IV. Global Finance and National Law
It is the dichotomy between global financial markets and institutions and national law, policies and regulation that more clearly illustrates the need to internationalise the law of money and finance. Indeed, at the national level, financial law is mostly governed by hard law rather than soft law, which suggests that the real challenge in moving forward in the quest for international law in monetary affairs and financial regulation lies precisely in the resolution of this dichotomy.
In the quest for international law in financial regulation we need a combination of general principles (such as non discrimination and transparency)—which represent a mix of ethics and efficiency that withstand the passage of time—with more prescriptive technical rules that can be adjusted to new circumstances with flexibility. In accordance with the principle of subsidiarity and regulatory competition some global standards may be not only impractical but undesirable. The same may be true for avoiding unnecessary risks inherent to uniform regulation. Yet there are a number of concepts—credibility, confidence, fairness—that should permeate through all the different layers of regulation and influence the behaviour of bankers and financiers. Regulation should be designed in good times, when rapid credit expansion and exuberant optimism cloud the sound exercise of judgment in risk management, rather than in bad times, in response to a crisis. The biblical story of Joseph offers instructive lessons in this regard. We must also remember that markets are part of the solution since it is well functioning markets that generate growth.
It is argued that some aspects of the new lex financiera and the emerging international architecture should be sanctioned by a Treaty. Nothing less than a Treaty is legally binding from a formal point of view. Perhaps the ‘core values’ of non-discrimination and transparency as a prerequisite for both good governance and sound financial regulation, as Christine Kaufmann and Rolf H. Weber point out, and fairness could form the basis of formal international law in the field of money and finance.[1]
Drawing on the lessons of history, it was in the context of World War II that countries were ready to make the sacrifices needed in terms of sovereignty by signing a number of international treaties that gave rise to international organizations such as the United Nations, the International Monetary Fund and the World Bank. John Maynard Keynes had wisely stated that in order to win the war we needed to ‘win the peace’. It was this understanding that also inspired Henry Morgenthau (then US Treasury Secretary) to proclaim in the opening remarks of the Bretton Woods conference in New Hampshire in July 1944 that ‘prosperity like peace is indivisible’.[2] Neither Keynes nor Morgenthau were thinking only in territorial/national terms: they were thinking in international terms. And we also need now to think in international terms to solve some of the problems of our times. Kaufman and Weber point out that ‘sound financial regulation is not an objective in itself but a means to an end’.[1] They recall how Franklin Roosevelt and Winston Churchill agreed in 1941 that stable monetary and financial systems were one of the pillars of the peaceful post-war order.
The dichotomy between global finance and national law is particularly acute in the resolution of cross border banks and systemically important financial institutions (SIFIs). Financial institutions, though global in ambitions and often in international presence, are still subject to the control of national authorities. Banking remains a sensitive sector at the core of a nation’s concerns. Regardless of how much a bank expands internationally, it is still recognized as a legal entity under the domestic laws of the place of incorporation. Constitutional and cultural differences, national habits and, at times, national oligopolies often obstruct international coordination, and may hinder other regional efforts, as evidenced by the EU experience.
The dichotomy between national law and international markets and institutions is particularly relevant in the case of resolution and insolvency. Financial institutions may claim to be global when they are alive; they become national when they are dying. The bankruptcy of Lehman Brothers is a clear example of this dichotomy. If at the national level, bank crisis management is complex (with the involvement of several authorities and the interests of many stakeholders), this complexity is far greater in the case of cross border bank crisis management. In any financial crisis, it is necessary to have a clear and predictable legal framework in place to govern how a financial institution would be reorganized or liquidated in an orderly fashion so as not to undermine financial stability. We do not have such a framework yet with regard to cross-border banks (nor for any cross-border financial institution), neither at the European level nor at the international level, though the recent release by the Financial Stability Board of international standards on effective resolution regimes is a step in the right direction.[4] The capital standards, in particular Basel I, contributed to the international soft law agreement that was then widely implemented in many jurisdictions around the globe. The challenge is now to implement the FSB resolution standards—endorsed by the G20 Heads of State at its summit in Cannes on 4 November 2011—to achieve regulatory and legislative convergence in this key area.[5]
The fear of failure needs to always be present in banking and finance, as Lastra and Wood emphasize.[6] Risk is at the essence of finance and, by definition, risk brings return but risk also entails failure. We need market discipline in regulation, but we also need market discipline in protection. As Lee Buchheit put it in his testimony to the House of Lords in 2009:
The fundamental principle of the capitalist system is that within the constraints of the law, and regulation if it is a regulated entity, every enterprise is free to pursue its affairs as it sees fit. No one guarantees that you will not fail, but by the same token, no one places any artificial constraint on your ability to succeed. The sanction that capitalism imposes on imprudence, incompetence, some times bad luck, is failure. It is the brooding presence of that sanction that keeps managers on their toes, that keeps them acting in a prudent way.[7]
Financial regulation needs to be redesigned to respond to the needs of international financial markets. Global problems—and the crisis was indeed a global problem— require global solutions. The limitations of sovereignty as an organising territorial principle that forms the anchor of the nation state are all too clear when it comes to global finance. And the system of incentives that govern financial institutions must also be redrawn. Capitalism relies on the lure of wealth (privatisation of gains) and the discipline imposed by the fear of bankruptcy (privatisation of losses).
The financial crisis has triggered a revolution in regulatory thinking. For markets to prosper, markets need rules and international financial markets need international rules. We need an effective system for the cross border resolution of banks and other financial institutions, and in order to achieve it, we need international law. The question of who will enforce it remains a daunting challenge, though the IMF is well placed to adopt a role as a ‘global sheriff’ with regard to international financial stability. Sean Hagan reflects in his contribution about the changing and expanding mandate of the Fund as an international financial insti- tution.[8]
The quest for international law in financial regulation does present complex and difficult challenges. But since the world’s economic and financial problems will not solve themselves, we should echo Einstein’s words: ‘We can’t solve problems by using the same kind of thinking we used when we created them’.
- [1] See above n 23.
- [2] See ‘Address by the Honorable Henry Morgenthau, Jr, at the Inaugural Plenary Session 1 July1944,’ in United Nations Monetary and Financial Conference, Bretton Woods, New Hampshire, 1—22July 1944: Final Act and Related Documents (Washington: US Government Printing Office, 1944).
- [3] See above n 23.
- [4] See ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’, Financial Stability Board October 2011,
- [5] Hal S. Scott elaborates upon capital regulation. With regard to cross border resolution of banksand other financial institutions, see generally Rosa M. Lastra, Cross Border Bank Insolvency (Oxford:Oxford University Press, 2011).
- [6] See above n 18.
- [7] See Lee Buchheit, ‘The Future ofEU Financial Regulation and Supervision’ Report of the Houseof Lords’ European Union Committee, June 2009, Vol. II, Evidence, H.R Paper 106-II, p. 5.
- [8] See Sean Hagan in this volume at Chapter 22.
