V. Soft Law Versus Hard Law
The reliance on soft law and soft institutions to govern international money and finance is in stark contrast to the law and institutional framework that govern international trade. As explained in the Introduction, when it comes to monetary and financial issues, we have a black hole in terms of ‘hard’ international law. We do have a large number of international soft law rules, but little hard law. The corpus of international monetary and financial law has been heavily reliant upon soft law, with the one relevant exception of the law of the IMF, in particular the
Articles of Agreement of the International Monetary Fund. The regulatory function at the international level is shared by a variety of actors, including informal groupings of an international character such as the Financial Stability Board, the Basel Committee on Banking Supervision, the International Organization of Securities Commissions (IOSCO) and the International Association of Insurance Supervisors (IAIS), professional associations—such as the International Swaps and Derivatives Association (ISDA)—and other entities. International financial soft law is often a ‘top-down’ phenomenon with a two-layer implementation scheme. The rules are agreed by international financial standard setters and national authorities must implement them in their regulation of the financial industry. The financial intermediaries are the ‘final’ addresses of those rules. Standards and uniform rules, however, can also be designed by the financial industry itself. Self-regulation, by definition, has a ‘bottom-up’ character, comprising rules of practice, standards, master agreements, usages as well as rules and principles agreed or proposed by scholars and experts.
The lack of formal commitments and formal rules works well in good times, but not in a crisis. In the words of Chris Brummer, ‘the predominance of international soft law in finance does not, however, imply its perfection’. What is needed in a crisis is certainty, clarity, predictability and ex ante knowledge as to the loci of power and the rules and processes that must be followed. This typically requires hard law, not soft law, as well as an adequate institutional framework.
Chris Brummer and Joseph Norton elaborate upon the issues of legitimacy and representation in the international financial law making process. While soft law is harder in practice and more influential than generally assumed, Brummer calls for more robust monitoring of regulatory rules oversight. The increasingly important role of the G20 and the mandate of the Financial Stability Board ought to be examined under the prism ofgreater legitimacy and fairer representation, including emerging economies and developing countries in such process. Norton’s paper extrapolates lessons from the regulation of sovereign wealth funds and suggests the need for new procedures and processes in international financial regulation.
Whether we need a new institutional structure or a revamping of the current structure with a new mandate focused on financial stability issues remains an issue ofintense debate. Indeed while some think the IMF should assume a leading role in the international financial architecture, i.e. reform of the current system, as advocated by the IMF General Counsel, others would prefer a new structure, gravitating around the FSB and the G20. What ever the solution, the current soft law approach is no longer suitable to produce the public goods of financial stability, trust and market integration. A bolder approach is called for.
The move towards formalization of law (from informal to formal law) is a perennial trait in the history of law. The evolution of international law and of commercial law, to cite two relevant examples, provides clear evidence in this regard. The primary sources of international law are conventional law (treaty law), customary law and the general principles of law, as recognised by Article 38 of the Statute of the International Court of Justice. Customary international law results when states follow certain practices generally and consistently. Customary law, however, can evolve into conventional law. Indeed, important principles of customary international law have become codified in the Vienna Convention of the Law of the Treaties, thus acquiring the characteristic of ‘conventional law’. The birth and development of formal commercial law was influenced by the medieval lex mercatoria, that is by the mercantile codes and customs which reflected the usages of trade, the international maritime and commercial practice at the time. Many of the uncodified usages of trade that constituted the lex mercatoria eventually became formal law.
Financial and monetary law being a relatively novel subject compared with other more established areas of law is navigating towards greater formalisation. The crisis has accelerated that trend and the emerging lex financiera is international in character.
John Maynard Keynes in the debate that led to the establishment of the International Monetary Fund famously stated: ‘Perhaps the most difficult question is how much to decide by rule and how much by discretion’. That challenge remains in the current process of internationalization of the law of money and finance. The rules versus discretion debate that has dominated monetary policy and administrative law for so many decades finds a new dimension when it comes to the understanding of this emerging lex financiera.
To begin, it is important to realise that rules and discretion are not mutually exclusive, since rules may grant discretion (for example a rule on monetary or supervisory independence grants a degree of discretion to the central bank in the pursuit of its tasks). Also, it is not a matter of fundamental difference between hard and soft law. While soft law rules tend to allow for a greater margin for discretion and offer a higher degree of flexibility and pragmatism than hard law rules, they may also entail rigid standards (such as Basel III), as formal, hard law may grant extensive discretion in operation and implementation. It is rather a divide between a rule-based or rule-oriented approach and a policy-based approach. The discretionary, policy-based powers granted to central banks have been a defining feature of the financial crisis. It is the prompt and immediate nature ofthe assistance provided by central banks that makes them uniquely capable of managing a crisis. However, that very discretion granted to central bankers in the exercise of their lender of last resort role is now being increasingly curtailed after the crisis. For example, the
Dodd—Frank Act 2010 restricts the room for manoeuvre of the Federal Reserve System in the interpretation of Section 13.3 of the Federal Reserve Act, the arcane legal provision that provided the legal basis for the emergency liquidity assistance and rescue packages that the Fed helped put together.
Yet, there is no fundamental divide between a rule-based or a rule-oriented approach and discretion. The latter often is part of the law, and depends upon regulatory density chosen. The law readily modulated rules and discretion as appropriate to take into account the relevant circumstances which often cannot be foreseen and remain unpredictable. A fundamental divide rather exists between a rule-based approach and those voices arguing the matter should be left to markets and government intervention be limited to discretionary policies. We submit that a rule-based approach establishes a proper framework within which discretion may be exercised to a certain extent. The law shapes the scope of policy space available. This is true both for financial and for monetary affairs. Both can and need to be addressed in international law. Both may be inspired by the idea of providing an appropriate regulatory framework for competition. Again, it is not a matter of wholesale harmonization, but of asking which elements inherently need common denominators in order to provide a proper framework for competition.
As to financial regulation, it is not a matter of proposing single and uniform harmonised rules across the board. It is rather a matter of defining those elements which are necessary to bring about and allow proper regulatory competition between different systems, as Tietje and Lehman argue.
Decentralization should take place to the utmost extent possible in order to avoid undue risks of policy failures. At the same time, it is a matter of identifying inherently common rules which in a global system should be shared. Minimal capital requirements for large operators, for example, are indispensable parameters for competition. Other inherently shared elements entail common prudential standards currently entailed in Basel II and III and additional disciplines on disclosure and transparency as Scott argues. It calls for future principles of taxation of capital flows in international law, such as a Tobin tax discussed by Kern Alexander. Common rules relating to the problem of moral hazard and the Too Big To Fail problem and its variants (too interconnected to fail, too complex to fail, etc.) equally need to be addressed on a global level. While competition law and policy, as it currently stands, was of little importance in addressing the financial crisis according to Philip Marsden and Ioannis Kokkoris, the underlying ideas could well be put to work to develop specific rules on merger controls for international banking and financial corporations. Finally, and not particularly addressed in this volume is the need to develop shared rules and principles on international bankruptcy relating to financial institutions, as mentioned above when referring to the FSB Key Attributes of Effective Resolution Regimes.
Competition law and policy could also inspire future rules addressing the relationship of different currency regimes. We submit with Baltensperger and Cottier that international monetary law should be inspired by disciplines of competition law as national currencies find themselves in a competitive relationship. Moreover, they amount to monopolies which may be abused and therefore call for an appropriate regulatory framework. It is doubtful that this can be achieved on the basis of soft law. Both competition law and international trade regulation rely upon hard law in addressing monopolies both in domestic and international law.
The shift towards a greater role for hard law will not remain without an impact on treaty-making powers. The chapter by Baltensperger and Cottier further argues that the lack of independent treaty making powers by central banks is one of the main reasons for recourse to soft law.44 The enhanced role of central banks in the current debt crisis beyond traditional tasks, including oversight over financial sector in a number of countries such as UK, calls for enlarged accountability which may need translation into more formal international commitments. To the extent that independence of central banks and lenders of last resort should be combined with hard law, we need to review current treaty making powers. New avenues need to be sought for central banks which combine independence and new formal treaty making powers. National statutes establishing independence reserve institutions should explicitly define and limit the scope of powers and tasks that the institution is entitled to engage in international treaties. It should be commensurable to domestic regulatory powers assigned. Such parallelism will allow centrals bank to engage in international agreements which form part of international law and could be made subject to international adjudication and enforcement. Moreover, transparency requirements in terms of formal and informal consultations made prior to setting policies and engaging in international commitments should be established. International Agreements transgressing these goals should remain with the Government and democratic processes of accountability. The allocation of powers in financial and monetary affairs between government, parliament and central banks will amount to one of the most important challenges in coming years. Lessons may be learned from other areas of international law and relations, in particular trade regulation.
-  See Chris Brummer in this volume at Chapter 5.
-  Ibid.
-  See Joseph J. Norton in this volume at Chapter 6.
-  See above n 33.
-  Sir Roy Goode recalls in his writings that the lex mercatoria or law merchant (which wasinternational rather than English and which was administered by its own mercantile courts) wasgiven full recognition by the common law courts (absorbed in the common law itself). The fertility ofthe business mind and the fact that a practice which begins life by having no legal force acquires overtime the sanctity of law are key factors to which the commercial and financial lawyer must continuallybe responsive.
-  John Maynard Keynes, ‘Proposals for an International Currency (Clearing) Union’, 1942.
-  See above n 4.
-  See Hal S. Scott in this volume at Chapter 12.
-  See Kern Alexander in this volume at Chapter 19.
-  See Philip Marsden and Ioannis Kokkoris in this volume at Chapter 18.