Regulating the Financial Markets: Lessons, Challenges, and Prospects in the Aftermath of the World Crisis Howard Davies Director, LSE EFSA Ewart Memorial Hall Cairo, 12 December 2010

Five Topics 1.The Financial Stability Board 2.European Regulation 3.Regulation and Markets: A New Contract? 4.Effective Governance in Financial Firms 5.Financial Sector Pay

1. The Financial Stability Board

The Pre-Crisis Architecture

Global current account imbalances grew rapidly from 2003 Estimates of account balances for selected countries ($ Billion), Source: The Turner Review: A regulatory response to the global banking crisis. March 2009.

The Post-Crisis Architecture

At a minimum, the FSB should: -Have a legal personality and a larger staff of its own -Have a full-time chairman -Be the accountability mechanism for the standard-setters like the Basel Committee and IOSCO, acting on behalf of the G20 -Monitor regulatory changes in individual countries.

2. European Regulation

CoRePer Ambassadors (legislative) FSC Financial Services Committee 3L3 Committee EFC Economic and Financial Committee Council of Ministers (ECOFIN) European Parliament European Commission Council Working Groups (legislative) Government Level (Finance Ministries + Observers from regulatory level) ESC European Securities Committee ARC Accounting Regulatory Committee EIOPC European Insurance and Occupational Pensions Committee EBC European Banking Committee EFCC European Financial Conglomerates Committee AURC Audit Regulatory Committee Regulatory Level (Competent Authorities) CESR Committee of European Securities Supervisors CEIOPS Committee of European Insurance and Occupational Pension Supervisors CEBS Committee of European Banking Supervisors IWCFC Interim Working Committee on Financial Conglomerates EGAOB European Group of Audit Oversight Bodies Central Bank Level Outside Commission Committee Framework ECB Banking Supervision Committee of the ECB EU: Pre-Crisis

Macro- prudential supervision Micro-prudential supervision Source: De Larosière Report, February Members of ECB/ESCB General Council European Systemic Risk Board (ESRB) (Chaired by President ECB) Chairs of EBA, EIA & ESMA European Commission European System of Financial Supervision (ESFS) European Banking Authority (EBA) European Insurance Authority (EIA) European Securities and Markets Authority (ESMA) National Banking Supervisors National Insurance Supervisors National Securities Supervisors ++ Information on micro-prudential developments Early risk warning EU: Post-Crisis

3. Regulation and Markets: A New Contract?

“Those of us who have looked to the self- interest of lending institutions to protect shareholders’ equity … are in a state of shocked disbelief.” Alan Greenspan October 2008

“There is growing recognition that the dispersion of credit risk by banks to a broader and more diverse group of investors, rather than warehousing such risk on their balance sheets, has helped make the banking and overall financial system more resilient. The improved resilience may be seen in fewer bank failures and more consistent credit provision. Consequently the commercial banks may be less vulnerable today to credit or economic shocks.” IMF Global Financial Stability Report April 2006

4. Effective Governance in Financial Firms

5. Financial Sector Pay

Relative pay in the financial sector rocketed in the 1990s Excess wage in the US financial sector relative to non-farm private wage, by type of financial industry Source: Philippon and Reshef (2009), Wages and human capital in the US financial industry: 1909 – NBER Working Paper

The share prices of banks have languished Source: DigitalLook.com. Share prices, relative values (May 1999 = 100), May 1999 – Nov 2010

In conclusion, we still have a long way to travel No central global regulatory authority, with the power to deliver enhanced regulatory compliance. EU structures still not adequate for a single financial market. No consensus on the new relationship between regulators and markets, and signs that response to the crisis may produce a new disequilibrium with too large a role for the state. Despite a more robust approach to risk management, shareholder engagement is needed to make boards more effective. Shareholders must resolve the underlying principal/agent problem reflected in excess pay.

Regulating the Financial Markets: Lessons, Challenges, and Prospects in the Aftermath of the World Crisis Howard Davies Director, LSE EFSA Ewart Memorial Hall Cairo, 12 December 2010