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Transcript of an IMF Book Forum
Standards And Codes: Can They Prevent Financial Crises?

Thursday, May 27, 2004
Washington, D.C.

Participants:

Benu Schneider, United Nations Conference on Trade and Development
Randall Dodd, Derivatives Study Center and the Financial Policy Forum
Aziz Ali Mohammed, Honorary Advisor to the Chair, G-24
Jesus Seade (Moderator), International Monetary Fund

SEADE: Good afternoon to you all, and welcome to this forum, and to this interesting session at which we have the presentation for an important new book, "Standards and Codes: Can They Prevent Financial Crises?" edited by Benu Schneider, who is at my far right and will make an introductory presentation, with a number of co-authors or participants, contributors to the volume, most of which are not with us, but many of them are well-known to this house, to this institution, but one of them, in particular, fits both descriptions, being a contributor and also a very well-known person who left a deep mark in the institution: Aziz Ali Mohammed, who is a contributor and a former member of staff of the Fund, peaking at the very important job he held as Director, in fact, first Director, I think, of External Relations, and a contributor to this volume.

We also have with us Mr. Randall Dodd, who is the founder and Director of the Derivatives Study Center and the Financial Policy Forum, based here in Washington, D.C.

So a warm welcome to the three of them and to all of you.

Let me just make a few comments on the issue, rather than on the book, on the issue on the important topic of standards and codes. We all know the meltdown the world went through quite surprisingly all of a sudden mid to late 1997 in East Asia. And following that it became clear that a new financial architecture needed to be created to give more stability to the international financial system.

A number of initiatives were launched, but an important one was a standards and codes initiatives. We started with a few standards that were created, and that has gradually grown somewhat, but the idea was to have key areas of economic management, where certain basic rules had to be obeyed on best practice and on information of people generally--nationals of the country invest also in the markets--on how things are done as an effective crucial way of reducing surprises and thereby instability.

Those initial areas were on data--data transparency, fiscal transparency, monetary and financial and then on banking supervision. These continue to be core to the work of the Fund, but in addition, a number of areas have been developed, in particular, jointly with the World Bank, in the context of work we conducted in the financial sector.

The idea originally was that by throwing the doors open and having better structural approaches to best practice in these areas and to the dissemination of information you would reduce the scope, as I said before, for surprises for transparency markets of all kinds, financial markets, but also political markets would be better informed to create pressure on the governments and the people running those systems to do things better. And as a result of that, you would improve the management.

However, a number of difficult issues have, of course, accompanied us all along, and many of them are raised in an important way in this new volume, and I expect that at least some of the discussion will concentrate on some of these problems that have arisen on whether those standards are valuable to everybody in the same way, are they suitable to different kinds of countries, given that almost by definition they are quite uniform in their approach and contents? Are they suitable for everybody? To what extent are they applied to different kinds of countries? Do we have a coverage that does justice to the effort? Among the industrial countries they are having questions in some areas. Progress has been greater in some other areas. Also, at the other end of the spectrum, concerning the less-advanced countries which do not have access to financial markets, to capital markets, are the instruments suitable to them, and do they contribute anything useful to them? And should they be used in some different way? There are questions of resources. I see that internally, since I'm involved with the initiative inside the Fund, and we have limited resources to do it, and we face difficult questions, for example, on the extent to which we should put efforts into the upkeep of what has already been done, to do a new assessment of ROSCs that have already been done and to put the effort into keeping them up-to-date, otherwise they lose value, vis a vis expanding to countries that have not been covered. So there's an issue of resources in our house, but certainly there's also an issue of resources in the countries themselves, which may vary, it certainly varies from area to area. Some areas are more demanding. But the question of resources needs to be addressed.

And then, finally, what are the benefits? Is it just a way of being a good guy and behaving in a way that the international community has felt is appropriate or is there a direct benefit to the countries, whether in relation to financial issues, do spreads fall, or is best practice actually spreading within the countries thanks to the initiative?

So I hope that on some of these questions our speakers will be able to shed light on them. My intention is to offer the floor first to the editor, to Benu Schneider--again, my welcome--asking her to probably make an introduction for some 15 minutes or so, and then the two other panelists for some up to 10 minutes each, perhaps in the sequence that we have, and then at the end to throw it open. I may take the liberty to inject a comment or question here and there, but otherwise I've done my part.

Benu?

See Benu Schneider's presentation (456 kb PDF file)

SCHNEIDER: Thank you.

Thank you, John, and thank you, Jesus, for inviting me here today and opening up the discussion on standards and codes. There are several issues about standards and codes which I feel very strongly about, and I'm glad that we have the opportunity today to open up a dialogue and discuss some of these issues.

As Jesus just told us, the initiative was born out of the East Asian crisis when, for the first time, it was recognized that there are linkages between national and international regulatory bodies and that there are also linkages between the market and international financial institutions, and therefore in recognition of these linkages it was felt something had to be done.

The rationale for the initiative was backed by the G-7 countries, the Finance Ministers, the Governors who felt that their economies were being subjected to increased risk, and the developing world had to adhere by some rules and principles so that the industrialized economies would not be subject to risk, and therefore the initiative was actually borne at the behest of the G-7 Ministers and Governors, and the Financial Stability Forum, created in February 1999, to establish international rules, standards, codes for many areas. There are about 77 codes or even more because the BIS website doesn't give the complete data now, 12 of which have been identified as the key codes which are crucial for international financial stability.

Standards are not new. So it's not as if some of the standards we are talking about here are new. Standards have always been there. The OECD countries have always been adhering to standards, and they've been subject to self-assessments with a peer review process. Standards and codes have always been around.

What is new is the idea of defining and redefining them, so that all countries in the world adhere to a global set of standards and rules. So the initiative, itself, in that sense is not new. What is new is the emphasis given on the global sets of rules and standards.

Now, at first sight, the initiative is very appealing. Everyone in the world has the same regulatory principles, everyone is transparent. You've got market integrity and the rest of it, and it's very, very appealing. But when you start going down further into it and really thinking about it, there are several problems that are posed for all countries, I don't think just developing countries, but also the advanced industrial countries.

What I really want to argue today is that the first objective for which the Financial Stability Forum was set up, and these 12 codes in key areas were identified was global financial stability. And what I'm going to put into question today is, whether global financial stability served by these codes? The IMF has been conducting exercises, along with the Article IV consultations and the FSAP reports, together with the World Bank, which come out in the form of reports on observance of standards and codes.

There is thus is a surveillance mechanism in place. What I'm going to question is that the surveillance mechanism and the information which we are getting from it, does it really serve the goal of global financial stability? And what I'm going to argue out is that probably, no, at least for many years to come, it could be 15 years, it could be 20 years simply because implementation of standards and codes is a process. It takes a very long time, and so what we do in the intervening time, since implementation of standards and codes is a process? So probably the way it is going for the present, it may contribute to international financial stability, but it's definitely not going to take care of global financial stability.

But what the initiative might do is to serve a second objective, and the second objective might be financial sector reform that we have international rules for developing countries, as well as the industrialized countries against which they can benchmark their financial sectors, their data dissemination, institutional and market infrastructure and bring about financial sector reforms. This would be the thread of the argument throughout, where I'm questioning whether standards and codes contribute to global financial stability or whether we need to shift track? It is a stock-taking exercise because the initiative has been there since '99. Some years have now passed.

And let's look at what's been happening to analyze whether the first objective get resolved or do we have to change track and move to the second objective and have the first objective as a residue emanating from the overall objective of financial sector reform.

Now, if the goal is indeed international financial stability, then we should be focusing on key players in financial markets. So, if we are going by the first objective for which this initiative was set up, and the surveillance mechanism was set up at the IMF, then we should have concentrated on key players in financial markets.

Now, what I've done in this graph that I've basically classified the available ROSCs into key players in financial markets and non-key players in financial markets for each of the 12 codes. I apologize. I think you can't read the titles. I'll read them in order. They are fiscal transparency, banking supervision, monetary transparency, data dissemination, payment systems, insurance, and supervision, securities regulation, corporate governance, antimoney laundering, insolvency and auditing and accounting. They are in that order.

There have been more ROSCs conducted for non-key players in financial markets, rather than key players in financial markets. The figures inside the bars are the proportion of those within that particular group to show where they stand. And so what you find is actually that you don't have enough information on all of the key players in international financial markets. The key players are the G-10 countries and top emerging markets who are expected to affect global financial stability, that if something happens in an emerging market or in an industrialized country, that that would affect global financial stability.

Now, if you look at corporate governance and accounting and auditing, there's no ROSC for any of the industrialized countries for that. We know the Enron collapse, we know WorldCom, we know the problems with corporate collapses. But if the focus is on global financial stability, then some of the key things that we need to look at are also in the corporate sector, and one has not taken care of that. So it's been largely ignored in the surveillance mechanism, as we don't have any ROSC for corporate governance for the industrialized countries, so the small numbers which you see here in the graph are only for emerging market economies. There's no industrialized country in that group.

The other source of information which you have on compliance is a private-sector initiative called eStandards Forum. If you go to their website, they compile information for about 87 countries. And what they basically do is that they take the reports in the public domain and try to put that information together, and they work out the degree of compliance and put that information on their website.

The disadvantage of that process is it depends on the person integrating that information. It's usually someone who's doing his masters or just finished his masters. And financial sector in each of these issues are very complicated fields, and, the information provided on the eStandards Forum website is almost the form of tick boxes because the private sector would like to get information in the form of tick boxes and use them in their risk assessments.

So an initiative, which is a process which takes years to implement because each of these codes takes years to implement in every country, depending on the type of country and the resources needed, may quickly get translated into risk assessments, and we are not very sure about the reliability of that information.

But one of the advantages of the website is found in the realization that initially even some of the G-7 countries did not comply with the transparency codes even when a lot of emphasis in the standards and codes exercise, a lot of it has been on transparency. And even the G-7 countries are not fully compliant with the transparency codes.

Let me give you an example. You take the SDDS, for instance. Many industrialized countries do not want to provide information on their international investment position. If you go to the IMF data sources, you do not find the recent data on their international investment position or many of them would not like to provide information by how much they've gone forward on their international reserves.

Therefore, the burden of transparency has actually been on emerging market economies, although what we find is that although the initiative emanated from the background of the East Asian crisis, the problem of compliance is a global issue, and it's not even complete for the transparency codes in the G-7 countries, and that compliance is weak both in the OECD and non-OECD countries.

So this first reaction to the crisis that it is an emerging market problem and that these countries had done something terribly wrong is not borne out by evidence because the problem is widely prevalent.

Now, there are other problems, of course, which I'm not going to talk about in detail. It is the quality of ROSCs. People find the language turgid. They find them spotty, dated. There is no continuous stream of information. There are problems in priority setting, in sequencing and follow-up action. For instance, there has been very little follow-up action on the recommendations made in the FSAPs. There's very little link between the First Initiative that was set up to provide technical assistance and the recommendations in FSAPs.

Now, I'll move to another problem, and that is to talk about the problems in monitoring and the resources that Jesus also referred to in his introduction to the Forum today, that there are problems relating to human and financial resources both at the Bretton Woods Institutions, as well as in the country concerned.

On the monitoring of standards and codes, I am going to introduce a proposal and question: why is it that the Bretton Woods Institutions need to do the surveillance? We already have an established system in the OECD. The OECD countries have the FATF model of self-assessment with a peer review process. This was also suggested by Paul Martin at that time in his statement to the IMFC. Isn't this a better way to move forward?

Some of the advantages of the FATF model derives from its ability to resolve the problem of ownership (because standards have been devised by the industrialized countries, with a few developing countries participating),appropriateness, and the problem of voice for developing countries.

If we have self-assessments, and the self-assessments are backed by a peer-review process, it might be a better way forward. Initiatives, like the First Initiative that will provide technical assistance, may be used to actually help some countries to do some self-assessments if they don't have the technical expertise.

A country like India has done self-assessments. So has the United States. They are two countries that I know of. And they were perfectly capable of doing it on their own, but there might be another country that cannot do it, and that's the way technical assistance should go in doing self-assessments.

And what's going to happen in the process is that the countries will themselves understand where they are with their compliance to the codes. In the peer-review process, people understand the problems in that particular country about appropriateness, and the evolution of standards would be a flexible process because then one really understands the conditions on the ground.

It's not possible for the IMF to do ROSCs for all its member countries in the world and provide continuous information. And what I think the IMF should be doing is to act as the central coordinator, a Secretariat like the one at the OECD, where it actually coordinates this entire process of self-assessments with a peer review process.

This would also take care of the problems of resources and also the basis for conflict of interest if the IMF is carrying out the ROSC because the IMF is a creditor. It provides technical assistance to the country, it's providing the surveillance, and it's also providing information to the market, and these are conflicting objectives. So there is this conflict of interest at the IMF of whether it is performing the surveillance function, and I think you could get rid of some of these problems. So that's the first proposal that I'm making in the book, and that is that on the monitoring mechanism, it might be better to move ahead with self-assessment with the peer review process.

Axel Nawrath makes a proposal in the book that self-assessment is the first step. The next step might be that the standard-setting bodies actually do the exercise of the peer review process, and the IMF then acts as the one that collects information and provides the coordinating role or it could be the OECD kind of model where the IMF actually is the main Secretariat for doing something like this, but that's open for discussion.

Now, let's look at what the incentives are for countries complying with standards and codes. And in the case of developing countries, you could talk about self-interest, you could talk about technical assistance, policy advice, loans from the IMF, access to finance or incentives from the markets through information to the market and so forth.

But this incentive structure is a very asymmetric incentive structure when you look at developed and industrialized countries, for the simple reason that in the industrialized countries there has been no recent crisis-therefore self interest is muted. They've all occurred in emerging markets, the industrialized countries don't have that much of foreign exchange risk because they can borrow in their own currencies, which reduces the possibility of crisis, and they don't need technical assistance as an incentive, which is in the case of many of the developing countries that have allowed ROSCs to be conducted.

The industrialized countries do not borrow from the Bretton Woods Institutions, so that also does not work as an incentive. And where the market incentives are concerned, the market is really not interested in what the industrialized countries are doing. Germany did not comply with fiscal transparency at the time of the initiative. The ROSC on fiscal transparency was I think late last year, sometime late last year. And I spoke to Deutsche Bank, and I said, "Don't you factor this in, in your risk assessment?"

They said, "We are not bothered."

So where information on the industrialized countries is concerned, the market tends to ignore that information. So the emphasis that is placed on these codes is also asymmetric in the sense of the incentive structure to this initiative. But then I go back to it, that if the goal is global financial stability, but the incentive structure to comply with the codes is an asymmetric one, then how do you ensure global financial stability.

Now, there are other asymmetries as well: asymmetries in resources, they also introduce problems of disadvantage and competitiveness in the financial sector for developing countries and emerging market economies. Also, there is asymmetry in transparency, that the burden of providing information is on developing countries, but you do not get the same kind of information from the private sector or the industrialized countries.

And I think here the example that I'm giving is that hedge funds don't supply information on their domestic currency holdings of some of the countries, so that the countries cannot anticipate what is going to happen and that this information should be supplied.

Now, yesterday, I spoke in New York on the same topic, and Carl Adams, who is the Executive Director of the eStandards Forum was my discussant. And he turned around and said, yes, I agree that it's asymmetric, i.e., the emphasis on transparency, but actually many people in the private sector also don't want transparency for the simple reasons that they can make profits out of the limited information, which they hold on a country. So they don't think that a transparent world is actually conducive to the private sector because they can't make profits.

So there is no way we can push through for the fact that the private sector would supply information on any of the things which developing countries demand. I just put one example here.

Now, the asymmetry in jurisdiction is something that Mr. Aziz Ali Mohammed is going to cover when he speaks.

Now, I will move on to the next point, and where I say I question whether transparency is a good thing. There are several chapters in the book by people from the private sector who are actually questioning, not whether transparency is good, but whether too much of transparency is a good thing because they think that transparency alone cannot avoid a crisis or contagion.

Now, the SDDS, is one of the major tools of providing transparency. Only 57 out of the 184 IMF member countries subscribing to the SDDS, and this is both because of the weak market response, as well as the weak government response. So there are problems on both sides.

Now, on that issue, what I am looking at is subscription to SDDS and GDDS and FITCH sovereign ratings. Does subscription affect sovereign ratings? The countries in the graph are classified into investment grade and speculator grade. And I'm looking at countries which provide information, which comply with SDDS, the GDDS and those that have neither subscribed to GDDS or SDDS. And what we see is that in both categories, both in the investment grade, as well as the speculative grade, we have those countries that have subscribed neither to GDDS or SDDS. So in actual practice, a country can get a credit rating even if it does not comply with the SDDS and the GDDS.So this whole issue about market discipline, bringing about some kind of a stability does not work as we see it through the ratings picture.

Now, in the same line of argument, the other argument put forth has been that compliance with the codes brings down spreads. There have been a couple of papers from the IMF to that effect. Now, I can't say that this econometric exercise which I've done before coming here is perfect, but once I allow for auto correlation and fixed effects, I find that the SDDS is not significant. And I think that the problem with some of the studies that have been coming out of the IMF is the fact that they do not factor in the information that spreads have been going down for all countries, not just for the countries that comply with the SDDS or the GDDS. The international environment and international liquidity has not been factored in those exercises.

So all I want to say with these little econometric results here is that, even if the model is not perfect, at least with econometrics, you can turn the argument around and get some results. I do not find SDDS significant in bringing down spreads. So, actually, there is no evidence to say that the private sector responds to ROSCs as we've already seen it in the investment grade, and SDDS subscription graph. And with spreads, also, that there's no firm evidence to prove that if a country is compliant to the SDDS that it would bring down spreads.

Now, I will refer to some of the private-sector work in the book. These last two charts were something that are not in the book. That is the new work that I am doing on standards and codes. There is a paper by Metcalfe and Avinash Persaud in the book, and they really question whether information is a good thing. And in their econometrics they find that too much disclosure actually leads to a crisis and contagion, so that too much transparency is not good, as it leads to herding behavior, and compliance with the codes does not bring about reduction in volatility. Briefly, to sum up the private sector view, David Lubin argues that the emphasis should have been on the foreign exchange balance sheet of the country, as the weaknesses in the foreign exchange balance sheet led to the crisis. Standards and Codes is public-sector led initiative, and the private sector is not interested in it.

The view from the credit rating agency has been that standards and codes may--there's no conclusive evidence--affect credit ratings, but there is no evidence on bond spreads.

Now, the other point is that there is no economic proof also that standards and codes are appropriate. There are a number of studies cited in the book that show that we don't have any proof that this really works.

Now, this was meant to be a voluntary process, but recently there seems to be some shift in this perception. For instance, I read a letter written by the Government of Ecuador, requesting for a standby agreement, and it is very clear in that letter that Ecuador had to publish a ROSC in order to be able to get a standby agreement.

There is a May 5, 2003, document on surveillance and those issues, and you have recommendations of the fiscal ROSCs which go into Fund Programs. Ghana's arrangements for a Fund program also include recommendations of financial sector ROSCs, and as in the case of Brazil, corporate governance.

This is what I'm questioning. If the goal is financial sector reforms, then definitely the shortcomings which you find through the ROSCs should be included in the program, but since it is a process and the duration of the program is a short period, standards and codes exercise is a process which lasts many years. Is it appropriate to make it sound like soft conditionality?

And if the objective is financial sector reform, then one should not be providing that information to the market and to the world at-large. Then, the objective should be just the emphasis on financial sector reform. Would the ROSCs actually serve the purpose of contributing to financial sector reform?

And the arguments against conditionality are many. You don't have ownership. You don't know about appropriateness. We haven't talked about transition periods at the time that is needed to implement the standards.

And I'll finally end up with that the goal is global financial stability, and it is going to take years to implement, what are we doing about financial stability in the intervening period? Because this is a process.

Thank you.

SEADE: Thank you very much. Our next speaker will be Aziz Ali Mohammed.

MOHAMMED: Thank you.

The chapter that was assigned to me by Benu was to look at how the standards and codes initiative is being implemented through the Bretton Woods Institutions. That was my limit.

And given the time lags, my material only goes through the end of 2002, and I have been a little concerned whether things have changed very much since I completed my chapter. But looking at material recently, I found that, really, there has been a continuation of the work that the institutions have been doing, but an interesting development that has happened is that both institutions have begun to feel the resource constraint.

My sources indicate that there are to be 24 financial sector assessments, FSAPs they call them, in the coming year. Obviously, I was thinking of 2003. Well, there was a decision made sometime in the spring of 2003 to reduce the number of FSAPs that would be done to 18 instead of 24. And the question that naturally arises in one's mind is that if these institutions, who share equally the budgetary costs of doing FSAPs, feel that a resource constraint is beginning to operate on them, what about the resource constraints on the countries who are the, what should I say, beneficiaries or victims of the process?

The issue that I feel is important to look at is how appropriate is it for the Bretton Woods Institutions to be undertaking this work? And are there particular areas in the initiative which may be even less appropriate than others?

Benu suggested that I mention one particular question, and that is what is the jurisdiction of the World Bank in this area? The World Bank simply has no jurisdiction in its articles of agreement to be dealing with Part 1 countries. And how is this issue financed, if the Bank comes into the picture, in doing either ROSCs or FSAPs in the major industrial countries?

Well, the issue has been financed by essentially putting this as a joint effort so that it doesn't look as if you're only looking at developing countries, emerging market countries, but that the Bank and the Fund are involved in industrial countries as well. And it is under, as it were, the mantle of the IMF's Article IV surveillance process that the World Bank engages in this exercise with the industrial countries. But this is, after all, only a marginal point as far as the appropriateness issue is concerned.

To me, the appropriateness issue goes to three major areas:

Number one, is it reasonable that institutions which are in the lending business that are creditors of many of the countries where they are working, are really able to provide a completely objective monetary function? And it's not clear to me that that has been happening.

Now, the institutions, of course, have something to say on that subject. They say: Look, there are certain areas that the institutions are themselves the standard-setters, and there are certain areas where the institutions are monitors of standards being set elsewhere.

Now, in the areas in which they are standard-setters themselves, and these are areas of data dissemination, areas like transparency in fiscal, monetary and financial matters and, to some extent, the banking supervision area. The Fund, in particular, has been in the business of setting standards even before this particular issue came along. The transparency initiative goes back to 1996, 1997, in the case of the Fund. In certain areas, the World Bank has been serving as the standard-setter--insolvency regimes, creditor rights, for example.

Now, where the Fund and the Bank are standard-setters, they are clearly acting within the jurisdiction laid down by their Executive Boards. And since the developing countries are members of the Executive Boards, clearly, they are having an input into the whole process of setting standards and that this is a good thing that should be happening, that the Developing Country Directors in the Executive Boards are able to put their points across.

But there remains the issue, whether in these areas the institutions really ought to be taking the kind of activist role, a pro-activist role, whether it is the standard-setters or as standard monitors.

The second issue that comes up is what is the cost that is being incurred by the developing countries, and how does that cost compare with the benefits to be obtained? The point that Benu has been making is that it is not clear that there are major benefits being obtained, and therefore the cost-benefit ratio for developing countries is probably not as useful or as favorable to the developing world as the initiative was meant to be, meant to provide.

And the third point, and this is the point where I think the issue of appropriateness comes most closely, most clearly, is the 12th. Initially, there were 11 standards. The 12th standard was the one on anti-money laundering and the combating of the financing of terrorism. And there is a real question whether financial institutions, like the IMF and the World Bank, should be pushing or being pushed into an area which is really quite foreign to their culture, to their ways of operating.

And it is this lack of appropriateness which, in a way, affects thinking in the developing countries about all of the standards and not simply the one that applies to what they call the antimoney laundering and the financing of the--the combating of the financing of terrorism.

And I'd like to leave it at that, that there are issues of appropriateness that are important for the Bretton Woods Institutions to consider, particularly in light of what seems to be a certain lack of interest in the industrial countries and in the markets on the product that has been produced by these institutions.

SEADE: Thank you very much.

We should move immediately to Mr. Dodd for your comments, please.

DODD: Thanks very much.

I had sort of a different line of presentation that I wanted to add because these guys know so much better than I about some of the problems faced and the process of it. I just wanted to make a few other observations that I hope will add some value to the discussion, though.

One is just to identify three or four areas I think where the standards and codes project thing represents a very daunting task. The most obvious to those discussed in Benu's book are, of course, the scope and scale of the enterprise. Not only is it something that's global in scale, but also in terms of scope. Even with only 12 codes, that's still actually quite a bit of terrain to cover if one wants to focus on the concrete, detailed policy rules or guidelines that one wants to discuss.

And as daunting as a task that is, I do think there's some up sides from that, that we also need to keep in mind from a developing country point of view, and that one of the things I've been very concerned about is the way in which some of the major players in the financial markets, the New York-London, for example, financial institutions play sometimes a very pernicious role in developing countries.

I've sat with members of the IMF staff and talked about this, about some of the problems that have emerged in the wake of the East Asian Financial Crisis. And one senior member of PDR told me that, "While I didn't see one sin committed in East Asia, it didn't have its counterparty bank in New York or London," and so I think there are some reasons there for why some guidelines and rules that are consistent across borders might actually play a salutary role. Another daunting task, and one that Benu and Aziz Ali have talked about very well, is some of the difficulty in the process. And the final one, and the one that I wanted to perhaps try to contribute to, is the issue of some sense of both intellectual and economic policy coherence in this process. When I read through the literature and read through some of the debates, there's a certain tendency toward ad hoc rate. I think it's due, in part, to the, as I said earlier, the daunting scope of the enterprise. We're talking about everything from sovereign bankruptcy procedures to regulation of securities markets, antimoney laundering and how to tie all of this together. It's a very difficult task, I grant, but there are some reasons to tie it all together or attempt to because, one, you want to be consistent both across policies and across countries as they're going from developed to developing countries.

Also, in terms of the process, the more coherent it is, the better off we are. I think a lot of us here come from economics backgrounds. And I know from my own background this is not thing that I was really taught. We didn't really study financial economics as a matter of most Ph.D. programs. And so what we did learn as economists was to identify markets, and why should financial markets therefore be different than any other, and identify how, invariably, government regulation messes things up. And so people can go through their whole career explaining how the government is always an inferior, a non-Pareto, optimal situation and that the evaluation of policies is an evaluation of which ones mess it up more or less? The ones that mess it up less are better. This tax is better than that because it's less distortionary.

I think in this enterprise, though, we need to have a better foundation than that. And I think what we need to think about is creating an intellectual framework in which we can identify where markets either fail, where they're imperfect, where they're incomplete, and then ask whether government regulations can, in fact, make the markets better, where the government involvement in setting standards and codes, rules or guidelines, if you will, can actually improve market efficiency as well as stability. And in that regard it really adds some value to the debate and make it more of something that people want to embrace.

And I just don't see that development in the literature, and I apologize if it's there, and I've overlooked it. And I just want to say though that there is some effort toward developing that, but due to disorganization, lack of discipline and having other things to do, I haven't finished it. But I hope to throw it up on my website in the next couple of weeks. It's www.financialpolicy.org.

Let me tell you a little bit of where I think this would go and where this might help. For example, there's a lot of debate over capital requirements, whether Basel II is appropriate or not and whether it's better than Basel I. No one has really come up, as I've seen, with a very good explanation of why we care about capital requirements quite so much. I mean, are these really the principal source for banking sector stability? We haven't really established that point

John Eatwell has argued that they're really not such a great source of a buffer. They really don't function as a buffer. They may function, though, as a governing device to limit risk that has a virtue, but it's not per se a buffer. My other regulatory measures, in fact, would be a better buffer, whether it's deposit requirements, some restrictions on the range of assets they might invest in. There are other measures that might do a better job of ensuring stability than capital requirements. Debate doesn't seem to be occurring. Instead, we're locked into some very technical, tedious, little debates about whether internal risk assessment models are appropriate compared to more rigid ones than we had in Basel I, and that's a good debate, but it's hardly exhaustive, it hardly fully addresses the issue.

Let me suggest, in a very brief few minutes, I have just another way of beginning to think about this. And like I say, I fleshed it out, but due to just laziness and lack of talent, I haven't got it polished yet, but I really hope to make it available very soon.

The first thing I want to think about is identifying some market problems such as the externality of risk. One of the problems that I think underlies financial markets is the social cost of the failure of an institution or a transaction or the broader financial system is often greater than the cost of individuals that are investing. In other words, there's an externality of risk. If I do something, and it blows up in my face, the social costs exceed my cost. What does that mean? Markets don't fully discipline my risk-taking activity.

So, if you can argue that the private costs are less than the social costs, then the private instruments are not going to sufficiently regulate the market, and therefore you need to do what? Come up with a better scheme to try to limit, mitigate and deal with risk protection. One way of doing that, of course, is capital requirements not just for banks, but for broker-dealers, other financial intermediaries, perhaps even people engaging in insurance and derivatives transactions.

But why just look at the institution as a capital requirement? Why don't we really look at the transactions? Why don't we focus as much on the way in which we collateralize loans as much as the bank holds as capital against the risks embedded on their asset side? Why don't we establish collateral requirements not only for securities transactions, but also derivatives transactions?

And so these may be a much better way of governing, if you will, risk-taking activity than what we have sort of fallen into, as the economics profession, of focusing on a couple of little technical debates about Basel II. And so I think capital and collateral requirements are lessons that you can see embedded in the history of, for example, U.S. banking regulation and financial market regulation and how, despite the fact that we've had two economic downturns in the last 14 years, at neither one of them did we have a substantial failure of financial institutions. Enron failed, WorldCom failed, financial institutions didn't fail.

The other thing to think about, as well as externality of risk, is information. There has been a lot of work on asymmetry of information, and that's important, and I think that's an important way in which to motivate a discussion on transparency, but more, as we know, important to markets than symmetry is also just the cost of information. How can all of the market participants be fully informed if the information is costly or just completely unavailable?

And if you look at the history of this country and its financial--of the U.S., I'm sorry, the country where we're sitting--and its financial market regulation, it's been driven very much by disclosure requirements, registration requirements, reporting requirements. This dated information does not come from nowhere. Firms tend to want to hoard information because they have incentives to do so. They must be required to disclose information so all of the market is better informed, and the whole market is therefore more efficient.

So here we see the herding as sort of a market failure that won't get us to the Pareto-optimal situation, and we need uniform disclosure, so it doesn't disadvantage any one person disclosing, but, if you will, disadvantages everyone equally to move on to another level of market efficiency. That's true for the symmetry issues, as well as the cost issues. Sometimes the government just needs to absorb the cost of collecting and disseminating information. It's, by and large, not terribly expensive insofar as a comparison to the potential effects on the market.

In that context, the debate over transparency then can be informed by what sort of valid proprietary information versus what is really needed for the market in order to create more efficient price discovery process.

And so in that context, also, we have prohibitions against fraud and manipulation, things I haven't heard come up in the context of standards and code discussion, but are absolutely critical for maintaining the integrity of these prices that we're going to discover with our hope-to-be-efficient and stable markets. And so we need to have not only reporting, and registration, and disclosure requirements, but we need to have strict prohibitions against fraud and manipulation, otherwise the prices can send off false signals, and this is a big problem.

In the U.S., for example, where it's otherwise somewhat regulated, we have huge, gaping holes in our own markets, which has led to problems with energy price manipulation, amongst other items, through the use of over-the-counter derivatives which are markets in which fraud and manipulation remain legal at this point.

The next thing besides risk and information I want to mention is that some areas of financial markets are natural monopolies. Liquidity tends to gravitate to liquidity. As a result, you generally find that one exchange, one market emerges amongst them all, and it's because of the effective information and the advantages of liquidity that there's natural monopolies being formed.

And when that occurs, the government needs to play a role to make sure that the rules governing that monopoly exchange or market are suitable for the overall economy. And we see the way that's done, for example, again, in the U.S. with our futures exchanges and stock exchanges and how there's regulations governing their disclosure of information and integrity of the participants.

The last thing I want to mention again is this issue of destructive competition--fraud and manipulation, disseminating false information in the marketplace. These are other areas where you can identify places where the market fails with the proper measures by the government standards and codes, if you will, and you can move to a more efficient marketplace.

Let me wrap up by saying that this is just a beginning of a way to think about how we can build our standards and codes on a more coherent, economic foundation and generate more consistent policies that I think will also help inherently protect the interests of developing countries from being, if you will, the victims or somehow the passive recipients of policies designed for other people's self-interests.

Because as I've worked for years in the U.S. trying to shape financial market regulation, I find that far too often, in the absence of a good, honest intellectual discussion on the matter, in which economics can be employed to identify the public interest, and then what happens instead is that the results become just the result of the conflict between private interests, between large-cap firms and high-tech firms, between Wall Street firms and Main Street firms, between, in this case, Wall Street, U.K. firms and developing country financial institutions.

That's not the level on which you want the debate and the conflict to occur. What you need instead is to come up with a better intellectual foundation.

Thank you.

SEADE: Thank you, Randall.

Well, we have had three very exhaustive presentations of issues of importance here. Now on to the questions, please.

QUESTION: First of all, I'm in the Fund, so the polite thing for me to do is not to say anything critical. But in lieu of doing that, I just won't give my name and department, but you'll probably figure out what department I'm from.

I have some problems with both some of the premises that you have and some of the conclusions. First of all, let me start with the last thing, and that is the part about studying the effect of SDDS membership on borrowing rates for countries. You say you have empirical results, and I haven't seen your empirical results, so I can't question those at all. But in my department, there's a paper that's been done, pulled cross-sectional time series data, all of the auto correlation corrections and other corrections you'd like, and it shows very significant results for membership in the SDDS. The SDDS is standards for Special Data Dissemination Standards.

So I would at least urge that, at the very least, that the jury is out on that empirical question. Because that is, you know, getting people to join the SDDS, and that's the major inducement, I mean, that's a vital question. So I think it's important to point out that there still is some question about that at the very least.

The other thing is that, in a sense, when you're talking about self-assessments in lieu of ROSC assessments, I can only speak about this from the data side of the ROSCs. I can't speak about all of the dimensions. But at least officially those ROSCs are voluntary by the countries. Now, there may be some urging and some strong arm twisting, but they're treated as voluntary.

And in the ROSC missions that we do within our department, I think of them as having a high element of self-assessment in it. We go and we work with the countries, and they work with us to make an assessment. We prepare a report. The country reviews the report before it's issued. It's not like an auditor coming in and making an independent report. So I think there's a stronger element of self-assessment in there than what you would say.

In fact, I would even argue that the term "standards and codes" is a little misleading. Because when you think of like international accounting standards or other national accounting standards, those are codified. Those are legal requirements. Those are prescribed for the way that either listed or all companies put together their data.

We are in more of a recommended mode when it comes to what we are doing. We publish lots of methodological guides on balance of payments, government finance, national accounts, monetary statistics. In those guides, you'll find the word "recommended." You'll seldom find where we're telling anybody what to do. So there's a voluntary element to this that comes through in the way I think the process works, and maybe you've recognized that in what you're doing.

The last point I would make is that I think the initial premise about, well, it's a shame that these haven't been done first for the major players in the market--the largest G-10 countries. First of all, these are standards and codes. The assessment of those is an auditing function. Hopefully, the G-10 countries are already doing more of those things than the other countries.

The other element of that is the fact that we all know the contagion effects, and the effects that the weakest players can have on the whole, whether it's in the context of a country or in the context of the international system. So I think there's at least some other side to some of these issues.

SEADE: Thank you very much.

QUESTION: My question relates to one observation made by Benu Schneider, either commenting that this standards and codes evolution is a process, you know, taking a lot of time and all of that.

My understanding is that standards and codes as they are, they have been [?], and then they have been captured, and then they are put in some codes and standards. And the assessment by the Fund or the Bank, it attempts a kind of snapshot picture or a static analysis of complaints or noncomplaints toward externalities complaint or what externalities have not complained. So, at a later stage, a final assessment is there, at that stage, some improvement we may find.

So in what sense do we consider this as a process? That is my question.

SCHNEIDER: I'll take the last question first and then move to the other one.

What I meant was that the implementation of standards and codes is a process, that it takes years to implement some of the codes. So, if it is tied to the period, for instance, of the Fund program, and the program is, let's say, a standby agreement of 1 year or 15 months or 18 months, the program is over, the process of implementation is longer, and the market is trying to assess it almost immediately.

Whereas, if you look, at each code the time required to implement it is of varying degrees. Data dissemination might not take that much time as market integrity, market structure and institution building. They take time. In that sense, I meant that the implementation of standards and codes is a process. It's not something that can happen overnight.

The questions from the Fund or the comments on spreads, and self-assessment, and key players in financial markets, I've read the Fund papers on spreads and the paper you're talking about. And the point that I was trying to make with mine is that I've also taken account into things and countries, and I get different results. Lionel Price has worked on it at Fitch Sovereign Ratings, and he doesn't see the impact on spreads.

And so the question is very much open. What I was trying to say is that we don't have any conclusive evidence that subscribing to the SDDS leads to a lowering of spreads. There's absolutely, I mean, because the paper which you're talking about does not take into consideration countries in the sample that do not subscribe to SDDS, one, and one that spreads were going down generally in that period in which the assessment is being made.

QUESTION: Well, if you say the question is open, then we can agree that there's at least an open question there.

SCHNEIDER: That's what I'm saying. Because I was on the panel with Anne Krueger in Davos, and Anne Krueger made this point that, because I was telling her that the ROSC exercises are really getting muddy in the sense that they're not leading anywhere, and there's room for rationalization, and what one does with this exercise. And her response was that, as long as spreads go down, and we have evidence that spreads are going down, then the exercise is worth it simply from that point of view that spreads go down.

And what I was trying to simply show with that econometric exercise and some of the factors which have not been taken into consideration in your paper, that the jury is still out, the question is still open, we don't have conclusive evidence that subscribing to SDDS leads to a lowering of spreads.

SEADE: I think that's more or less the line that--

QUESTIONER: It's not my paper.

SCHNEIDER: Yes.

QUESTIONER: I used to be a professional econometrician for decades, but it's my colleague's paper.

SCHNEIDER: Yes.

QUESTIONER: So understand I'm not defending my own work.

SCHNEIDER: Then, there is this issue about that the key players in financial markets might be doing their own thing or at least you trust them, that they will be doing something about looking after their issues, and it's the others that you have to worry about.

But if you look at the countries for which some ROSCs are available, for instance, Angola, Tanzania, Uganda, I don't see how anything happening there is going to affect global financial markets, at the moment at least--maybe 10 years from now, when they are participating in global financial markets in a big way--and that is what I meant by there is need for prioritization of key players in financial markets.

COMMENT FROM AUDIENCE: Well, maybe that's right about the small ones. But I mean, when you were talking about the Asian tigers and so forth, I mean, there's a middle range.

SCHNEIDER: I put them into key players in financial markets. There were the G-10 countries, plus the major emerging market economies among the category of key players.

SEADE: Well, thank you very much.

Let me just say a couple of words by way of closing, since I personally also have some involvement in the ROSC process. In the Fund, both in my department, fiscal, but also Fund-wide through a committee we have to oversee the process.

Let me just say that, first of all, I do honestly believe that the process is strongly and sincerely presented by staff as being voluntary. We have a number of countries, a number of regions with a majority of countries which are not very interested in having ROSCs, and you can see that the statistics do not change from year-to-year. If they don't want ROSCs, they don't get ROSCs.

In other regions, we are under pressure to do more than we can, and I appreciate the problem of resources in the countries, but I assure you again, I'll tell you there is also a problem at this end, and we try to respond as best we can. But it's a very popular instrument. Many countries want more of it, like it, and we very much work with them.

So I can identify with the comments made on not only the voluntary nature in an official sense, but the cooperative nature of it. So it's really very much in the spirit of technical assistance, even though it is formally part of the surveillance process, but it is technical assistance which is requested, it's given, and then you work with them.

By the same token, it is not, I mean, I heard a lot of commentary about the standards and codes, and the standard-setters, and the monitors of the standards. There may be some of that in some of the standards. I'm not equally familiar with all of them, but in general terms the flavor is one of recommendations. The standard is really a target right there at the end that no country on earth has reached. So you go and do a ROSC for any country.

I, personally led the one to Germany. I didn't recognize the country that you referred to when you say that something like quite a lot of deficit on the transparency front. It was a remarkably transparent, an incredibly transparent country. Nevertheless, we were quite critical, in some respects, because it's a country full of complexities. It's federal structure and all of that makes some things difficult to understand for themselves. So what good is it to publish if you don't understand what's going on?

So our line of criticism was, in good measure, in terms of clarifying to the public, to the users, having simpler systems of transparencies and in that sense. So we have something to recommend to Germany or to Finland or to the U.S. just as we have something to recommend to Africa or anywhere else in the world.

It's never seen as an examination that you have to pass or fail, in a conceptual sense, but a process in which it is in your interests to move forward, and it is our role to advise on what could be the next steps.

So the key word in all of this is really "priorities," which are the main actions that should be taken, which are the main areas we should be looking at, and how can they move forward? Nevertheless, it is extremely useful to have a book like yours and the presentation that we had today. It certainly puts a spotlight on the areas we have to worry more about, we have to think about. The question of self-assessment can be used, to a greater extent. It's already happening. It's very much in the nature of the beast, but nevertheless that we have to think more carefully how to best balance it against the users of the markets and to observers of the ROSCs, which requires a certain amount of uniformity. So you have different considerations. But these are issues in which we are actively thinking and working, and we will now have the benefit of your book to draw on.

Thank you very much and thanks to everybody.

[Whereupon the proceedings were adjourned]




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