Getting to yes on transatlantic financial regulation

WASHINGTON, DC – As 2014 gets underway, signs of a fraying regulatory relationship between the European Union and the United States seem to be everywhere. The US Federal Reserve’s tough new regulations on foreign banks have spurred the European Commission to threaten retaliation. Progress toward reconciling US and EU rules on derivatives – one of the main causes of the financial crisis – has fallen apart. And plans by the EU and the United Kingdom to “ring-fence” bank deposits are poised to depart in form and substance from one another and from the newly unveiled Volcker rule in the US. But the lesson that most observers draw from these increasingly high-profile disputes – that, even in financial regulation, power politics trumps the common good – is incomplete. After all, regulatory disparities are not just a product of divergent national interests; how effectively diplomacy is practiced and coordinated can play a role as well. For example, a recent study highlighted the failure of G-20 leaders to define a consistent and achievable roadmap for implementing the financial-reform agenda announced after the 2008 crisis. For roughly the past decade, heads of state have been calling on regulators to tackle big issues, such as capital standards, along with other matters like over-the-counter derivatives and credit-ratings reforms. But, during this period, officials have acted more or less at their discretion, leaving problems to be addressed according to different economic and political cycles. Radical disparities between the rule-making cultures of the US and the EU are exacerbating the problem. Unlike the US, where independent agencies lead the rule-making process according to Congressional dictates, legislative actors in Brussels and Strasbourg – the European Commission, the European Council, and the European Parliament – set regulatory agendas and write the rules. And, though EU agencies like the European Central Bank are assuming an increasing share of regulatory responsibility, divergences in decision-making procedures continue to affect the rate and nature of transatlantic coordination. Making matters worse, market and monetary reforms have occasionally merged, with rule-making becoming partly dependent on the decisions of disparate agencies and institutions. Meeting enhanced Basel III capital standards, for example, is about more than just rules; it requires the recapitalization of banks – a process that is taking longer in Europe than in the US, partly because the eurozone has had to negotiate funding mechanisms for banks and cash-strapped governments. Now these delays are raising doubts in the US about the EU’s commitment to reform. All of these problems reflect the simple fact that policymakers lack suitable tools for conducting regulatory diplomacy in a world of dynamic market reform. The conventional means for doing so – mutual recognition and substituted compliance – were developed in an environment in which countries would spur each other to raise standards by offering foreigners easier access to domestic markets once regulations in their home countries mirrored their own. Neither mechanism foresees a situation whereby all countries simultaneously seek to upgrade their financial systems across a variety of sectors. Meanwhile, the traditional forum for EU-US talks, the Financial Markets Regulatory Dialogue – which brings regulators together at irregular intervals to haggle over lists of divergent regulations one by one – is all too often slow and circumvented. The good news is that European and American policymakers have options for clearing the structural roadblocks. They should begin by developing a new “toolkit” to help countries not just meet existing standards, but also work together to improve standards in an environment of rapidly changing markets. Whether implemented as part of the Transatlantic Trade and Investment Partnership talks or on an informal basis, mutual-recognition and substituted-compliance programs should become more robust, and they should provide procedural mechanisms for coordinating rule-making and administrative processes in real time. Moreover, coordinating mechanisms should be – to the extent possible – objectives-based processes measured against international commitments and best practices. Finally, given the interface between financial supervision and monetary relations, the Financial Markets Regulatory Dialogue should be revived alongside G-20 meetings of treasury officials and central bankers. Instead of relying on the multi-regional Financial Stability Board to hash out differences and set the regulatory pace, EU and US regulators should be encouraged to present joint solutions and reforms for wider international consideration. Of course, reforming the transatlantic regulatory architecture can do only so much for financial diplomacy, and national interests will always be important. But, in a world of trillion-dollar capital flows and ever-higher stakes in a sound global financial system, even modest improvements can make a big difference. Better rule-making mechanisms are a good place to start. Chris Brummer is Professor of Law at Georgetown University Law Center and Project Director of the Atlantic Council’s Transatlantic Finance Initiative Copyright: Project Syndicate