Council of Financial Regulators Annual Report – 2001 3. Major Issues for the Council in 2001

The Global Environment

Global economic conditions were particularly challenging for policy makers in 2001, with a marked slowdown in global growth, substantial adjustments in equity markets and other financial markets and severe financial shocks in the latter part of the year. The Council paid close attention to the impact of these developments on the stability of the Australian financial system.

The slowdown in global growth became evident around the start of 2001, in the wake of the collapse of the high-tech ‘bubble’, and it became more broad-based as the year proceeded. Economic forecasters progressively marked down their view of US and world growth prospects and there was an increasing realisation that Japan was again in recession. These developments were already in train prior to the events of September 11.

The terrorist attacks of September 11 sharply increased the risks to global financial stability, not only in the United States but around the world. The attacks themselves disrupted the normal operation of financial markets and impaired the trading capacity of financial institutions. Policy responses were prompt. In common with central banks in other major countries, the RBA sought to ensure, through its daily market operations, that uncertainty and heightened risk aversion did not lead to settlement problems or systemic failures in the Australian market. The RBA took steps to reassure participants that financial markets in Australia would function normally and that adequate liquidity would be available to meet their settlement needs. The RBA did not, however, see a case to depart from its normal timetable for considering monetary policy as a result of these developments. The key priority immediately following September 11 was to ensure that the financial system remained functional. The RBA liaised closely with APRA in the aftermath of the terrorist attacks, while APRA and ASIC also exchanged information in relation to specific institutions which appeared to be vulnerable. APRA subsequently issued a media release confirming that the Australian banking system clearly remained profitable and well-capitalised.

The terrorist attacks had an immediate impact on consumer and business confidence in the United States and elsewhere, reflected in a sharp fall in share prices and increases in risk measures such as credit spreads, but some of these impacts were short-lasting. The attacks have also led to the largest ever claims on the international insurance chain and cast doubt over the solvency of segments of the global insurance industry. Indications are that the overall direct exposure of Australian insurers is relatively small, although a more lasting impact is likely to be an increase in global reinsurance premia and the withdrawal of terrorist cover by reinsurers.

In December, the major US energy company Enron filed for Chapter 11 bankruptcy protection. At first, the concern was that Enron could disrupt financial stability through the impact on its creditors or the unwinding of its large positions in financial markets. These fears have not been realised, mainly because exposures to Enron appear to have been widely dispersed. In Australia, a number of banks announced exposures to Enron, although these were small relative to the size of their overall loan portfolios. The more durable consequence of Enron's collapse is the increased scrutiny now being placed, in the United States and elsewhere, on accounting, disclosure and corporate governance standards.

The collapse of Enron was followed closely by the largest ever sovereign debt default when, after continuing economic and political turmoil, the government of Argentina defaulted on its debt and abandoned its decade-long currency board arrangements. Australia has very limited direct financial and trade linkages with Argentina, so the potential for the Argentine crisis to impair the health of the Australian financial system through these channels was considered minimal. Globally, there was only limited immediate contagion from Argentina to other emerging market economies, reducing the possibility of spillover effects in international financial markets.

In the face of the downturn of economic activity and this series of shocks, the prognosis for the world economy around the end of 2001 was a gloomy one, with fears of a prolonged and deep recession. Within a few months, however, a sense of optimism about global prospects began to reemerge on better news about the US economy, and international financial markets took on a generally more positive tone. Despite the difficult external environment in 2001, the Australian economy recorded a relatively strong performance which, in turn, helped to underpin the stability of the Australian financial system.

International Co-operation

Although international financial markets and core financial systems proved resilient to the unprecedented shocks of 2001, these shocks exposed issues that require attention from policy makers and confirmed the importance of maintaining the momentum of international monetary and regulatory reform. For one thing, the events of September 11 have renewed the focus on contingency planning and disaster recovery, to which much of the Year 2000 preparations had earlier been directed. For another, the collapse of Enron and other large corporate failures have highlighted the need to strengthen the basic foundations of markets through sound practices of corporate governance, improved audit quality and more effective regulatory oversight. Council members participate in a wide range of international groupings dealing with these and other reform issues. The Council itself acts as a forum for sharing information and co-ordinating the participation of its members in these activities.

One of the key groupings is the Financial Stability Forum, which was established in 1999. The Forum provides for the regular exchange of high-level views on potential vulnerabilities in the international financial system and helps to prioritise the various reform efforts that are underway at any one time. It brings together national authorities responsible for financial stability in significant financial centres, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts. The Governor of the RBA represents Australia.

During 2001, the Forum – which held its first Asia-Pacific Regional Meeting in Tokyo in October – also reviewed progress in addressing some of its earlier concerns about vulnerabilities in the international financial system, particularly lax regulatory practices in some offshore financial centres (OFCs) and the activities of highly leveraged institutions (HLIs). The Forum noted that some OFCs had made good progress in implementing international standards of supervision and regulation, though others were lagging behind. Further steps to encourage compliance will be considered once the International Monetary Fund (IMF) has completed an assessment program of OFCs. The Forum was also generally encouraged by changes in the industry and market environment for HLIs. Improved counterparty risk management and strengthened regulatory oversight of HLI counterparties appear to have reduced the leverage of HLIs from previous peaks; in addition, HLIs are now generally smaller in size. These developments have lessened the risks that HLIs could pose for the international financial system. However, the Forum has warned against complacency and urged continued improvements on public disclosures by HLIs to strengthen market discipline and reduce systemic risk.

The Forum has also been seeking to reinforce international crisis management arrangements, in particular, the practical issues associated with the winding down of a large and complex financial institution. A Crisis Management Contact List has been established, covering central banks, supervisory/regulatory agencies, finance or treasury departments, key international financial institutions, and global service providers in some 30 countries, including Australia.

A second international grouping with which Australia is associated is the G20, which was also established in 1999. The G20 brings together representatives of a cross-section of systemically significant economies, and of the IMF and World Bank; the aim is to promote co-operation so as to achieve stable and sustainable world economic growth.^[3] The Ministerial meeting, attended by the Treasurer and the Governor of the RBA, is held annually while Deputies' meetings are held twice-yearly.

The primary focus of the G20 has been on ways to reduce the frequency and severity of financial crises. In November 2001, the Ministers and Governors reaffirmed their commitment to efforts to reduce susceptibility to financial crises through their work in four key areas: the selection of appropriate exchange rate arrangements; prudent management of external liabilities; implementation of international standards and codes of best practice; and the development of a workable framework for involving the private sector in crisis prevention and resolution. The G20's agenda also includes consideration of the challenges posed by globalisation. Ministers and Governors have agreed on the importance of developing policies to ensure that the benefits of globalisation are maximised and shared by developing and poor countries. Members have undertaken case studies reviewing experiences with globalisation to provide a foundation for an appropriate policy framework. Building on this work, the RBA and the Australian Treasury jointly convened a conference on ‘Globalisation, Living Standards and Inequality: Recent Progress and Continuing Challenges’ in Sydney in May 2002.

The G20 responded to the emergence of terrorism as a threat to international financial stability by committing to an Action Plan to deny terrorists and their associates access to financial systems; the RBA has taken action to work towards these aims. The G20 has urged countries outside the grouping to take similar steps.

ASIC, principally through its membership of the International Organisation of Securities Commissions (IOSCO), as well as through its regional training and bilateral enforcement activities, plays an active role in international co-operation efforts in financial market regulation. Following the events of September 11, ASIC became a member of the IOSCO September 11 Taskforce, which was established to explore actions that securities regulators should take in light of those events. ASIC was also involved in regular IOSCO activities throughout the year including attendance at meetings of the IOSCO Implementation Committee, which reviews progress in the implementation of IOSCO principles in the Asia-Pacific region. Along with 41 other IOSCO members, ASIC took part in the IOSCO-sponsored International Internet Surf Day aimed at increasing investor protection and market confidence.

One particular area in which ASIC was involved during 2001 concerned cold-calling. Cold-calling is the practice whereby an unlicensed person makes unsolicited telephone offers urging unsuspecting investors to buy securities in overseas stocks. In June 2001, ASIC presented a proposal at the IOSCO annual meeting that Asia-Pacific Regional Committee (APRC) members agree to work towards developing a regional cold-calling communications strategy. That proposal was adopted, and ASIC subsequently canvassed all APRC members on any enforcement actions or consumer protection measures they had taken in relation to cold-calling. In October 2001, at the IOSCO Technical Committee meeting in Rome, ASIC presented a briefing paper which it had prepared with the Securities Exchange Board of India, as well as a general communiqué drawing attention to the dangers for investors of investing through a cold-caller; the communiqué was issued in February 2002. At the same time, ASIC worked closely with Hong Kong enforcement officials, and with Thai police investigating various cold-calling firms operating from Thailand which had been sent money by Australian investors.

During 2001, ASIC hosted numerous visits from regional regulatory staff and continued to provide training and assistance. A number of senior ASIC officers gave presentations at various regional seminars, including a conference on financial service reform hosted by the Asia-Pacific Economic Cooperation (APEC) in Beijing in November 2001. During the year, ASIC also negotiated MOUs with regulatory counterparts overseas – the Comission Nacional de Valores Mobiliarios of Portugal, the Capital Markets Board of Turkey, the Hong Kong Securities and Futures Commission and the Commodity Futures and Trading Agency of Indonesia.

APRA was also active in a range of international groupings throughout 2001 and views international co-ordination and co-operation as an important aspect of its work. APRA is represented on, and provides input to, a range of groups established under the auspices of the Basel Committee on Banking Supervision. These include the Core Principles Liaison Group (CPLG), the main forum for consultation between the Basel Committee, which largely comprises central banks and bank supervisory agencies from G10 countries, and non-member countries. APRA plays an active role on the CPLG Capital Working Group, which provides advice and guidance on the development of the new Basel Capital Accord. APRA was a member of a separate Task Force established by the Financial Stability Forum and the Basel Committee to produce a ‘tool kit’ containing guidance for supervisors when dealing with weak banks. The Task Force's report, which was released in March 2002, assesses various methods of dealing with bank problems, including preventative measures, early identification, corrective actions, resolution issues and exit strategies. APRA is also represented on the Basel Committee's Electronic Banking Group, which examines the prudential issues arising from electronic banking activities and, in particular, develops guidance for supervisors in dealing with the specific risk management and cross-border issues that e-banking presents.

APRA is represented on the Executive Committee of the International Association of Insurance Supervisors (IAIS), where an APRA executive is currently Deputy Chair; during 2001, it provided the Chair of the IAIS Solvency Sub-Committee, which is developing international guidance on the establishment of solvency standards for life and general insurance companies. APRA is also a member of the Joint Forum, established by the IAIS, the Basel Committee and IOSCO to examine cross-sector issues. The Joint Forum produced two major discussion papers in 2001: one on the similarities and differences in the Core Principles for the respective sectors and another which examined the different approaches to risk assessment and capital adequacy adopted within the banking, insurance and securities industries.

During 2001, the International Network of Pensions Regulators and Supervisors was established. Given APRA's responsibilities with respect to Australia's well-developed superannuation sector, APRA has taken considerable interest in the establishment of this new grouping and is a member of its technical committee.

Together with the RBA, APRA participates in the Working Group on Banking Supervision of the Executives' Meeting of East Asia-Pacific Central Banks (EMEAP), a grouping of regional central banks and monetary authorities. The Working Group provides a forum to discuss financial developments in the region as well as progress on the new Basel Capital Accord.

Finally, APRA and ASIC have been active supporters of the APEC Financial Regulators Training Initiative. During 2001, APRA hosted a course for APEC banking supervisors on corporate governance and internal controls. The objective of such courses is to ensure a strong transfer of knowledge to countries within the region who are seeking to upgrade their regulatory systems, by drawing on the skills and expertise of other supervisors.