G-20 Targets Hedge Funds as Leaders Near Consensus

Date: Monday, March 30, 2009
Author: Simon Kennedy, Matthew Benjamin and John Rega, Bloomberg

Leaders of advanced and emerging economies are closing ranks behind plans for tougher rules on financial markets to prevent another collapse like the one that wiped out much of Wall Street.

A global approach to regulation has been gaining momentum ahead of the Group of 20 summit April 2 in London. U.S. President Barack Obama, U.K. Prime Minister Gordon Brown and their G-20 counterparts aim to merge their national blueprints for strengthened regulation into a united front to rein in hedge funds, derivatives trading, executive pay and excessive risk- taking by financial firms.

“There is reason for optimism that progress toward stronger global regulation has begun,” says Daniel Price, who was President George W. Bush’s G-20 negotiator and is now senior partner for global issues at Sidley Austin LLP in Washington. “We’re beginning to see the outlines of a convergence.”

Agreement on a shared regulatory agenda would provide the G-20 summit with a measure of success even as leaders remain at odds over trade policy, fiscal stimulus and the status of the dollar. A joint regulatory approach is crucial to prevent investors from seeking out markets with the most permissive rules, setting off a race to the bottom as countries vie to attract capital.

The call for greater regulation unites China, possessor of the most vibrant economy in the developing world, and the U.S., possessor of the world’s largest economy. China’s central bank governor, Zhou Xiaochuan, challenged the West to fix flaws in financial supervision on March 26, the same day U.S. Treasury Secretary Timothy Geithner outlined a broad initiative designed to do just that.

International Framework

“Having the U.S. and Chinese on board makes it a whole lot more likely” that an international framework will eventually emerge, says Harvard University’s Kenneth Rogoff, former chief economist of the International Monetary Fund.

Rogoff says that “it seems virtually certain that four to five years from now, the world will have either a global financial regulator or, more likely, a treaty on global financial regulation with a secretariat, akin to the World Trade Organization.” Still, he adds, “nothing is going to happen quickly.”

‘Lobbying Ferociously’

John Taylor, a former U.S. Treasury official and now at Stanford University, says the process is “going to be drawn out” as lawmakers in individual countries wrangle over rewriting the rules. That will give financial firms the opportunity to seek changes that dilute new restrictions, says Richard Portes, a professor at the London Business School.

“Banks are lobbying ferociously against anything that will undermine their businesses and pay,” he says.

When G-20 leaders last met in November, with the Bush administration in its final months, the U.S. resisted European suggestions for a single global regulator and government oversight of hedge funds. Now, proposals from the Obama administration are giving the push for a global regulatory overhaul a second wind.

“We must ensure that global standards for financial regulation are consistent with the high standards we will be implementing in the United States,” Geithner told Congress March 26.

Calling for “new rules of the game,” Geithner plans to bring hedge funds, private-equity firms and derivatives markets under federal supervision for the first time. A new systemic- risk regulator would have power to force companies to increase their capital or cut their borrowing, and authorities would be able to seize them if they came unstuck.

‘More Effective Role’

Geithner suggests empowering the Financial Stability Forum, a group of international market regulators, to “play a more effective role” alongside the IMF and the World Bank in promoting and monitoring new international regulations.

“There now appears to be common interest in pushing for a global systemic regulator,” says Stephen Roach, chairman of Morgan Stanley Asia in Hong Kong. “It won’t be easy, however, for Europe and the U.S. to come to a consensus on who that new regulator should be and what type of enforcement mechanism can be used to empower any such body.”

The U.S., which has long expected other nations to follow its lead on regulations, may now have to yield to more cooperation, says former Federal Reserve Chairman Paul Volcker.

Zhou’s Advice

“The U.S. is no longer in a position to dictate that the world does it according to the way we’ve done it,” Volcker, head of Obama’s Economic Recovery Advisory Board, told a March 6 conference at New York University.

China’s Zhou underscored that point in an article published by the People’s Bank of China March 26 that criticized western economic policies and recommended regulators be allowed to “act boldly and expeditiously without having to go through a lengthy or even painful approval process.”

“China has to be listened to,” says Glenn Maguire, chief Asia-Pacific economist at Societe Generale SA in Hong Kong. “What they are trying to do is exert maximum influence on the design of the new global financial architecture.”

A new collaborative strategy was evident in a working paper released on March 27 by the Canadian government on behalf of the G-20, which comprises 19 developed and emerging economies plus the European Union and represents 85 percent of the world economy.

The working paper recommended that leaders agree to regulate hedge funds and other nonbanking pools of capital that pose “systemic” risks and strengthen rules requiring financial institutions to build up capital cushions.

First Rules

“We have reason to believe that there will be a fair degree of consensus,” Canadian Prime Minister Stephen Harper said in an interview with Bloomberg News.

The EU will propose its first rules for the $1.4 trillion hedge-fund industry next month, while the U.K. is also considering stepping up oversight.

After financial firms raced to raise more than $1 trillion of capital to cover losses, governments want “institutions to take less risk and build up buffers in good times,” says Marco Annunziata, chief economist at UniCredit MIB in London.

The U.K.’s market regulator cites Spain as a model, after preemptive cushioning helped its biggest lenders, including Banco Bilbao Vizcaya Argentaria SA, avoid the need for government recapitalization at the end of a real-estate boom. The country was nevertheless forced to mount its first major bank rescue today, of Caja Castilla-La Mancha savings bank.

Revamp

In addition, central banks and regulators are signed up to a revamp of the so-called Basel II bank-capital standards after a 2003 rewrite was never fully applied in the U.S., leaving European banks to compete under different rules.

G-20 countries are also spurring accounting-standard setters to speed up the work of narrowing differences so investors can compare financial statements around the world.

Any agreement at the G-20 would hand leaders a way of papering over other policy differences. European governments have resisted a U.S. push for more stimulus spending. The World Bank says most G-20 members have taken actions that restrict trade, even after pledging to avoid protectionism.

A fresh split emerged last week as China proposed the creation of a new international reserve currency, only to run into immediate U.S. opposition.

On regulation, at least, “there’s definitely a unified framework forming now,” says Jim O’Neill, chief economist at Goldman Sachs Group Inc. in London. “Whether it works will only be known when the next crisis hits.”

To contact the reporters on this story: Simon Kennedy in Paris at skennedy4@bloomberg.netMatthew Benjamin in Washington at mbenjamin2@bloomberg.netJohn Rega in Brussels at jrega@bloomberg.net.