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Risk Mitigation

Overview: Regulatory Co-operation

Updated 7/28/99

The Barings failure demonstrated that because global markets are linked through market members trading for themselves or their customers in many countries, no single market authority has all the relevant information on the financial entities it supervises. To carry out their supervisory and oversight functions properly, regulators require a well-developed international network of information. Indeed both the Basle Committee on Banking Supervision and the International Organisation of Securities Commissions believe that close international co-operation is crucial to meeting the regulatory challenges of the future.

Thus the need for a formalised method of regulatory co-operation, as free as possible from national and international impediments. Regulatory co-operation generally refers to arrangements such as Memoranda of Understanding (MOU), which regulators have put in place to facilitate the exchange of information internationally. MOUs are statements of intent which do not impose legally binding obligations on its signatories. As such they have no power to overcome domestic laws, nor do they affect other channels of co-operation such as mutual assistance in criminal matters. The strength of MOUs is that they facilitate the exchange of information by accommodating differences between regulators and by responding to changing legal environments.

The technical committee of IOSCO released "Principles for Memoranda of Understanding" in 1991. This report provides a blueprint for securities and futures regulators to use when developing MOUs with their counterparts. The principles cover subject matter, confidentiality, implementation procedures, the rights of persons subject to an MOU request, consultation, public policy exception, types of assistance, permitted uses, participation by the requesting authority and cost-sharing.

Significant effort has been expended since then to improve these arrangements. In 1993, IOSCO released a report titled "Mechanisms to Enhance Open and Timely Communication between Market Authorities of Related Cash and Derivative Markets During Periods of Market Disruption" . As its title suggests, this report concentrated on how regulatory decision-making during periods of great price volatility could be facilitated by regulators co-operating. The paper looks at the types of shared-information available - product specifications, prices, average trading volume, margin requirements, circuit breakers, price limits and trading halts. It also analyses the methodology and mechanisms for sharing. March 15, 1996 marked a milestone in regulatory co-operation. On this day, 49 futures exchanges and clearing organisations, and 14 futures regulators, signed the "Memorandum of Understanding and Information Sharing Agreement" in Boca Raton, Florida. Another 6 exchanges signed the Memorandum after Boca.

The MOU enables information to be shared on a bilateral basis between the relevant requesting and requested market authorities. One important characteristic of these MOUs is a trigger-based agreement where information is shared once certain triggering events have occurred. Pre-agreed exposure levels are part of this triggering mechanism because they permit an integrated multilateral assessment of market risks. So are a large decrease in a member's capital position; large cash flows in proprietary or customer accounts; or a concentration of positions in any futures or options contract. All information shared is confidential, even if the MOU is terminated. The Declaration provides a conduit of information flow when local concerns or laws or special financial services issues necessitate the involvement of a government authority. The Boca Raton document also contains emergency contact lists.

"Report on Co-operation between Market Authorities and Default Procedures" (1996) explains trigger levels, information sharing agreements and identifies best practices on the treatment of proprietary and customer positions, funds and assets at defaulting firms. The authors of the report, the IOSCO's Technical Committee, recommend that market authorities establish qualitative and/or quantitative criteria appropriate to their markets as trigger levels for identifying large exposures. Positions should be continuously monitored and market authorities must have ready access to the actual ownership of these positions. An appendix to the report contains a survey of current procedures for identifying large exposures in Australia, Canada, France, Germany, Hong Kong, Italy, Japan, Mexico, the Netherlands, Spain, Switzerland, the United Kingdom and the United States.

The document also spells out the factors that should be taken into consideration when developing information-sharing agreements (ISAs). They are: the purpose and subject matter of the ISA, types of communication, confidentiality and permitted uses of shared information, limitation of liability, consultation, public policy exception, relationship to other agreements and the market authority best suited to enter into the ISA.

In May 1996, the Basle Committee and IOSCO agreed to promote additional co-operative and collaborative arrangements to improve their supervision of diversified financial groups. The principal focus of their initiative will be:

  • The types of groups or institutions for which such arrangements would be useful and appropriate;
  • The types of information that may need to be exchanged;
  • Ways to facilitate the resolution of possible legal, confidentiality, policy or practical issues that may arise; and
  • Any additional arrangements that may be appropriate to co-ordinate the activities of the relevant supervisors.

This work has been, for the most part, undertaken in the Joint Forum, which was established in early 1996 by the Basle Committee on Banking Supervision, IOSCO and the IAIS. The Joint Forum is comprised of an equal number of senior bank, insurance and securities supervisors representing each supervisory constituency. The Forum is looking at practical means of facilitating exchange of information between supervisors within their own sectors, and between supervisors in different sectors; as well as investigating the legal or other barriers which impede such an exchange of information.

"A Report from the Regulators Participating in the Windsor Meeting" (1996) details the progress domestic regulators have made towards sharing information with their peers from other countries. The actions of the following countries are described: Australia, Brazil, Canada, France, Germany, Hong Kong, Italy, Japan, the Netherlands, Singapore, South Africa, Spain, Sweden, Switzerland, United Kingdom, and the United States of America.

Regulatory co-operation presumes market authorities want to help each other; this may not always be the case. The Technical Committee of IOSCO tackles the issue of unfriendly market authorities in "Report on Issues Raised for Securities and Futures Regulators by Under-Regulated and Uncooperative Jurisdictions" (1994). In such circumstances, it suggests using the local registrar of companies as well as criminal and judicial channels.

Following the Sumitomo debacle (see "Analysing Sumitomo" by Mari Kooi ), supervisors of commodity futures markets from 17 countries met in London to discuss the oversight of commodity futures markets. The "London Communique on the Supervision of Commodity Futures Markets (1996)" was released by the Japanese Ministry of International Trade & Industry in conjunction with the Japanese Ministry of Agriculture, Forestry and Fisheries, the US Commodity Futures Trading Commission and the UK Securities and Investments Board. Because none of the work undertaken so far on regulatory co-operation specifically addressed the commodities market, the supervisors identified issues peculiar it. They called for an exchange of information, including identification of large exposures, both on a regular basis and in emergencies. They also agreed that authorities of related markets should share surveillance information to manage a market disruption and should designate contact persons for such purposes They pledged to procure greater access to information on prices, open interest, and deliveries. Market authorities should keep confidential such requests for information and the information exchanged. Authorities were also asked to consider a set of contract design principles to ensure that contract terms and conditions were not open to abuse.

The cross-border marketing of collective investment schemes (CIS) requires a joint regulatory effort. A "Discussion Paper on International Cooperation in Relation to Cross-Border Activity of Collective Investment Schemes" (1996) details some of the routes available - MOUs, mutual assistance agreements and other informal information sharing arrangements. The document also includes a template of a mutual recognition agreement and a Declaration on Co-operation and Supervision of Cross-Border Investment Management Activity, which provides a framework for providing regular information about relevant cross-border activity.

The insolvency or threatened insolvency of a CIS manager, trustee, custodian or affiliated companies of any of these entities can often trigger a crisis of confidence. "Regulatory Cooperation in Emergencies (1996)" identifies the main scenarios of CIS emergencies and considers the relevant regulatory co-operation policies and, in particular, the policies for determining suspension of redemption of CIS units.

The initiatives described so far relate mainly to the futures and securities industry. A series of banking regulatory co-operation documents have also been issued, beginning with the bank supervisors' Concordat of 1975. A revised version of the Concordat was issued in 1983, a supplement in 1990 and a more normative version in 1992 ("Minimum Standards for the Supervision of International Banking Groups and Their Cross-Border Establishments.") Each of these documents address the relative roles of the home and host supervisor, the need for effective consolidated supervision by the home supervisor and the mechanics of supervisory information exchanges.

The most recent document in this series was prepared by a working group comprising members of the Basle Committee on Banking Supervision and the Offshore Banking Supervisors, who made 29 recommendations aimed at improving the supervision of banks' international activities. In The Supervision of Cross-Border Banking (1996), they make it clear that the financial activities of international banks must be subject to effective home and host supervision. To achieve this aim, the access of home supervisors to information necessary for effective consolidated supervision, and host supervisors for effective host supervision, must be improved. Principles 23 to 25 of this report deal with this issue.

The working group that wrote this report was set up to consider some of the problems which arose from the implementation of the 1992 minimum standards for cross-border supervision. The Basle Committee's 1992 minimum standards established four main principles:

  1. All international banks should be supervised by a home country that capably performs consolidated supervision.
  2. The creation of a cross-border banking establishment should receive the prior consent of both the host country and the home country authority.
  3. Home country authorities should possess the right to gather information from their cross-border banking establishments.
  4. If the host country determines that any of these three standards is not being met, it could impose restrictive measures or prohibit the establishment of banking offices.

The 1996 report dealt with two main problems. The first relates to information access; i.e. home supervisors having difficulty obtaining all the information they require for effective consolidated supervision. The second relates to host and home supervisors having no common standards to judge each other's supervisory work and gaps in supervision posed by 'shell branches' and 'sister institutions'. The document sets out the conditions attached to greater information-sharing between home and host supervisors. For example, it states that home supervisors do not routinely need to know the identity of individual depositors and that all information exchanged is subject to strict confidentiality. To ensure that all cross-border banking operations are subject to effective home and host supervision, the report sets out a set of principles, in Annex B, which can be used by host supervisors as a checklist to determine whether home supervisors are meeting the 1992 Minimum Standards. The checklist gives pointers on how to check whether the home country supervisor has the power to exercise global oversight and the abilities to perform consolidated supervision. A fuller explanation of the 1992 standards are contained in "Minimum Standards for the Supervision of International Banking Groups and their Cross-Border Establishments (1992)."

Home supervisors require two main types of information - quantitative and qualitative. They need to be able to verify that quantitative information received from a bank's overseas subsidiaries and branches is accurate and to reassure themselves that there are no supervisory gaps. If the home supervisor needs information about non-deposit operations, host supervisors are encouraged to provide the necessary information if this is not provided through other supervisory means. Where the liabilities side of the balance sheet is concerned, home supervisors do not routinely need to know the identity of individual depositors. However, in certain well-defined circumstances, home supervisors need access to individual depositors/ names and to deposit account information.

In the case of information that is specific to the local entity, an early sharing of information may be important to enable a potential problem to be resolved before it becomes serious. The home supervisor should therefore consult the host supervisor and the latter should report back its findings. In particular, it is essential that the home supervisor inform the host supervisor immediately if the former has reason to suspect the integrity of the local operation, the quality of its management, or the quality of internal controls being exercised by the parent bank.

Co-operation between home and host country supervisors is also needed in addressing Year 2000 cross-border issues. In a paper titled, "Supervisory Cooperation on Year 2000 Cross-Border Issues (1998), the Basle Committee puts forward five recommendations. While home supervisors have organisation-wide supervisory oversight responsibility, they must be prepared to cooperate with host supervisors on issues related to the progress of firms operating in host markets. The host country supervisor must focus on the readiness of local operations and must communicate to the home country supervisor any concern about the firm's preparations for Year 2000. Firms on their part must provide all relevant information to home and host country supervisors.

In Principles for the Supervision of Financial Conglomerates (1995), a document written by the Tripartite Group of bank, securities and insurance regulators, supervisory co-operation is touted as one of the eight major principles of financial supervision. This is because the financial activities of many financial conglomerates are subject to regulation from different regulators in one country; and also often a number of regulators from other jurisdictions.

The Joint Forum's Framework for Supervisory Information Sharing (Supervision of Financial Conglomerates), 1999 follows up the Tripartite Committee's recommendations. The paper outlines a framework to facilitate information-sharing between regulators of financial conglomerates. It contains a matrix which helps regulators identify the types of information they need to supervise a conglomerate; the latter being dependent on how the institution is structured and managed. For example, a regulator supervising a conglomerate which is structured and managed along global business lines and global control functions needs different information from someone who is supervising a conglomerate whose business activities are aligned with legal entities and local control functions. The framework also sets out the circumstances for information-sharing and a Conglomerate Questionnaire which helps supervisors collect pertinent information on organisational structure, corporate governance, management oversight, risk management and the control environment.

A key objective of information sharing is to identify problems early enough to encourage the management of regulated entities to take action to address concerns. The Joint Forum says that special emphasis must be given to information flows to the primary supervisor. It recommends, "The timely communication of unusual findings and significant developments to the primary supervisor will permit their analysis and evaluation against other information and the assembly of the 'supervisory puzzle.' In particular supervisors should share information on issues of risk management and internal controls which could impact on the control environment of entities in other jurisdictions." The Framework for Supervisory Information Sharing paper is accompanied by Principles for Supervisory Information Sharing (1999). The five principles are:

  1. Sufficient information should be available to each supervisor, reflecting the legal and regulatory regime and the supervisor's objectives and approaches, to effectively supervise the regulated entities residing within the conglomerate.
  2. Supervisors should be proactive in raising material issues and concerns with other supervisors. Supervisors should respond in a timely and satisfactory manner when such issues and concerns are raised with them.
  3. Supervisors should communicate emerging issues and developments of a material and potentially adverse nature, including supervisory actions and potential supervisory actions, to the primary supervisor in a timely manner.
  4. The primary supervisor should share with other relevant supervisors information affecting the regulated entity for which the latter have responsibility, including supervisory actions and potential supervisory actions, except in unusual circumstances when supervisory considerations dictate otherwise.
  5. Supervisors should purposefully take measures to establish and maintain contact with other supervisors and to establish a climate of cooperation and trust amongst themselves.

These principles were further elaborated on in ten key principles of information sharing issued by the G-7 finance ministers in May 1998. The are contained in Annex 1 of the paper.

The Coordinator Paper (1999) spells out seven principles for regulators to follow when identifying a coordinating supervisor. The choice of roles and responsibilities of a coordinator are influenced by the need to balance the benefits of improved coordination against the risks of creating a new level of supervisory oversight or an extension of a governmental safety net to additional entities, regulated and unregulated, within a conglomerate. Adding (or appearing to add) a layer of oversight or safety net can undermine market discipline, increase regulatory burden and increase moral hazard. Recognition must also be given to the practical constraints facing a coordinator and these issues must be resolved before a coordinator is appointed and its role defined.

The need for regulatory co-operation across industry groups is also taken up by the G-30 in their report on reducing systemic risk. Global Institutions, National Supervision and Systemic Risk (1997) examines the potential for systemic risk arising from the gap between the global operations of financial institutions and markets and nationally-based systems of accounting, reporting, law and supervision. One of its proposals calls for "National and functional supervisors (to) agree upon a lead coordinator for global firms, apply a global review framework to all parts of a financial group and agree upon consistent reporting requirements for global firms." The G-30 argues some of the large international financial institutions that dominate finance today need global, hands-on supervision. In the absence of a global agency, it suggests "someone at the centre of the process to coordinate contacts among supervisors and their sharing of information. Bank and securities supervisors are now pursuing a lead-coordinator model for information sharing in emergencies. Over the long-term, consideration should be given to changing the role of administrative coordinator to that of a coordinating supervisor who will take the lead in routine supervisory matters affecting a global firm."

The G-30 believes that regulatory cooperation across borders and functions will come about only "if supervisors recognise their mutual interdependence and adopt common supervisory techniques." Such harmonisation might lead in the long term to coordinated, global inspections, although clear differences between banks, securities houses and insurance companies will complicate this.

Mutual interdependence of markets, and thus of their regulators is one issue dealt with in the Emerging Markets Committee report on the East Asian crisis. The report, "Causes, Effects and Regulatory Implications of Financial and Economic Turbulence in Emerging Markets" (1998) recognised the systemic risk implications of the crisis. The report recommends that regulators consider the development and implementation of crisis-management procedures for co-ordinating emergency responses to crises within one market and across markets. The dangers of not doing so were seen in the case of one jurisdiction where the inadequacy of prevailing arrangements between banking and securities authorities reportedly led to some clearance and settlement problems during a period of severe market stress.

See also market integrity, systemic safety

  • Principles for Memoranda of Understanding (1991)
  • Minimum Standards for the Supervision of International Banking Groups and their Cross-Border Establishments (1992)
  • Mechanisms to Enhance Open and Timely Communication between Market Authorities of Related Cash and Derivative Markets During Periods of Market Disruption (1993)
  • Report on Issues Raised for Securities and Futures Regulators by Under-Regulated and Uncooperative Jurisdictions(1994)
  • The Supervision of Financial Conglomerates. Discussion Documents" (1995)
  • London Communique on the Supervision of Commodity Futures Markets (1996)
  • Discussion Paper on International Cooperation in Relation to Cross-Border Activity of Collective Investment Schemes (1996)
  • Regulatory Cooperation in Emergencies (1996)
  • The Supervision of Cross-Border Banking (1996)
  • Report on Co-operation between Market Authorities and Default Procedures (1996)
  • A Report from the Regulators Participating in the Windsor Meeting (1996)
  • Global Institutions, National Supervision and Systemic Risk (1997)
  • Principles for the Supervision of Financial Conglomerates (1995)
  • Framework for Supervisory Information Sharing (Supervision of Financial Conglomerates), 1998
  • Principles for Supervisory Information Sharing (1998)
  • The Coordinator Paper (1998)
  • Analysing Sumitomo by Mari Kooi (article)
  • Causes, Effects and Regulatory Implications of Financial and Economic Turbulence in Emerging Markets (1998)

Updated 7/28/99


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