International co-operation is a key factor for economic development. Hence, compliance with international and regional standards is key to the sustainable growth of an international financial centre. As a result, the regulatory framework at national level is significantly influenced by institutions for international and regional cooperation (IRIs).
This article considers the establishment of IRIs, such as the Financial Stability Board (FSB) and the European System of Financial Supervision (ESFS), which includes the European Supervisory Authorities and the Single Supervisory Mechanism (SSM). It succinctly tries to address the questions: What has led to the establishment of these institutions? How do they influence the regulatory and supervisory framework at national level?
The central argument of this article is that crises form the catalyst for the establishment and further development of IRIs. Such institutions promote harmonisation, cooperation between financial supervisors and convergence of supervisory practices to solve common problems.
IRIs are supranational bodies that play an important role in the international architecture by developing regulatory standards, monitoring their implementation, carrying out research on novel, high-risk areas in finance, and setting up supervisory convergence and cooperation mechanisms. All in all, the mechanisms – both technical and cooperative – help to achieve greater international financial resilience which, in turn, helps to decrease the likelihood of a future financial crisis.
Crises and financial debacles, besides uncovering the limitations of the financial system – which need to be mitigated – also generate the necessary political will and momentum for a strong policy response that, in certain instances, included the establishment of an IRI, which help to achieve greater international financial resilience which, in turn, helps to decrease the likelihood of a future financial crisis. This is important as, in the international system, states will not, under normal circumstances, willingly lose their independence and agree to a transfer of powers to an IRI.
Most of the IRIs have been created following a crisis or significant financial debacles. For example, the Basel Committee on Banking Supervision was established in 1974 in the aftermath of the failure of Bankhaus Herstatt in Germany. More recently, the 2009 global financial crisis triggered the establishment of IRIs with both international and regional reach.
Regionally, it resulted in the establishment of the ESFS. The introduction of the ESFS was an important novelty, as the system is hard law-based. This means the ESFS has the power to take concrete action through, for instance, breach of EU law, when states and their financial supervisors do not comply with European directives, regulations and guidelines.
Eventually, the eurozone sovereign debt crisis led to the establishment of the SSM, with the European Central Bank being granted the function and powers of a central, supranational bank supervisor. The SSM – which basically bypasses national competent authorities’ direct power over its jurisdiction’s significant banking institutions – exemplifies the extent of political will for change resulting from a crisis to the extent that it led to a meaningful transfer of powers from the national to the supranational.
The 2009 financial crisis prompted the creation of the Financial Stability Board
Internationally, the 2009 financial crisis also prompted the creation of the FSB. The FSB – an important standard-setter in prudential regulation – largely differs from the ESFS because it is soft law-based. This means that FSB’s members are under no legal obligation to follow the institution’s recommendations. The lack of legally binding and enforcement mechanisms, however, does not necessarily imply poor compliance.
The fact is that the FSB employs strong pressure points, such as the Committee on Standards Implementation (SCSI), which regularly produces and publishes monitoring reports. Pressure points are important to ensure that threats to financial stability stemming from the interconnectedness of the financial system are properly addressed and, as a result, mitigate cross-border contagion.
In addition, the publishing of monitoring reports by the FSB is largely a “name and shame” approach, through which the institution hopes to discourage non-compliance behaviour. The use of these soft enforcement mechanisms is not new and it is very similar to how international law operates, especially jus cogens (non-binding customary law). Indeed, governments are generally reluctant to be perceived as not being compliant with the international agreements, as this would give their jurisdiction the reputation of being unreliable.
In conclusion, crises and significant financial failures have generated the political will that is often lacking under normal circumstances. In turn, political will and momentum have created new IRIs and have strengthened old ones, by delegating more power to supranational mechanisms – e.g. SSM under the ESFS.
More recently, the European Union has proposed and is currently discussing the establishment of an Anti-Money Laundering Authority to address the financial crime failures identified during the past decade. This sustains the point that changes to the architecture of financial regulation is largely contingent on political will, the main trigger of which is a reaction to crises and financial failures.
This is also true for institutions which are soft law-based, such as the FSB. Indeed, the setting up of the FSB and the fact that the institution is empowered with strong – albeit legally soft – enforcement mechanisms come to show that even at a decentralised international level, actors are willing to delegate power in the aftermath of a crisis.
Christopher P. Buttigieg is the chief officer supervision of the Malta Financial Services Authority. Beatriz Brunelli Zimmermann is a junior analyst at ICT Risk and Cybersecurity at the MFSA. The opinions expressed in this article are those of the authors and do not necessarily reflect those of the MFSA.