information.)

230 Profile: European Union

tion in the event of liquidity or solvency The Role of the European problems. The second MoU, adopted in Central Bank (ECB) 2003, aims to ensure the early assessment The ECB’s formal role in crisis manage- of systemic crises (national and European) ment stems from its statutory tasks and sets out principles, procedures, and provided in the Treaty of Rome. The tasks information requirements between EU relevant for crisis management include banking supervisors and central banks. A the conduct of monetary policy opera- third MoU was adopted by EU banking tions, ensuring the smooth functioning supervisors, central banks, and finance of payments and settlement systems, and ministries in May 2005 on cooperation contributing to financial stability. and information sharing in crisis management situations. In June 2008, the 2005 The Role of National MoU was extended through the EU MoU Central Banks (NCBs) on cross-border financial stability.6 This NCBs of the Eurosystem7 are not only MoU commits all signatories to cooperate involved in crisis management mechanisms across borders, in normal times, to ensure through their participation in EU policy- preparedness for the management of a making and in various committees such as potential cross-border crisis situation, and the EFC, but they also benefit from their in crisis situations. It is designed to facili- Governors’ membership in the Governing tate the management and resolution of Council of the ECB. The Governing Coun- cross-border systemic financial crises and cil consists of six members of the Executive seeks to facilitate private sector solutions, Board of the ECB and the Governors of the to minimize the economic and social costs, NCBs of the 15 Eurosystem countries. while promoting market discipline and NCBs have a particularly important role limiting moral hazard. to play in the management of banking fail- The 2008 MoU extends the 2005 MoU ures and financial crises. They can detect in two ways. First, it includes common warning signs early and assess what chan- principles on cross-border crisis manage- nels are best to address unfolding events. ment, a common framework for assessing In addition, they can provide emergency the systemic implications of a financial liquidity assistance or serve as lender of last crisis, and common practical guidelines resort to individual institutions. Emergency for crisis management. Second, consider- lending assistance remains the prerogative ing the increasing interconnectedness of the NCBs. among financial sectors, the securities market, insurance, and occupational pen- European Union Committees sion supervisors joined the MoU, thereby European supervisors are interlinked via acknowledging that the involvement of a various committees and include the Bank- broader range of authorities is necessary. ing Supervision Committee (BSC) and the

6 The MoU of June 2008 has been signed by central banks, financial (not only banking) supervisory authorities, and finance ministries. The MoU includes 118 signatories from 27 Member States and the ECB. Following the MoU’s implementation, other relevant authorities (for example, deposit insurance schemes and competition authorities), if in agreement, may sign the document. 7 The Eurosystem comprises the ECB and the NCBs of the Member States that have adopted the euro. The Eurosystem is governed by the Governing Council and the Executive Board of the ECB.

231 Financial Crisis Management Mechanisms

Committee of European Banking Supervi- and euro-area levels. Testing has also taken sors (CEBS).8 These committees are meant place at the national and regional levels. to enhance cooperation and coordination Notwithstanding the structures in place among supervisors at various levels and on to enhance EU cooperation and coordina- a number of different issues. They include tion on matters related to financial crisis supervisors from all countries in the EU management, central bankers and supervi- and are not limited to Eurosystem member sors continue to debate the procedures states. and structures for crisis prevention and crisis resolution, particularly those pertain- Stress Testing ing to cross-border banking and financial The EU authorities and the Eurosystem groups. One area for reform is deposit conduct stress testing and simulation guarantee schemes. The European Com- exercises focusing on policy arrangements mission and members states continue to and contingency planning issues at the EU discuss this issue.

Acronyms and Abbreviations

BSC Banking Supervision Committee CEBS Committee of European Banking Supervisors CRD Capital Requirements Directive ECB European Central Bank ECOFIN Economic and Financial Affairs Council EFC Economic and Financial Committee EU European Union FCD Financial Conglomerate Directive NCBs National central banks

8 The CEBS includes representatives of central banks, the ECB, and other supervisory authorities. The ECB provides the secretariat to the BSC.

232 membership in international financial institutions

Membership in international or multinational financial institutions is one method of developing codes of conduct, standards, and best practices. The institutions can facilitate cross-border coordination during normal times. The following matrix indicates the membership of the countries included in this report in a number of relevant international financial institutions. The institutions in the matrix address a variety of financial activities (for instance, banking, insurance, and securities), establish regional coordination, and bring together supervisors from various financial services disciplines, such as the Joint Forum and the Financial Stability Forum. Membership of International Financial Institutions

BCBS CEBS CEIOPS CESR CGFS CPSS FATF FSF IADI IAIS IOSCO JF Australia •2 • • • • • Brazil •2 •3 • • • Canada • • • • • • • • China •2 • • •5 France • • • • • • • • • • • • Germany • • •1 • • • • • • • • Hong Kong •2 • • • • • • Italy • • • • • • • •1 • • • Japan • • • • • • • • • Mexico •2 • • • • The Netherlands •1 • • • • • • • • •6 • Qatar •2 • Singapore •2 • • • • • Spain • • • • •2 • • • • Switzerland • • • • • • • • United Kingdom • • • • • • • • • • • United States • •1 •1 • • • •4 •7 •1

1 Chairman 2 Associate Member 3 President 4 Vice Chairman 5 Vice Chairman of the Executive Committee 6 Vice Chairman of the Technical Committee 7 Chairman of the Technical Committee

234 BCBS CEBS CEIOPS CESR CGFS CPSS FATF FSF IADI IAIS IOSCO JF Australia •2 • • • • • Brazil •2 •3 • • • Canada • • • • • • • • China •2 • • •5 France • • • • • • • • • • • • Germany • • •1 • • • • • • • • Hong Kong •2 • • • • • • Italy • • • • • • • •1 • • • Japan • • • • • • • • • Mexico •2 • • • • The Netherlands •1 • • • • • • • • •6 • Qatar •2 • Singapore •2 • • • • • Spain • • • • •2 • • • • Switzerland • • • • • • • • United Kingdom • • • • • • • • • • • United States • •1 •1 • • • •4 •7 •1

BCBS: Basel Committee on Banking Supervision CEBS: Committee of European Banking Supervisors CEIOPS: Committee of European Insurance and Occupational Pensions Supervisors CESR: Committee of European Securities Regulators CGFS: Committee on the Global Financial System CPSS: Committee on Payment and Settlement Systems FATF: Financial Action Task Force FSF: Financial Stability Forum IADI: International Assocation of Deposit Insurers IAIS: International Assocation of Insurance Supervisors IOSCO: International Organization of Securities Commissions JF: Joint Forum

235

Appendix Supporting Institutions

The G30 would like to thank the many institutions and individuals who contributed their input and insights and helped make this study a success. We would particularly like to thank the following institutions for their support.

Australia Germany Reserve Bank of Australia German Federal Ministry of Finance Australian Prudential Regulation Authority Deutsche Bundesbank Australian Securities and Investments Bundesanstalt für Finanzdienstleistungsauf- Commission sicht (BaFin) Commonwealth Bank of Australia Bundesverband Deutscher Banken Deutscher Sparkassen- und Giroverband Brazil Banco Central do Brasil Hong Kong The Hong Kong Monetary Authority Canada Department of Finance Italy Bank of Canada The Ministry of Economy and Finance Office of the Superintendent Banca d’Italia of Financial Institutions Japan China Bank of Japan The People’s Bank of China Financial Services Agency China Banking Regulatory Commission China Securities Regulatory Commission Mexico Chinese Insurance Regulatory Commission Secretaría de Hacienda y Crédito Público Banco de México European Union Comisión Nacional Bancaria y de Valores European Central Bank Comisión Nacional de Seguros y Fianzas Instituto para la Protección al Ahorro France Bancario Banque de France Comisión Nacional del Sistema de Ahorro Commission Bancaire para el Retiro Autorité de Marchés Financiers Comisión Nacional para la Defensa de los BNP Paribas Usuarios de las Instituciones Financieras Asociación de Bancos de México

238 The Netherlands United Kingdom Ministry of Finance Her Majesty’s Treasury De Nederlandsche Bank Financial Services Authority Autoriteit Financiële Markten Bank of England British Bankers Association Qatar Morgan Stanley & Co., International, Ltd. Qatar Financial Centre Regulatory Authority United States U.S. Department of the Treasury Singapore The Board of Governors of the The Monetary Authority of Singapore Federal Reserve System Bank of America, Asia Federal Reserve Bank of New York Bank of Singapore Federal Deposit Insurance Corporation Temasek Holdings (Private) Limited Office of the Comptroller of the Currency Securities and Exchange Commission Spain National Association of Insurance Ministry of Economy and Finance Commissioners Banco de España U.S. Commodity Futures Trading Comisión Nacional del Mercado de Valores Commission Dirección General de Seguros y Fondos de New York State Banking Department Pensiones The Financial Industry Regulatory Asociación Española de Banca Authority Bolsas y Mercados Españoles The Securities Industry and Financial Markets Association Switzerland American Bankers Association Federal Finance Administration Promontory Capital Swiss National Bank Swiss Federal Banking Commission International Institutions Zurich Financial Services Financial Stability Forum, Bank for International Settlements International Monetary Fund

Note: Deloitte & Touche LLC provided support in all 17 markets surveyed.

239

Group of Thirty Members

Paul A. Volcker Chairman of the Board of Trustees, Group of Thirty Former Chairman, Board of Governors of the Federal Reserve System Jacob A. Frenkel Chairman, Group of Thirty Vice Chairman, American International Group Former Governor, Bank of Israel Geoffrey L. Bell Executive Secretary, Group of Thirty President, Geoffrey Bell & Company, Inc. Montek S. Ahluwalia Deputy Chairman, Planning Commission of India Former Director, Independent Evaluation Office, International Monetary Fund Abdulatif Al-Hamad Chairman, Arab Fund for Economic and Social Development Former Minister of Finance and Minister of Planning, Kuwait Leszek Balcerowicz Chairman of the Board, Bruegel Former President, National Bank of Poland Former Deputy Prime Minister and Minister of Finance, Poland Jaime Caruana Counsellor and Director, MCM Department, International Monetary Fund Former Governor, Banco de España Former Chairman, Basel Committee on Banking Supervision Domingo Cavallo Chairman and CEO, DFC Associates, LLC Former Minister of Economy, Argentina E. Gerald Corrigan Managing Director, Goldman Sachs & Co. Former President, Federal Reserve Bank of New York Andrew D. Crockett President, JPMorgan Chase International Former General Manager, Bank for International Settlements Guillermo de la Dehesa Romero Director and Member of the Executive Committee, Grupo Santander Former Deputy Managing Director, Banco de España Former Secretary of State, Ministry of Economy and Finance, Spain Mario Draghi Governor, Banca d’Italia Chairman, Financial Stability Forum Member of the Governing and General Councils, European Central Bank Former Vice Chairman and Managing Director, Goldman Sachs International Martin Feldstein President Emeritus, National Bureau of Economic Research Former Chairman, Council of Economic Advisers

241 Roger W. Ferguson, Jr. Chief Executive, TIAA-CREF Former Chairman, Swiss Re America Holding Corporation Former Vice Chairman, Board of Governors of the Federal Reserve System Stanley Fischer Governor, Bank of Israel Former First Managing Director, International Monetary Fund Arminio Fraga Neto Partner, Gavea Investimentos Former Governor, Banco do Brasil Timothy F. Geithner President and Chief Executive Officer, Federal Reserve Bank of New York Former U.S. Undersecretary of Treasury for International Affairs Gerd Häusler Managing Director and Member of the Advisory Board, Lazard & Co Former Counsellor and Director, International Capital Markets Department, International Monetary Fund Former Managing Director, Dresdner Bank Philipp Hildebrand Vice Chairman of the Governing Board, Swiss National Bank Former Partner, Moore Capital Management Mervyn King Governor, Bank of England Former Professor of Economics, London School of Economics Paul Krugman Professor of Economics, Woodrow Wilson School, Princeton University Former Member, Council of Economic Advisors Guillermo Ortiz Martinez Governor, Banco de Mexico Former Secretary of Finance and Public Credit, Mexico Tommaso Padoa-Schioppa Former Minister of Economy and Finance, Italy Chairman, International Accounting Standards Committee Former Member of the Executive Board, European Central Bank Former Chairman, CONSOB Kenneth Rogoff Thomas D. Cabot Professor of Public Policy and Economics, Harvard University Former Chief Economist and Director of Research, IMF Tharman Shanmugaratnam Minister of Finance, Singapore Former Managing Director, Monetary Authority of Singapore Lawrence Summers Charles W. Eliot University Professor, Harvard University Former President, Harvard University Former U.S. Secretary of the Treasury Jean-Claude Trichet President, European Central Bank Former Governor, Banque de France

242 David Walker Senior Advisor, Morgan Stanley International, Inc. Former Chairman, Morgan Stanley International, Inc. Former Chairman, Securities and Investments Board, UK Zhou Xiaochuan Governor, People's Bank of China Former President, China Construction Bank Former Asst. Minister of Foreign Trade Yutaka Yamaguchi Former Deputy Governor, Bank of Japan Former Chairman, Euro Currency Standing Commission Ernesto Zedillo Director, Yale Center for the Study of Globalization, Yale University Former President of Mexico

Senior Members William McDonough Vice Chairman and Special Advisor to the Chairman, Merrill Lynch Former Chairman, Public Company Accounting Oversight Board Former President, Federal Reserve Bank of New York William R. Rhodes Senior Vice Chairman, Citigroup Chairman, President and CEO, Citicorp and Citibank Ernest Stern Partner and Senior Advisor, The Rohatyn Group Former Managing Director, JPMorgan Chase Former Managing Director, World Bank Marina v N. Whitman Professor of Business Administration & Public Policy, University of Michigan Former Member, Council of Economic Advisors

Emeritus Members Lord Richardson of Duntisbourne, KG Honorary Chairman, Group of Thirty Former Governor, Bank of England Richard A. Debs Advisory Director, Morgan Stanley & Co. Gerhard Fels Former Director, Institut der deutschen Wirtschaft Wilfried Guth Former Spokesmen of the Board of Managing Directors, Deutsche Bank AG Toyoo Gyohten President, Institute for International Monetary Affairs Former Chairman, Bank of Tokyo

243 John G. Heimann Senior Advisor, Financial Stability Institute Former US Comptroller of the Currency Erik Hoffmeyer Former Chairman, Danmarks Nationalbank Peter B. Kenen Senior Fellow in International Economics, Council on Foreign Relations Former Walker Professor of Economics & International Finance, Department of Economics, Princeton University Jacques de Larosière Conseiller, BNP Paribas Former President, European Bank for Reconstruction and Development Former Managing Director, International Monetary Fund Former Governor, Banque de France Shijuro Ogata Former Deputy Governor, Bank of Japan Former Deputy Governor, Japan Development Bank Sylvia Ostry Distinguished Research Fellow Munk Centre for International Studies, Toronto Former Ambassador for Trade Negotiations, Canada Former Head, OECD Economics and Statistics Department

244 Group Of Thirty Publications Since 1990

REPORTS Sharing the Gains from Trade: Reviving the Doha Round Study Group Report. 2004 Key Issues in Sovereign Debt Restructuring Study Group Report. 2002 Reducing the Risks of International Insolvency A Compendium of Work in Progress. 2000 Collapse: The Venezuelan Banking Crisis of ‘94 Ruth de Krivoy. 2000 The Evolving Corporation: Global Imperatives and National Responses Study Group Report. 1999 International Insolvencies in the Financial Sector Study Group Report. 1998 Global Institutions, National Supervision and Systemic Risk Study Group on Supervision and Regulation. 1997 Latin American Capital Flows: Living with Volatility Latin American Capital Flows Study Group. 1994 Defining the Roles of Accountants, Bankers and Regulators in the United States Study Group on Accountants, Bankers and Regulators. 1994 EMU After Maastricht Peter B. Kenen. 1992 Sea Changes in Latin America Pedro Aspe, Andres Bianchi and Domingo Cavallo, with discussion by S.T. Beza and William Rhodes. 1992 The Summit Process and Collective Security: Future Responsibility Sharing The Summit Reform Study Group. 1991 Financing Eastern Europe Richard A. Debs, Harvey Shapiro and Charles Taylor. 1991 The Risks Facing the World Economy The Risks Facing the World Economy Study Group. 1991

THE WILLIAM TAYLOR MEMORIAL LECTURES Two Cheers for Financial Stability Howard Davies. 2006 Implications of Basel II for Emerging Market Countries Stanley Fisher. 2003 Issues in Corporate Governance William J. McDonough. 2003 Post Crisis Asia: The Way Forward Lee Hsien Loong. 2001 Licensing Banks: Still Necessary? Tommaso Padoa-Schioppa. 2000

245 Banking Supervision and Financial Stability Andrew Crockett. 1998 Global Risk Management Ulrich Cartellieri and Alan Greenspan. 1996 The Financial Disruptions of the 1980s: A Central Banker Looks Back E. Gerald Corrigan. 1993

SPECIAL REPORTS Global Clearing and Settlement: Final Monitoring Report Global Monitoring Committee. 2006 Reinsurance and International Financial Markets Reinsurance Study Group. 2006 Enhancing Public Confidence in Financial Reporting Steering & Working Committees on Accounting. 2004 Global Clearing and Settlement: A Plan of Action Steering & Working Committees of Global Clearing & Settlements Study. 2003 Derivatives: Practices and Principles: Follow-up Surveys of Industry Practice Global Derivatives Study Group. 1994 Derivatives: Practices and Principles, Appendix III: Survey of Industry Practice Global Derivatives Study Group. 1994 Derivatives: Practices and Principles, Appendix II: Legal Enforceability: Survey of Nine Jurisdictions Global Derivatives Study Group. 1993 Derivatives: Practices and Principles, Appendix I: Working Papers Global Derivatives Study Group. 1993 Derivatives: Practices and Principles Global Derivatives Study Group. 1993 Clearance and Settlement Systems: Status Reports, Autumn 1992 Various Authors. 1992 Clearance and Settlement Systems: Status Reports, Year-End 1990 Various Authors. 1991 Conference on Clearance and Settlement Systems; London, March 1990: Speeches Various Authors. 1990 Clearance and Settlement Systems: Status Reports, Spring 1990 Various Authors. 1990

OCCASIONAL PAPERS 77. Distorting the Micro to Embellish the Macro: The Case of Argentina Domingo Cavallo, Joaquín Cottani, 2008 76. Credit Crunch: Where Do We Stand? Thomas A. Russo, 2008 75. Banking, Financial, and Regulatory Reform Liu Mingkang, Roger Ferguson, Guillermo Ortiz Martinez. 2007

246 74. The Achievements and Challenges of European Union Financial Integration and Its Implications for the United States Jacques de Larosiere. 2007 73. Nine Common Misconceptions About Competitiveness and Globalization Guillermo de la Dehesa. 2007 72. International Currencies and National Monetary Policies Barry Eichengreen. 2006 71. The International Role of the Dollar and Trade Balance Adjustment Linda Goldberg and Cédric Tille. 2006 70. The Critical Mission of the European Stability and Growth Pact Jacques de Larosiere. 2004 69. Is It Possible to Preserve the European Social Model? Guillermo de la Dehesa. 2004 68. External Transparency in Trade Policy Sylvia Ostry. 2004 67. American Capitalism and Global Convergence Marina v. N. Whitman. 2003 66. Enron et al: Market Forces in Disarray Jaime Caruana, Andrew Crockett, Douglas Flint, Trevor Harris, Tom Jones. 2002 65. Venture Capital in the United States and Europe Guillermo de la Dehesa. 2002 64. Explaining the Euro to a Washington Audience Tommaso Padoa-Schioppa. 2001 63. Exchange Rate Regimes: Some Lessons from Postwar Europe Charles Wyplosz. 2000 62. Decisionmaking for European Economic and Monetary Union Erik Hoffmeyer. 2000 61. Charting a Course for the Multilateral Trading System: The Seattle Ministerial Meeting and Beyond Ernest Preeg. 1999 60. Exchange Rate Arrangements for the Emerging Market Economies Felipe Larraín and Andrés Velasco. 1999 59. G3 Exchange Rate Relationships: A Recap of the Record and a Review of Proposals for Change Richard Clarida. 1999 58. Real Estate Booms and Banking Busts: An International Perspective Richard Herring and Susan Wachter. 1999 57. The Future of Global Financial Regulation Sir Andrew Large. 1998 56. Reinforcing the WTO Sylvia Ostry. 1998 55. Japan: The Road to Recovery Akio Mikuni. 1998 54. Financial Services in the Uruguay Round and the WTO Sydney J. Key. 1997

247 53. A New Regime for Foreign Direct Investment Sylvia Ostry. 1997 52. Derivatives and Monetary Policy Gerd Hausler. 1996 51. The Reform of Wholesale Payment Systems and Impact on Financial Markets David Folkerts-Landau, Peter Garber, and Dirk Schoenmaker. 1996 50. EMU Prospects Guillermo de la Dehesa and Peter B. Kenen. 1995 49. New Dimensions of Market Access Sylvia Ostry. 1995 48. Thirty Years in Central Banking Erik Hoffmeyer. 1994 47. Capital, Asset Risk and Bank Failure Linda M. Hooks. 1994 46. In Search of a Level Playing Field: The Implementation of the Basle Capital Accord in Japan and the United States Hal S. Scott and Shinsaku Iwahara. 1994 45. The Impact of Trade on OECD Labor Markets Robert Z. Lawrence. 1994 44. Global Derivatives: Public Sector Responses James A. Leach, William J. McDonough, David W. Mullins, Brian Quinn. 1993 43. The Ten Commandments of Systemic Reform Vaclav Klaus. 1993 42. Tripolarism: Regional and Global Economic Cooperation Tommaso Padoa-Schioppa. 1993 41. The Threat of Managed Trade to Transforming Economies Sylvia Ostry. 1993 40. The New Trade Agenda Geza Feketekuty. 1992 39. EMU and the Regions Guillermo de la Dehesa and Paul Krugman. 1992 38. Why Now? Change and Turmoil in U.S. Banking Lawrence J. White. 1992 37. Are Foreign-owned Subsidiaries Good for the United States? Raymond Vernon. 1992 36. The Economic Transformation of East Germany: Some Preliminary Lessons Gerhard Fels and Claus Schnabel. 1991 35. International Trade in Banking Services: A Conceptual Framework Sydney J. Key and Hal S. Scott. 1991 34. Privatization in Eastern and Central Europe Guillermo de la Dehesa. 1991 33. Foreign Direct Investment: The Neglected Twin of Trade DeAnne Julius. 1991

248 32. Interdependence of Capital Markets and Policy Implications Stephen H. Axilrod. 1990 31. Two Views of German Reunification Hans Tietmeyer and Wilfried Guth. 1990 30. Europe in the Nineties: Problems and Aspirations Wilfried Guth. 1990 29. Implications of Increasing Corporate Indebtedness for Monetary Policy Benjamin M. Friedman. 1990 28. Financial and Monetary Integration in Europe: 1990, 1992 and Beyond Tommaso Padoa-Schioppa. 1990

249

Group of Thirty 1726 M Street, N.W., Suite200 30 Washington, DC 20036 ISBN 1-56708-142-8