The Next Step in Global Financial Regulation: Global Regulation of Interconnectedness
| DOI | http://doi.org/10.1111/j.1758-5899.2010.00039.x |
| Author | Hal S. Scott |
| Date | 01 October 2010 |
| Published date | 01 October 2010 |
The Next Step in Global Financial
Regulation: Global Regulation of
Interconnectedness
Hal S. Scott
Harvard Law School and Director, Committee on Capital Markets Regulation
A response to ‘Global Financial Regulation after the Credit Crisis’
Howard Davies*
It is quite clear that we cannot have a global financial sys-
tem with national regulation. It is equally clear that full
global regulation is not now possible given national politics.
There are thus two challenges facing us: (1) what improve-
ments can we now make to increase international coordina-
tion; and (2) what are the key steps that need to be taken
in order to achieve global regulation someday. The new
Council on International Financial Regulation, which I
co-chair with Michel Prada, and of which Howard Davies
is a member, has been formed to address these challenges.
I think we should not underrate the progress made in
international cooperation during the financial crisis. The
Obama administration only advanced its reform program in
June 2009 after coordinating with the G20, and the key
parts of its program were consistent with the eight G20
declarations made in the previous April. The US, the
world’s leading economy and power, has thus embraced the
spirit of international cooperation, a key development in
enhancing coordination. To be sure, since that time there
have been significant departures from global cooperation.
The rest of the world was blindsided by the Volcker rules
that were advanced after Obama lost his 60-vote majority
in the US Senate. And the EU has clashed with the US
over its insistence on making hedge funds in Europe sub-
ject to capital and leverage requirements. Also, even the
EU was blindsided by the German short-selling ban. How-
ever, these are truly exceptions to the rule of increased
coordination.
Howard Davies is right to remind us that international
cooperation could well diminish as the crisis recedes in
time. However, I think this is much less likely than in the
past. Countries now recognize that they cannot unilaterally
protect themselves in a financial crisis given the degree of
globalization and that the costs of such crises are very high.
This is primarily due to the cross-border operations and
interconnectedness of financial institutions – factors whose
importance will only increase over time.
It is interesting to consider the relevance of the develop-
ment of global regulation in the trade field to the prospect
of developing global regulation of finance. On the one
hand, it shows that countries can give up their sovereignty
to a properly designed international organization. On the
other hand, the heart of the WTO process is dispute reso-
lution among countries over trade disputes. This is a differ-
ent problem, and poses a less daunting challenge, than
coordination of regulation over worldwide finance. To be
sure, trade rules have broadened out to deal with regula-
tion, principally to limit non-tariff barriers, but this has
been the most contentious part of the WTO process, and
it still deals with relations between states as opposed to
coordination of policies of different states in dealing with
firms and markets.
What would be a good next step? Perhaps we can try to
achieve global regulation of interconnectedness, a major
concern emerging from the crisis. This would best take the
form of position limits on net exposures (including all
lending and derivatives) of financial institutions to each
other. I do not limit such obligations to ‘systemically
important institutions’ as they are difficult to identify,
change over time and, if identified, create moral hazard
and competitive distortions. Such net exposures, like single
borrower limits, should apply to all financial institutions,
and not exceed a fixed, say 15–25 per cent, of capital. Since
interconnectedness is global, this can only be achieved by
global coordination and perhaps an international body to
oversee the process of: (1) collecting, storing and monitor-
ing information about positions on a timely basis; (2) set-
ting parameters for valuing positions and collateral (not
*Davies, H. (2010) ‘Global Financial Regulation after the Credit
Crisis’, Global Policy, Vol. 1, No. 2, pp. 185–190.
DOI: 10.1111/j.1758-5899.2010.00025.x
Global Policy Volume 1 . Issue 3 . October 2010
Copyright Ó2010 London School of Economics and Political Science and John Wiley & Sons Ltd. Global Policy (2010) 1:3 doi: 10.1111/j.1758-5899.2010.00039.x
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