Council of Financial Regulators Annual Report – 2000 3. Major Issues for the Council in 2000

Reform of the International Financial System

The Council is a forum for sharing information and co-ordinating the participation of its members in the process of international monetary reform – a process given considerable impetus by the global financial instability of 1997 and 1998. That instability highlighted the need to shore up the international financial architecture in critical ways. One was through encouraging earlier identification of, and concerted responses to, incipient vulnerabilities in the financial system; another through the development of internationally agreed standards of best practice that could be applied consistently across financial institutions and countries; and a third through improved information exchange and co-ordination among the main authorities responsible for promoting financial stability. Two new international groupings – the Financial Stability Forum and the G20 – are now carrying forward much of these reform efforts. The resilience of major financial markets and institutions in the face of slowing world growth and some sharp corrections in asset prices in the first part of 2001 is testimony to the importance of these efforts.

The Financial Stability Forum was established in February 1999 to promote international financial stability through enhanced information exchange and co-operation in financial supervision and surveillance. It brings together senior representatives from international financial institutions, international groupings of regulators and supervisors, committees of central bank experts and national authorities responsible for financial stability in significant international financial centres. Australia is represented by the Governor of the RBA.

The Forum's initial focus was on highly leveraged institutions (HLIs), capital flows and offshore financial centres, and international standards for sound financial systems (discussed below). A working group on HLIs, on which the RBA was represented, recommended a package of measures to address both systemic risk and market dynamic concerns arising from the activities of HLIs. These measures included enhanced public disclosure by HLIs, through both regulation and legislation. The issue of disclosure has been taken up by a multi-disciplinary Working Group on Enhanced Disclosure,^[4] which undertook a pilot study of data on market, credit and liquidity risks collected from forty-four financial institutions in nine countries. Two Australian financial institutions took part in this study, with APRA assistance. In its final report, released in April 2001, the Working Group recommended a specific set of disclosures to be provided by all types of financial institutions, and identified other disclosures which should be the subject of further investigation. The Working Group believes the recommendations can be a springboard for collaboration between the public and private sectors and among authorities across financial sectors.

The Forum has also been looking at factors affecting liquidity in financial markets and at the feasibility of developing international guidance on dealing with weak banks and systemic banking problems. In addition, it has been exploring the issues that would arise should one of the very large and complex financial institutions now present in the financial landscape encounter serious difficulties. The potential for such institutions to complicate policy responses was considered in a study on consolidation in the financial sector by the G10 countries, Australia and Spain. Both the RBA and the Australian Treasury participated. The study, which was published in January 2001, concluded that existing policies appeared adequate to contain individual and systemic risks in the intermediate term, but national authorities were encouraged to step up their contingency planning for working out a troubled large and complex institution in an orderly way.

The G20 was formed in December 1999 tfinancial policy issues among systemically significant economies and to promote co-operation so as to achieve stable and sustainable world economic growth.^[5] It has met on five separate occasions – twice involving the Treasurer and the Governor of the RBA, and three times at Deputies level. The formative work of the G20 focussed on policies to reduce the vulnerability of countries to financial crises. The four key areas discussed have covered exchange rate arrangements; external liability management; private sector involvement in crisis prevention and resolution; and the implementation of international standards and codes. At the October 2000 meeting of Ministers and Governors, the G20 work program was broadened to include an examination of the challenges of globalisation and appropriate policies to ensure its benefits are maximised and shared widely. Case studies on selected G20 members' experiences with globalisation are being prepared in time for discussion at the 2001 annual meeting.

International Standards and Codes

Since the Asian crisis, international standards for sound financial systems have come to be seen as having a critical role in crisis prevention, both in strengthening the functioning of markets and in providing a sharper focus to policy discussions. Such standards bear directly on the responsibilities of each Council member, and all have been actively involved in their development and implementation.

This particular multilateral initiative gained momentum when a task force, established under the auspices of the Financial Stability Forum and including representation from the Australian Treasury, identified 12 key international standards, covering matters such as monetary and fiscal policy transparency, corporate governance and prudential supervision. These standards have been designated by the Forum as the minimum requirements for good practice in sound financial systems and deserving to be implemented as a matter of priority. Among these standards, the RBA has been closely involved in the development of the Core Principles for Systemically Important Payment Systems and APRA in the development of the Core Principles for Effective Banking Supervision and the Insurance Core Principles. The latter sets of principles identify the key requirements for a system of prudential regulation to be effective and cover such issues as licensing, on- and off-site surveillance, capital adequacy, enforcement and wind-up provisions. APRA has been a member of the Core Principles Liaison Group of the Basel Committee on Banking Supervision, which comprises a mix of G10 and non-G10 countries, since its establishment. APRA also plays a prominent role on the International Association of Insurance Supervisors (IAIS); a senior APRA officer is currently deputy chair of the IAIS Executive Committee and took an active part in drafting the Insurance Core Principles.

More broadly, APRA provides considerable input into the development of international standards and codes. For example, an APRA officer is chair of the IAIS Solvency Sub-Committee, which is examining the development of international solvency standards for the insurance sector. APRA is also represented on a non-G10 Capital Working Group of the Basel Committee, which is providing guidance on the development of the new Basel Capital Accord (see below).

APRA has also acknowledged the benefits of conducting a self-assessment of its own practices against relevant international standards and codes. It has recently published its self-assessment of Australia's compliance with the Core Principles for Effective Banking Supervision (available on the APRA website) and, once its new supervisory regime for general insurance is in place, intends to undertake similar self-assessments against the Insurance Core Principles and the IMF Code of Good Practice for Monetary and Financial Policies.

Council members have also played a role in the implementation of international standards, mainly by contributing resources to the IMF-World Bank Financial Sector Assessment Program (FSAP). This Program considers a country's observance of relevant standards as an input into judgments on financial sector vulnerability and development needs. Council members have participated in FSAP visits to Canada (ASIC), India (RBA) and Israel (APRA).

ASIC, principally through its membership of the International Organisation of Securities Commissions (IOSCO) and through training and other initiatives in the region, has been involved in a number of issues related to standard-setting. IOSCO played a particularly significant role in 2000. In May, ASIC hosted the 25th Annual Conference of IOSCO in Sydney. An important aspect of the final communiqué of this Conference was the release of a ‘Bulletin on Investor Protection in the New Economy’ which recognised the need, in the context of technological change, to identify market and investment risks, to disclose these risks to investors and for market professionals to properly discharge their responsibilities. At the Conference it was also announced that IOSCO had evaluated the International Accounting Standards issued by the International Accounting Standards Committee (IASC), which form one of the 12 key standards for sound financial systems, and approved a resolution recommending that IOSCO members permit the use of these standards for cross-border offerings and listings.

Following the earlier publication of its Objectives and Principles of Securities Regulation (another of the 12 key standards), IOSCO advanced the implementation of these principles during the year with the issue of three self-assessment surveys designed to meet the objectives of protecting investors, ensuring that markets are fair, efficient and transparent, and reducing systemic risk. Throughout the year IOSCO also published reports on issues such as collective investment schemes, the management of credit risks and market manipulation.

In March 2000, ASIC participated in an IOSCO-sponsored International Internet Surf Day aimed at increasing investor protection and market confidence. Securities and futures regulators from eighteen countries co-ordinated their efforts to identify securities and futures fraud on the Internet. In the same month ASIC hosted, with AusAid support, a Corporate Governance Roundtable in Sydney with senior personnel from nine jurisdictions in the region visiting a number of different financial institutions and regulatory agencies to discuss aspects of corporate governance.

During 2000, ASIC worked with Edith Cowan University and PriceWaterhouseCoopers to devise a program known as ACORN (AsiaCORporategoverNance), to be conducted over the next few years. Funded by AusAid, the program has adopted a practical focus, with the major aim of developing corporate governance programs in Indonesia, Vietnam, and the Philippines which would be run by local regulatory agencies. Also in the region, an ASIC senior officer gave presentations on ‘conduct of business’ rules and regulatory supervision to an APEC Financial Regulators Training Initiative workshop, hosted by the Asian Development Bank in July.

In the area of e-commerce, APRA is an observer on the Basel Committee's Electronic Banking Group, which was established in late 1999 to assess the specific supervisory issues arising from electronic banking developments and to develop guidance for the prudent risk management of e-banking activities. A major objective of the Group's work is to provide a harmonised approach to the supervision of e-banking by supervisory agencies, particularly in view of the cross-border nature of e-banking activities.

The New Basel Capital Accord

During 2000, the Basel Committee on Banking Supervision finalised a second set of proposals for reforming the 1988 Basel Capital Accord, and released these proposals for public consultation in early 2001. APRA has taken a very close and public interest in these particular reform proposals.

The 1988 Accord has been the global benchmark for assessing banks' capital adequacy for over a decade. The Accord guidelines are applied in Australia to all authorised deposit-taking institutions (ADIs) – banks, building societies and credit unions. Over this period, however, there have been substantial changes in financial markets and significant improvements in risk measurement and management techniques. The objective of the reform proposals is to develop capital adequacy guidelines that are more accurately aligned with the individual risk profile of institutions, to lessen opportunities for regulatory arbitrage and to offer greater flexibility for supervisors to recognise/ encourage the use of more sophisticated risk management techniques. While the proposed guidelines focus primarily on internationally active banks, the underlying principles are also intended to be suitable for application to banks of varying levels of complexity and sophistication.

The New Accord consists of three mutually reinforcing pillars. Pillar 1 is the direct replacement for the 1988 Accord and sets out the framework for revised minimum capital requirements. Compared to the broad-brush approach of the 1988 Accord, credit risk will be treated more elaborately while the market risk charge will remain essentially unchanged. New explicit capital charges for operational risk and (if the supervisor chooses) interest rate risk in the banking book have also been proposed. Within each risk class, a menu of calculation methods will be available, ranging from a simple, standardised method to more sophisticated approaches involving institutions' own internal risk assessment methodologies. The framework builds in rewards for stronger and more accurate risk management systems.

Pillars 2 and 3 extend the idea of establishing agreed international guidelines to other aspects of capital adequacy regulation – the supervisory review process and market discipline (disclosure) requirements. To varying degrees, these additional elements already exist in many countries, including Australia.

In developing the new Accord, the Basel Committee has consulted internationally with supervisors and industry participants. APRA has itself consulted widely amongst Australian ADIs and other interested parties and has contributed to the consultation process through a range of international supervisory fora. It has made two formal submissions responding to the proposals, which are available on the APRA website. In addition, APRA has participated, in conjunction with a number of Australian ADIs, in the Basel Committee's global quantitative impact study on the effects of the new Accord.

The Basel Committee intends to finalise the new Accord in 2002, with implementation scheduled for 2005. APRA will be co-ordinating its implementation of the new supervisory requirements with other Council members, particularly in the area of disclosure.