Financial Associations Urge Reforms to Reverse Rising Regulatory Fragmentation
Commentary by Sebastian Souchet
Global financial market associations ("Associations") warned that rising regulatory fragmentation is threatening the global financial system. In a joint report, the Associations urged the Financial Stability Board, the Basel Committee on Banking Supervision and IOSCO to renew their commitment to reducing fragmentation and improve coordination of global financial standards.
In the report, the Associations, including the Bank Policy Institute, the Global Financial Markets Association, the Association for Financial Markets in Europe, SIFMA and the Institute of International Finance, argued that fragmentation is undermining the progress made since the 2008 financial crisis and is creating new risks by restricting the ability of globally active banks to move capital and liquidity across borders. They emphasized that this trend could (i) reverse gains in financial stability, (ii) weaken crisis response capabilities and (iii) introduce substantial costs to market participants and end-users. The associations highlighted that fragmentation—caused by a proliferation of localization policies, excessive regulatory divergence and misaligned implementation of international standards—can trap risk and capital within national borders, making financial systems more brittle.
To address these risks, the Associations:
- called on the IMF, FSB and BCBS to survey and evaluate all policies that lead to forced subsidiarization and assess their impact on global financial stability.
- urged jurisdictions with ring-fencing mandates to reconsider whether those policies remain fit-for-purpose given the evolution of global resolution planning frameworks.
- recommended that international standard setters jointly work with the financial industry to mitigate fragmentation in capital, liquidity and resolution policies.
- called for enhanced "home-host cooperation" to support efficient and prudent allocation of resources within banking groups.
- recommended that the FSB re-evaluate whether supervisory colleges and crisis management groups are functioning as intended, particularly regarding the geographic compartmentalization of Total Loss-Absorbing Capacity within global banks.
The Associations proposed a new global framework consisting of three phases: rulemaking, monitoring and review. During the first phase, they proposed that international standard setters engage with industry stakeholders early, consider regional specificities and avoid a one-size-fits-all "gold standard" approach. The Associations recommended that cost-benefit analyses and impact assessments—including effects on competition and growth—be conducted and published in all cases. During the monitoring phase, the Associations proposed that peer review processes incorporate a holistic view of national implementation that recognizes functionally equivalent local rules. In the review phase, the Associations urged standard setters to create a systematic feedback loop, allowing lessons learned from implementation and market developments to prompt timely amendments to standards.
Commentary
One area where fragmentation is of particular concern is regulatory capital. Material jurisdictional variations in regulatory capital requirements have the potential to lead to a "race to the bottom" on capital, which in turn would have serious consequences for financial stability and systemic risk. Jurisdictional differences in capital regulation can also lead to increased compliance costs for firms to the extent that such regulatory differences across jurisdictions necessitate distinct operational buildouts.
By contrast, consider recent comments from Deputy Secretary of the US Treasury Michael Faulkender suggesting that US prudential regulators should ensure that capital regulations are "Americanize[d]." Vice Chair Bowman also previously emphasized the need for policymakers to consider "international comparability and competitive disadvantages" regarding implementation of international standards, such as the Basel III framework. Notably, and notwithstanding Mr. Faulkender's comments, in a recent proposal to reform the enhanced supplementary leverage ratio, US prudential regulators' emphasized the value of international alignment on prudential standards to "limit[] the potential for a global 'race to the bottom'."