G-20 Calls for Broad Financial Regulatory Reform; Exec Comp Overhaul and Regulation of OTC Derivatives

In the final communiqué from their Pittsburgh summit, the G-20 leaders called for the sweeping reform of global financial regulation, including strengthening prudential oversight, improving risk management, enhancing transparency, promoting market integrity, establishing supervisory colleges, and reinforcing international cooperation. The G-20 endorsed tougher regulation of over-the-counter derivatives, securitization markets, credit rating agencies, and hedge funds. The G-20 also endorsed the institutional strengthening of the Financial Stability Board as it assumes its role of coordinating the international consistency of financial regulation. The G-20 said that the FSB’s ongoing efforts to monitor progress will be essential to the full and consistent implementation of needed reforms.

Noting that excessive compensation has encouraged excessive risk taking, the G-20 called for the reform of compensation policies as an essential part of increasing financial stability. They endorsed the FSB standards aimed at aligning compensation with long-term value creation, not excessive risk-taking, by avoiding multi-year guaranteed bonuses and by requiring a significant portion of variable compensation to be deferred, tied to performance and subject to appropriate clawback. Variable compensation could be in the form of stock or stock-like instruments, said the G-20, so long as equity compensation creates incentives aligned with long-term value creation and the time horizon of risk.

It is also important to assure that compensation for senior executives and other employees having a material impact on the firm’s risk exposure is aligned with performance and risk. This should be done by making firms’ compensation policies and structures transparent through disclosure requirements and limiting variable compensation as a percentage of total net revenues when it is inconsistent with the maintenance of a sound capital base. Corporate governance reforms are also critical, emphasized the G-20, especially the need to ensure the independent oversight of board compensation committees.

For their part, regulators should review compensation policies with institutional and systemic risk in mind and, if necessary in order to offset additional risks, apply corrective measures, such as higher capital requirements, to those firms that fail to implement sound compensation policies. Regulators should be authorized to modify compensation structures in the case of firms that fail or require extraordinary public intervention. The FSB is tasked with monitoring the implementation of compensation standards.

The G-20 supports legislation requiring all standardized OTC derivative to be traded on exchanges or electronic trading platforms and cleared through central counterparties. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements. Again, the FSB should assess implementation and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse.

Systemically important financial firms should develop internationally-consistent firm-specific contingency and resolution plans. There should be legislation creating a legal cross-border framework for crisis intervention as well as improving information sharing in times of stress; and developing a framework for the effective resolution of financial groups to help mitigate the disruption of financial institution failures and reduce moral hazard in the future. The FSB should propose measures, including more intensive supervision and specific additional capital, liquidity, and other prudential requirements.

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