Financial governance networks

Katharina Pistor

The global financial crisis has exposed fundamental weaknesses in the existing governance regime for global financial markets. Although the crisis is far from over, it is not too early to conceptualise a new governance regime for global finance. The new global governance of financial markets should ensure that individual countries can protect themselves against the negative impact of volatile capital flows, while facilitating a gradual process of re-building a global financial market place that is rooted in effective governance regimes. For this to take place, leaders should:

Establish several Financial Governance Networks (FGNs)
FGNs with different risk profiles should be established that reflect countries’ risk preferences with regard to financial activities conducted on their territory and the ability of institutions in those countries to cope with volatile capital flows (i.e. a country’s risk profile). Geography should not be the defining criteria for membership in a given FGN. The reason for this is that countries within the same geographic region may display very different risk profiles and/or risk preferences. Moreover, geography as the defining factor for governance precludes entry and exit. It also exposes countries to regional contagion effects. Instead, countries should be allowed to enter and exit; and FGNs should be allowed to admit and expel members depending on risk profiles and established standards.

Develop governance principles for regulation
Each FGN should develop governance principles on capital controls, the regulation of financial services as well as instruments that reflect the risk profiles and risk preferences of its members. FGNs will screen their members regularly for compliance with the established standards. Existing international organisations can play an important role in coordinating the establishment of FGNs by developing a first set of minimum standards. They may also help individual countries to meet the risk criteria of their preferred FGN. However, the development of detailed standards and their adaptation over time should be in the hands of FGNs and their members. This will facilitate information sharing and learning among FGN members and reduce problems associated with standardising on a single, but potentially flawed, model.

Set up an FGN arbitration tribunal
A tribunal should be established to resolve disputes between members and FGNs over entry and compliance with FGN criteria.

Institute a global risk monitoring board
This board, staffed with independent experts should be tasked with monitoring systemic risk in global financial markets and the exposure of different FGNs to such risk. The board should report on a regular basis and publish its reports. The global monitoring board should make recommendations for adjusting insurance premia of FGNs in accordance with changing risk patterns. (See below).

Create a global insurance fund
The purpose of the fund would be to cope with future crises. Each country will pay an annual premium based on the risk profile of the FGN it belongs to and weighted by the size of that country’s economy. The requirement to insure against additional risk would mitigate against a race to the bottom as a result of regulatory competition among FGNs. The fund should be able to adjust risk premia based on the recommendations of the global risk monitoring board.

These measures would bring about a shift from centralised governance by international organisations, such as Bank for International Settlements and the IMF, to multiple, decentralised, yet inter-linked, governance networks. Centralisation precludes inclusiveness in the formulation of governance standards. This is due to coordination problems among large numbers of countries and the tendency of more powerful players to dominate the process as well as outcomes.

Katharina Pistor is professor of law at Columbia University