Financial Stability Board: under the spotlight
Friday 17 June 2011 - by Will Henley
In a matter of weeks the Financial Stability Board will unleash highly anticipated proposals on global systemically important financial institutions.
The rules are expected to prescribe higher capital surcharges and, like those coming on over the counter derivatives, resolution regimes and shadow banking, may have a seismic impact on the financial industry.
Touted by US Treasury secretary Tim Geithner as the "fourth pillar" in the global economic governance architecture - after the World Bank, International Monetary Fund and World Trade Organization - the board is tasked with a central role in averting another crisis.
And yet, for all the fierce debate over who will take over at the IMF - whether it will be presided over by an emerging market representative or a European once again - few headlines have been written about the impending vacancy at the top of the FSB.
Mario Draghi, the governor of the central bank of Italy, who has been chairman of the FSB and its predecessor the Financial Stability Forum since 2006, is due to step down in April next year when his second three-year term expires.
However, as the official nominee, and a shoe-in, to replace Jean-Claude Trichet at the European Central Bank in November, it is highly possible that he may decide to leave his part-time role at the FSB even before then.
"It is somewhat ironic," says Lawrence Goodman, president of the New York-based Center for Financial Stability, "that a lot of the attention at present is on succession at the IMF.
"The FSB also plays such a critical role in ensuring that the world financial system's infrastructure is robust and well coordinated."
On Tuesday, at his first hearing before European parliamentarians, Draghi repeatedly referred to his work on the board in the past tense. It could have been a quirk in translation, or a Freudian slip.
But to date Draghi has given no indication that he intends to relinquish his post in the autumn if, as expected, he is approved by European parliamentarians and eurozone members on 23 and 24 June.
Like officials at the Banca d'Italia, FSB secretary general Svein Andresen - Draghi's right-hand man as the official charged with the day-to-day running of the board - sticks vehemently to the line that talk of succession is premature.
"Any speculation on the timing is not something that can be engaged with," he says from his office in Basel, Switzerland, which the FSB shares with the moderately less circumspect Bank of International Settlements and Basel Committee on Banking Supervision.
Yet despite reluctance to "engage" with the matter, important questions necessarily arise. First, what happens if Draghi tries to stay on at the FSB?
Can the Italian be responsible for the European Central Bank amid a eurozone crisis while also developing new rules for the worldwide financial system?
And, crucially, what is the process for choosing his successor?
On the first point, Andresen concedes that there could, potentially, be a conflict of interest. But he is quick to add that, by dint of being chosen from its membership, the chairman will inevitably have to balance competing agendas.
"The FSB has to be headed by a national [of a governmental financial institution] so in that respect there will always be a conflict of interest," he says. "It might become an issue, but he has not been appointed to this [ECB] position yet."
Others however are not so sure that Draghi should try to hold down both jobs.
Matthew Martin, head of Development Finance International, a London-based organisation which regularly consults with financial regulators across advanced and emerging markets, suggests that combining the two risks undermining the raison d'être of the board.
"The point of the FSB is to be an impartial arbiter," he says. "It might be a little difficult to be head of the European Central Bank, which is speaking for a large number of the 20 members of the FSB, then not to be advocating whatever Europe is thinking of doing to the detriment of whatever the US or emerging markets would prefer."
Moreover, Martin adds, the practical and time constraints of the ECB presidency may simply become too demanding for the Italian, meaning a transition process to find a successor should begin at least by September.
"Given that Italy's monetary and exchange rate policies are dealt with by the ECB you can manage to be chair of the FSB and governor of the central bank of Italy at the same time," he says.
"But it is not possible to imagine that the governor of the ECB, which is a very full time job, could also be chair of the FSB."
Among European parliamentarians, opinion is split on whether Draghi should continue at the FSB. Arlene McCarthy, vice chair of the European Parliament's influential Committee on Economic and Monetary Affairs, sees no problem in him remaining in place until April.
There is a need for Europe to "show a clear and persuasive lead globally", she says. "It is therefore wholly appropriate that the head of a major central bank, such as the ECB, and a key supervisory authority, such as the European Systemic Risk Board, holds the FSB chair," McCarthy says.
Burkhard Balz, German Christian Democrat MEP and a fellow member of the Econ committee, however disagrees. He says he is "rather sceptical" about Draghi trying to stay on past November, when the G20 heads of government summit in Cannes, France, will likely consider a range of FSB proposals.
Rather than see these through, Draghi should commit to Europe, Balz says. "The ECB should focus on the euro and the eurozone alone. I would therefore prefer a clear and transparent division between the two offices and thus a new FSB chair."
On one thing, however, both politicians agree. Regardless of whether Draghi leaves the board earlier or later, the recruitment process to find a successor should be as made as transparent as possible.
"I am convinced that the reputation and effectiveness of such bodies is enhanced if they have - and are seen to have - the best candidate for the job in the chair," McCarthy says.
"That is best ensured by an open and transparent recruitment process which involves all members of the FSB and includes consideration of a diverse pool of candidates, including more female candidates."
At present, however, the chair appointment procedure is shrouded in secrecy, or at the very least uncertainty.
Despite it espousing central bank good governance and transparency in all things fiscal, many analysts have concerns over the opaque nature of the FSB's own internal governance.
Draghi was appointed to predecessor the Financial Stability Forum in April 2006 behind closed doors by a then much slimmer membership, and there was little or no wider consultation with external private or public sector stakeholders, and nothing in the way of an open contest.
Even today there is apparently no formal application process nor a declared deadline for nominations. It is impossible to gauge whether anyone has indeed been asked to put their name forward.
Under the charter establishing the FSB, drafted after the April 2009 G20 London summit, the chair is to be appointed by the "plenary", composed of the heads of regulators, finance ministries and central banks from 24 individual countries, as well as a variety of international organisations.
These include the Bank for International Settlements, Basel Committee on Banking Supervision, European Central Bank, European Commission, IMF, OECD and World Bank, and less high-profile bodies such as the International Accounting Standards Board and Committee on Payment and Settlement Systems.
Though Europe's influence became diluted when the FSF morphed into the FSB - with the inclusion of more countries like Brazil, Indonesia and India and the doubling of member states from 12 to 24 - the region still controls a sizeable chunk of the seats in the plenary.
Countries like Britain, Germany and France each have three seats - one for each of their main financial authorities - while Argentina, Turkey and Singapore have just one apiece.
In a mirror of the debate surrounding the IMF managing directorship, there appears to be growing unease among emerging markets. Analysts say they feel aggrieved that some FSB members believe it is a fait accompli that the next chairman will again be a European, or at least from an advanced economy.
As Matthew Martin of Development Finance International explains, "given the controversy about the IMF going to a European there is a growing feeling among other G8 and emerging market regulators that it would not be right for European countries to presume that the successor to Mario Draghi will be another European.
"If we are going to carry on with a system where the US always gets the World Bank and the EU gets the IMF, in spite of public declarations to the contrary, wouldn't it be a good idea if an emerging market got the FSB?
"The regulations which are recommended by the FSB fundamentally affect developing countries' economies, which is why the emerging markets discuss very strongly in the FSB what is really best practice."
According to Jo-Marie Griesgraber, executive director of the Washington DC-based New Rules for Global Finance Coalition, the Basel based board "makes the IMF look positively open and democratic" - a highly critical view given the flak the IMF has received over the years.
"Machiavelli would blush for sure," she sighs. "They [the FSB members] don't like shadow banking, but they want to do everything in secret.
"There is not even a democratic germ, let alone a deficit, at the FSB. It is a real shadowy regulatory agency."
The potential for selection chaos is exacerbated further by the flimsy 11-page FSB charter. One reading of it shows that the chair is, technically, able to invite other organisations - including representatives of the private sector - to attend plenary meetings.
The question begs, would these other non-permanent representatives be able to vote, or at least exercise an opinion, on the election of a new chairman?
Domenico Lombardi, a G20 expert at the Brookings Institution think tank who is coordinating a high-level panel on FSB governance with a dozen or so former finance ministers, central bankers and academics, admits the board has a "perception issue", starting with the selection of the chairman.
"No-one really knows what are the driving forces behind the work programme, how the programme is formulated, or the internal dynamics of the organisation.
"It is not known if there are conventions or informal principles already agreed regarding who should chair the FSB - should it be a European or someone from an advanced economy or from a central bank rather than a regulatory agency or finance ministry?
"Or is it perfectly open? The FSB has not so far provided a great deal of information.
"It is important for the FSB to dismiss this perception by engaging stakeholders more effectively and enhancing its transparency so that stakeholders can gain a better understanding about how it works."
There are however more complications. With new regulatory bodies popping up in the EU - such as the European Banking Authority and European Systemic Risk Board - some say it is only a matter of time before these too seek to be represented within the FSB plenary.
This risks opening up a whole new can of worms. Should national authorities in Europe agree to forfeit their existing seats in order that they may be given over to the new regional bodies, or does the FSB simply swell further with EU over-representation?
Would such a move embolden emerging markets in their calls to increase their presence in the plenary? More pertinently, would this make it even more likely that the chairman will be a European, or in fact work against the continent in the selection process?
Lombardi's panel is scheduled to deliver its report in September at the margins of the annual meetings of the IMF and World Bank, and the hope is that the independent recommendations from both G20 and non-G20 eminent persons will help influence future reforms.
The dilemma over the chairmanship recruitment could, theoretically, be resolved by G20 leaders at Cannes in November.
But one wonders what would happen if, prior to then, Draghi were run over by a hypothetical bus or if the chairman, as the IMF has found to its cost, was even forced to prematurely resign his post?
With an international mandate handed to it, spanning G-Sifis, resolution plans, shadow banking, OTC derivatives and even exchange-traded funds, the organisation is only likely to find itself more and more under the glare of the spotlight.
The communique of the most recent G20 finance ministers meeting in Paris in April alluded to "preliminary proposals" by the FSB to "strengthen its capacity, resources and governance".
This is perhaps the strongest hint yet that the board, still barely two years old, may yet clarify and democratise its election and governance procedures.
Lombardi, despite the hopes for his panel, is realistic about the chances for sudden reform. "I wouldn't expect any sudden change in next few weeks or couple of months. The changes we should expect will come more likely in the next couple of years," he says.
He, like most other outside observers, is clear nonetheless that clarity and openness must come. "The FSB is one of the most powerful financial international organisations in the world and this not always appreciated," he says.
"It is discounted by some people, and this is a mistake."
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