Leaders uniting in plan to toughen rules

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 St.

A global approach to regulation has been gaining momentum leading up to Thursday's Group of 20 summit in London.

United States President Barack Obama, British Prime Minister Gordon Brown and their G20 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 US President George W. Bush's G20 negotiator and is now senior partner for global issues at Sidley Austin in Washington.

"We're beginning to see the outlines of a convergence."

Agreement on a shared regulatory agenda would provide the G20 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 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 US, possessor of the world's largest economy. China's central bank governor, Zhou Xiaochuan, challenged the West to fix flaws in financial supervision on Friday, the same day US Treasury Secretary Timothy Geithner outlined a broad initiative designed to do just that.

"Having the US 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 "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 Organisation." Still, he adds, "nothing is going to happen quickly".

John Taylor, a former US 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 chance 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 G20 leaders last met in November, with the Bush Administration in its final months, the US resisted European suggestions for a single global regulator and Government oversight of hedge funds.

Now, Obama Administration proposals 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 on Friday.

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.

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 rules.

"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 US 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 US, which has long expected other nations to follow its lead on regulations, may now have to yield to more co-operation, says former Federal Reserve chairman Paul Volcker.

"The US is no longer in a position to dictate that the world does it according to the way we've done it," says Volcker, head of Obama's Economic Recovery Advisory Board.

China's Zhou underscored that point in an article published by the People's Bank of China that criticised 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 by the Canadian Government on behalf of the G20, which comprises 19 developed and emerging economies plus the European Union and represents 85 per cent of the world economy.

The paper recommended 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.

"We have reason to believe that there will be a fair degree of consensus," said Canadian Prime Minister Stephen Harper.

The EU will propose its first rules for the US$1.4 trillion ($2.4 trillion) hedge-fund industry next month, while Britain is also considering stepping up oversight.

After financial firms raced to raise more than US$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.

Britain's financial-market regulator cites Spain as a model after its lenders, including Banco Bilbao Vizcaya Argentaria, avoided the need for Government recapitalisation.

And 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 US, leaving European banks to compete under different rules.

G20 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 G20 would hand leaders a way of papering over other policy differences. European Governments have resisted a US push for more stimulus spending. The World Bank says most G20 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 US opposition.

On regulation, at least, "there's definitely a unified framework forming now", says Jim O'Neill, chief economist at Goldman Sachs Group in London.

"Whether it works will only be known when the next crisis hits."

WHAT IS THE G20?

* Stands for the Group of 20 Finance Ministers and Central Bank Governors.
* A forum for co-operation and consultation on matters pertaining to the international financial system.
* Formally established in September, 1999 to replace the G33.
* Represents 85 per cent of the world economy.
* Comprises 19 developed and emerging economies plus the European Union.
* The 19 economies are: Argentina, Australia, Brazil, Britain, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, United States.

- BLOOMBERG