Stefano Pagliano: "A Global Financial Governance?"
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A presentation held by PhD Stefano Pagliari, Departement of International Politics, City University London, at the high level seminar "Towards a sustainable financial system", hosted by the Stockholm based think tank Global Challenge in cooperation with London School of Economics and Swedish House of Finance on September 12th 2013.
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Stefano Pagliano: "A Global Financial Governance?"
- 1. Regulating Finance in the Public Interest Regulatory Capture and Mitigating Strategies Dr. Stefano Pagliari Stefano.Pagliari.1@City.ac.uk
- 2. “Is it possible at all to create an international regime that prevents regulatory capture?” George Stigler (1971) & the motor trucking industry Mattli and Woods (2009): capture as “the control of the regulatory process by those whom it is supposed to regulate or by a narrow subset of those affected by regulation, with the consequence that regulatory outcomes favor the narrow `few’ at the expense of society as a whole” Material incentives vs. ideas (cognitive capture) Popular concept to explain flaws in rule-making, implementation, supervision but weak empirical standards
- 3. When is Regulatory Capture More Likely to Occur? 3 Factors Demand: Balance of Stakeholders
- 4. When is Regulatory Capture More Likely to Occur? 3 Factors Demand: Balance of Stakeholders Supply: Institutional Design of Regulatory Agencies
- 5. When is Regulatory Capture More Likely to Occur? 3 Factors Demand: Balance of Stakeholders Supply: Institutional Design of Regulatory Agencies The Broader Political- Economic context
- 6. Asymmetry among stakeholders competing for regulatory influence Financial Resources Technical Expertise and Information Asymmetries Collective Action Problems for deposit holders, investors, and consumers Congressional Lobbying from Securities Firms (Data” Centre for Responsive Politics) $0 $20,000,000 $40,000,000 $60,000,000 $80,000,000 $100,000,000 $120,000,000 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 $1.4 million spent daily by financial industry lobbies during the financial crisis to lobby Congress Demand Side: Balance of Stakeholders
- 7. Balance of stakeholders Heavy bias towards business Since the crisis: Greater diversity of stakeholders Greater diversity within the business community Source: Pagliari and Young 2013 Pre- Crisis Post- Crisis % Difference Finance (target) 75.1% 60.3% -19.8% Non-financial business groups 16.4% 24.2% +47.5% NGOs / Cons. / Trade Unions / Research 8.4% 15.5% +83.8% USA EU UK Financial business groups 66.6% 70,6% 59.6% Non-financial business groups 23.2% 18.9% 28.1% NGOs / Cons. / Trade Unions / Research 10.2% 10.5% 12.2% CRD IV (2010) Banks 43.7% Non-bank financial groups 33% Non-financial business groups 19.6% NGOs / Cons. / Trade Unions / Research 3.6%
- 8. Balance of stakeholders Heavy bias towards business Since the crisis: Greater diversity of stakeholders Greater diversity within the business community Differences between rule- making and implementation
- 9. Supply Side: Institutional Design of Reg. Agencies Formal Independence Consultative Processes Transparency
- 10. Supply Side: Institutional Design of Reg. Agencies Mandate Funding Hiring (Revolving Doors) Inter-temporal conflict of interests Preferential Access & Inside Knowledge Socialization, Psychological Biases, & intellectual capture US vs. Europe SEC Staff Shares traded in US 1939 1,700 260 mln 2001 2,900 2 bln. 2009 3,584 5.4 bln.
- 11. The Broader Economic and Political Context Capture through the political process Electoral weight of Financial industry Finance and the Real economy Banks as primary sovereign-debt holders Cyclical Nature of Capture SlumpSlump Crisis Crisis Boom Boom Pressures on regulators not to „remove the punchbowl from the party‟ Electoral pressures to re- regulate Pressures on regulators not to forestall economic recovery
- 12. What can we do about it? Paradox of financial regulation: Interaction between regulators and regulated firms… … is necessary to design regulatory policies … open the policymaking process to the risk of regulatory capture Some degree of regulatory capture is inevitable Channel participation of stakeholders through safeguards & mitigating strategies
- 13. 1. Promoting Greater Balance & Diversity of Stakeholders Breaking up large banks (Johnson) Creation of Participatory Mechanisms: “fair, transparent, accessible, open” (Mattli & Woods) Tripartitism Proxy Advocates (Consumer Panels; Finance Watch) Altering incentives of financial firms lobbying E.g. Insurance industry and car safety standards Promoting long-termism and diversity within financial industry (compensation rules, fiduciary duties of boards, whistleblowers)
- 14. 2. Getting the institutional design right Mandate: danger of conflicting/ambiguous mandates Internal decision-making processes Rotation requirements, internal audit, devils‟ advocates; IMF‟s IEO: „strengthen the incentives to “speak truth to power”‟ and „create internal advisory boards „to challenge and think the unthinkable‟
- 15. 2. Getting the institutional design right Hiring practices: Mitigating strategies: e.g. disclosure, cooling off periods, complement “revolvers” and career supervisors Promote diversity of experiences and training (e.g. IMF) Funding Level Sources (government vs. levies from fin. industry)
- 16. Limits of existing checks Board of Directors; Parliament; Press. Transparency Sunshine clauses requiring US regulators to publish details of meeting with industry representatives 3. External Checks & Balances
- 17. Public Interest Review Bodies “The Sentinel” (Barth Caprio and Levine 2012) Reciprocal oversight from other domestic regulators Macroprudential regulators; Consumer protection bodies; Reciprocal oversight from foreign regulators Financial Stability Board‟s peer review, Colleges of Supervisors, IMF‟s surveillance (FSAP and ROSC) 3. External Checks & Balances
- 18. Conclusion Paradox of financial regulation: Interaction between regulators and regulated firms/stakeholders…. … is necessary to design regulatory policies … open the policymaking process to the risk of regulatory capture Some degree of capture is inevitable Channel participation of stakeholders through safeguards & mitigating strategies Thank you for your attention
Editor's Notes
- We have gone through the most extensive redesign of regulatory policies since the 1930s. We have expanded the perimeter of regulation to incorporate markets and institutiosn that were left outside. We have revised existing standards. Created new regulatory institutions.HOWEVER, not much discussion of what could be done to improve the regulatory process.Finanical regulation fails for a number of reasons:CasualiityIncompetence on the part of regulatorsDynamism of financial marketsPrivate interestsIn my presentation I’m taking the challenge to address one of the questions that was posed in the panel description: “Is it possible at all to create an international regime that prevents regulatory capture?” Origin of the concept:Concept is used frequently but in many different forms - to explain too much regulation, lack of regulation, or the wrong kind of regulation - different phases of the regulatory process (rule-making, supervision, enforcement and implementation)Little consensus regarding the extent of the problem and its causesHow do we prove the presence of capture? Where does the public interest resides in the presence of competing objectives (e.g. stability vs. growth)?When is a policy shift the result of the action of special interests?More groups or actors are capable to exercise an influence that knocks the regulator off its original balance (e.g. large consumers; electorally-driven politicians)Regulatory and supervisory process based on close and continuous interaction between regulators and regulated firms required to” to stay abreast of rapidly changing financial markets, to monitor the build-up of risks, to understand the impact of their regulatory policies. Proximity opens the regulatory process to the risk of unduly favoring narrow industry interests at the expense of the publicIncentivesInformationIdeas (socialization)PROBLEM OF EMPIRICAL EVIDENCEProblem of Empirical Evidence: “analysts have often inferred capture from episodes in which regulators partially relyupon firms, from patterns of regulatory advantage granted to certain groups, or simply ‘on the basis of observations of undesired regulatory outcomes, even though those outcomes might be caused by a number of things besides capture such as ‘regulators’ incompetence, inefficiency, or randomness’ (Carpenter and Moss)
- Money: More relevant in the US than in Europe; More relevant vis-à-vis politicians than regulatorsInformationlimited engagement of deposit holders, investors, consumers of financial services
- (endency to aggregate figures regarding the participation of different financial interest groups and the money spent by these groups to lobby policymakers often masks the fact that the interests and demands of different financial groups frequently diverge)debates surrounding financial regulatory policies do not always present the sort of frontal and asymmetrical clash between competing producers’ and consumers’ interests described by some regulatory capture theorists
- (endency to aggregate figures regarding the participation of different financial interest groups and the money spent by these groups to lobby policymakers often masks the fact that the interests and demands of different financial groups frequently diverge)debates surrounding financial regulatory policies do not always present the sort of frontal and asymmetrical clash between competing producers’ and consumers’ interests described by some regulatory capture theorists
- While the delegation of regulatory functions to independent agencies has been an attempt to protect the regulatory process from short-term pressures of politically influential stakeholders, the institutional design of independent regulatory agencies may still tilt the playing field in favour of certain stakeholders.
- While the delegation of regulatory functions to independent agencies has been an attempt to protect the regulatory process from short-term pressures of politically influential stakeholders, the institutional design of independent regulatory agencies may still tilt the playing field in favour of certain stakeholders. FUNDINGForinstance, while from 1939–2009 the number of SEC employees haslittle more than doubled, the number of shares trading hands each day in the US has increased more than twenty times.126 Also, therecent investigation in the UK into the failure of the Royal Bank of Scotland has raised concerns regarding the inadequacy of thefunding of regulatory agencies, as the task of supervising a bank with a presence in over 50 countries and employing 226,400 peoplewas fulfilled at the beginning of the crisis by a team comprising onlyfour-and-a-half membersINTELLECTUAL CAPTURE:Lord Turner talksed about Capture through the intellectural zeitgeistAccording to Kwak, thepotential for this sort of capture increases with the complexity of theproblem: ‘faced with uncertainty deciding between competingtheories of the world and the public interest, people are more likely to fall back on the signals communicated by identity, status, orrelationships’.
- Finally, while the different faces of capture described above pertain to the interaction between regulators and the regulated firms, different commentators have broadened this analysis to account for the role of the politicians, governments and legislative bodies who define the responsibilities that independent regulatory agencies need to follow and grant them the resources and powers to perform these tasks. n particular, in those circumstances where an apparent trade-off exists between the mandate of regulatory agencies to bolster financial stability and the goal of promoting economic growth (such as in defining appropriate capital requirements for banking institutions), then political incumbents as well as a number of societal stakeholders are more likely to support financial industry groups in demanding a watering down of the regulatory measures introduced in the middle of the crisis.68
- Carpenter and Moss: ‘all too often, observers of regulation are quicker to yelp about capture than to think hard about how it might be prevented or mitigated. Analyses stop at diagnosis without venturing to the matter of cure.’
- Important to reduce the risks that regulators find themselves exposed to one-sided evidence from the regulated financial industry. Limit the risk of groupthink and intellectual capture Competition among groups is beneficialLower risk of intellectual capture and groupthinParticipatory mechanismspublic consultationsby themselves are unlikely to be sufficient to ensure that a plurality ofstakeholders will be capable of having their share of the input into theregulatory processa highlytechnical area such as financial regulation, the financial industrygroups with the greatest technical expertise continue to be bestpositioned to take advantage of these mechanismsTripartitisme.g. regulatory agencies granting access to the information available to them (e.g. internal data and analysis) in order to compensate the information advantage of industry insiders‘form of affirmative action’ on the part of regulators to strengthen thevoice of those real economy interests whose representation is morefragmentedTripartitism & Proxy AdvocatesGranting less-funded groups full access to the data and analyses of regulators and privileged position at the negotiating tableSubsiding the creation of “public interest” voices (e.g. creation of Finance Watch by the European Parliament)Creating directroutes for designated consumer groups to present complaints towhich regulators need to respond within a defined timeframeProxy Advocatescapacity of these bodies to truly represent consumerperspectives in the regulatory process is constrained by differentfactors such a limit to the resources allocated to such bodies, as wellas their location within the organizationPROBLEM OF THESE STRATEGIESWhile the strategies described above seek to mitigate capture byincreasing the capacity of consumers of financial services and othernon-financial parties to act as counterweights to the producers’interests, this strategy is less applicable to the case of those marketswhere the counterparties are not retail consumers but rather otherfinancial groups, such as in the case of wholesale markets.
- Important to reduce the risks that regulators find themselves exposed to one-sided evidence from the regulated financial industry. Limit the risk of groupthink and intellectual capture Independence is a pre-requisite but not enoughMANDATEit is likely that ‘industry pressure anda focus on short-term economic concerns that are easily monitoredwill trump the long-term effects on the public that are harder toassess’.95Hiring Practices - Two competing views
- Important to reduce the risks that regulators find themselves exposed to one-sided evidence from the regulated financial industry. Limit the risk of groupthink and intellectual capture Independence is a pre-requisite but not enoughMANDATEit is likely that ‘industry pressure anda focus on short-term economic concerns that are easily monitoredwill trump the long-term effects on the public that are harder toassess’.95Hiring Practices - Two competing views
- Important to reduce the risks that regulators find themselves exposed to one-sided evidence from the regulated financial industry. Limit the risk of groupthink and intellectual captureSENTINEL-, Barth, Caprio, and Levine have called for the creation ofan independent institution called the “Sentinel” whose unique powerwould be to acquire information required to assess financialregulation and to provide an expert and independent assessment offinancial policies, thus allowing an informed debate Problems:Where do we finance these bodies?To Whatextent the highly political task of actually defining “public interest” ona given regulatory issue can be ‘entrusted to a group of disinterested“wise men”’.
- Important to reduce the risks that regulators find themselves exposed to one-sided evidence from the regulated financial industry. Limit the risk of groupthink and intellectual captureSENTINEL-, Barth, Caprio, and Levine have called for the creation ofan independent institution called the “Sentinel” whose unique powerwould be to acquire information required to assess financialregulation and to provide an expert and independent assessment offinancial policies, thus allowing an informed debate Problems:Where do we finance these bodies?To Whatextent the highly political task of actually defining “public interest” ona given regulatory issue can be ‘entrusted to a group of disinterested“wise men”’.
- Carpenter and Moss: ‘all too often, observers of regulation are quicker to yelp about capture than to think hard about how it might be prevented or mitigated. Analyses stop at diagnosis without venturing to the matter of cure.’