Next week, we’ll send you a new FedFin paper on the global financial regulatory framework. It builds on a 2012 analysis to show the way the happy concept of harmonious cross-border standards is collapsing and recommends what we hope are constructive ways to salvage as much of it as possible. Last year, some of you told us not to worry – global regulators would get the rules back on track. But, as the FRB’s new rule for foreign banking organizations shows, it ain’t so. And, it’s not just the Fed that’s walking away from global financial markets. The new EU financial-transaction tax is another dramatic rejection of the free flow of capital under comparable rules across borders. None of these developments is good for cross-border financial firms. Worse, none of them is good for cross-border finance – a necessary condition for cross-border prosperity.
Right now, a lot of energy is going into trying to beat back the FRB’s proposal, the EU tax and numerous other initiatives detailed in our new paper that are advancing as nations look out for themselves in the financial-services arena. All of this advocacy will doubtlessly alter some of these proposals, but none is likely to take any of them off track. The reason for this is simple: the 2008 financial crisis showed that cross-border finance poses profound risks not governed by home- or host-country standards. The G-20 took from this a mandate to rewrite global rules to apply them in harmonious, top-down fashion to prevent the next round of systemic risk. But, five years later and what’s happened: a lot of new standards enshrined on the websites of a lot of global regulators without meaningful implementation pretty much anywhere. To be sure, several of the largest global companies are considerably more robust than before – a good thing too, but this is largely the result of market pressure from spooked counterparties and investors, not regulatory rewrite. The new paper goes beyond the banking analysis in the 2012 one to focus also on insurance, securities and other financial services. Looking at developments like the collapse of Solvency II – the capital regime global regulators hope to apply to insurers – and efforts at cross-border standards for securities activities, we find little more progress on these fronts than in banking. However, some non-bank regulators are beginning to consider a new approach to harmonize rules without mandating top-down standards. These include options such as mutual recognition or “passporting” – essentially explicit criteria under which firms can gain unfettered access outside their home country. But, because these ideas are only in the drawing-board stage, the paper goes on to outline ways to make them happen quicker and, we hope, better.
The best model we know to guide thinking about cross-border financial services is the decades-old framework for cross-border trade in goods. To be sure, there has been a longstanding global trade-in-financial-services protocol. But, it’s largely focused on ensuring that cross-border finance is free and fair – looking to see if there is “national treatment” to determine which countries are providing appropriate access to foreign financial-services firms.
The problem with this approach, as the 2008 crisis made painfully clear, is that free and fair doesn’t always mean safe and sound. The vital missing element in current trade-in-financial-services protocols is prudence – how can host countries tell if parent regimes are sound enough to prevent contagion risk if a bank, insurer or securities firm crosses the border? In our new paper, we lay out an agenda for FSOC, the U.S. Trade Representative and the Financial Stability Board designed to harness safety standards long used to govern trade in manufactured and agricultural goods for finance. We think the U.S. should lead this effort because the U.S. has, perhaps along with the U.K., built out the most robust regime to date in the wake of the crisis. And, even if it hasn’t, we know one other reason the U.S. should lead this effort: it’s a vital national interest not just to have a safe and sound financial system, but one that’s also open to cross-border trade so the dollar stays the reserve currency and the U.S. stays a leader in global trade.