ECB Official Says Systemic Risk Regulation Must be Cross-Border

Noting that the financial crisis has shaken markets to their foundations and revealed gaps in risk management and the geographical reach of regulation, an Austrian Member of the European Central Bank called for cross-border systemic risk regulation in order to prevent regulatory arbitrage. In remarks to a panel at the German Office of the European Commission, Executive Board Member Gertrude Tumpel-Gugerell also reaffirmed the ECB’s belief that legislation implementing systemic risk regulation must include all systemically important institutions and markets, including hedge funds, credit rating agencies and OTC derivatives markets. Recently, ECB President Jean-Claude Trichet called for the regulation of hedge funds, OTC derivatives, and credit rating agencies since they can pose a systemic risk to the markets.

Recently the G-20 called for international cooperation and consistency as part of the reform of financial regulation, she noted, and the recommendation of the De Larosière Report for a globally coordinated legislative response to the financial crisis was endorsed by the European Commission. In the area of macro-prudential systemic risk regulation, the De Larosière Report urged the creation of a European Systemic Risk Council to be established under the auspices of the ECB.

The financial markets are inexorably globally integrated, reminded the central banker, and financial stability must be cross-border in order to ameliorate systemic risk and prevent regulatory arbitrage. Thus, reform legislation must provide for the global monitoring of system stability and the regulation of cross-border systemically important institutions. For the proper regulation of cross-border institutions that can impact systemic risk, she continued, there must be strong international cooperation and clear rules. For the global monitoring of systemic risks, the ECB official envisions close cooperation between the International Monetary Fund and the Financial Stability Board in the conduct of early warning exercises.

At a minimum, she emphasized that a coordinated EU solution must be found for the supervision of cross-border financial institutions and the monitoring of systemic risks. In order to augment this effort, she strongly urged the creation of the European Systemic Risk Council recommended by the De Larosière Report.

The Rick Council could improve the identification and assessment of systemic risks affecting the EU financial system by analyzing the interconnections among financial institutions and markets on the basis of both macro and micro-prudential regulatory information. The provision of the logistical and analytical support to the Council by the ECB would allow existing knowledge and skills in financial stability analysis to be exploited. The views of the regulators could be integrated in the process by ensuring their adequate representation on the Risk Council.

In her view, the success of the Risk Council would be conditioned on a number of factors. For example, the body’s effectiveness would crucially depend on the access of the central bank to relevant information for risk assessment and the monitoring of vulnerabilities in the financial system. Similarly, the Risk Council would need to rely on effective institutional mechanisms ensuring adequate information-sharing with micro-prudential regulators.

Also, risk warnings would have to be effectively translated into concrete recommendations on macro-prudential policies requiring follow-up actions by competent authorities. This would, in turn, require adequate mechanisms for monitoring and enforcement. Any recommendations from the Risk Council should concern mainly financial regulatory action and should not address either monetary or fiscal policy. Finally, the global dimension of the financial system calls for swift and comprehensive coordination between the Risk Council and the Financial Stability Board.