Wayne Byres, Chairman - The American Chamber of Commerce in Australia Business Briefing, Sydney
Thank you for the invitation to speak this afternoon.
I intend to talk today about international standards and national interests. The intersection of, and occasional conflict between, international standards and national interests is at the heart of many challenges in the world today. Trade policy and climate policy are two obvious examples where individual countries are seeking to balance their preferred domestic approach with the knowledge that finding common ground on a collective policy action will often deliver the most socially beneficial outcome.
However, APRA is not involved in negotiating trade or climate policy. Instead, I will focus my remarks today on more familiar territory for a prudential regulator: the making of international financial regulation, and its adoption in Australia.
Why are standards a good idea?
Before I do, though, I thought I would start with a reminder on why we want international standards at all. At a time when parts of the world seem to be moving away from a predilection for international coordination and cooperation towards a more fragmented approach driven by increasing nationalism and protectionism, it is worth reminding ourselves why something as basic as international standards are a good thing. A succinct rationale comes from the International Organisation for Standardization (ISO):
International Standards make things work. They give world-class specifications for products, services and systems, to ensure quality, safety and efficiency. They are instrumental in facilitating international trade.
As our host today, I could not help but note that the AmCham Constitution is premised on the promotion of cross-border trade, and the support for the adoption and maintenance of strong standards of international commercial practice. When it comes to the benefits of international standards for international trade, I am therefore conscious that I am preaching to the converted.
Modern society would not work without a great many widely accepted standards. Issues as fundamental as weights and measures, communications protocols, and product safety and reliability require good standards. If we want to harness the benefits of international trade – and Australia is certainly a country that seeks to do that – then international standards play an important role in delivering those benefits.
Of course, in many aspects of life, the world has chosen to apply standards nationally but not internationally. For example, we Australians drive on the left, while Americans drive on the right. That is annoying for those who regularly cross the Pacific and need to get behind the wheel of a car in both places, but even though it is different we can at least be thankful there is a well-enforced standard in each country. Frequent travellers between the two countries will also find it annoying that the lack of an enforced standard for electric power means that all of us have many recharging devices and adaptors for small electronic items cluttering up our homes and offices, when one would suffice. Similar drawbacks apply in many other areas of cross-border activity, such as international practices for clothing and shoe sizes, or tertiary academic degrees.
That these differences exist reflects the fact that the world has concluded that the benefits of an international standard, given the costs associated with imposing greater consistency on diverse domestic constituencies, are not justified. National interests – in the cases I have discussed, these are typically the avoidance of costs of changing long-standing and well-entrenched national customs and practices – have been judged to outweigh any benefit from the imposition of an international standard.
But there are many areas where the world has judged that greater standardisation across national boundaries is worth the cost. At any given time, the world’s standards organisations are busily building up our standards infrastructure. At present, for example, the ISO has on issue more than 21,000 different international standards, covering an incredibly diverse range of topics and activities. It currently has more than 500 new standards under development just in the area of information technology alone. Given the ISO doesn’t unilaterally decide to develop standards, but simply responds to the demands from member countries, it’s pretty clear the appetite for international standards remains strong.
International financial standards
Turning to the financial sector, the global financial crisis produced a strong appetite for improved international standards. The past decade has seen substantially increased activity by a range of international standard-setting bodies: the Financial Stability Board (FSB), the Basel Committee on Banking Supervision (BCBS), the International Organisation of Securities Commissions (IOSCO), and the International Association of Insurance Supervisors (IAIS). As a result, the international ‘rulebook’ has grown significantly.
This outcome reflects a key lesson from the financial crisis: that the global financial system is highly integrated, and even though most financial institutions were far removed from subprime lending in the US, the potential for contagion from problems in one part of the world to infect others meant that collective action was needed. Or to put it more simply, a highly connected system is only as strong as its’ weakest link, so to strengthen the system it is necessary to lift standards across the board.
From an Australian perspective, we have long seen international financial standards as being a public good from which we derive great benefit, in two main ways.
We see adhering to international standards as strongly in our interests. As a small-ish but open economy that relies to a large extent on accessing the savings of foreigners, the credibility that comes from being seen to adhere, and in many cases, clearly exceed international minimum standards is important. It allows our financial institutions to access international markets to an extent, and at a price, not possible if we sought to operate a system that was purely ‘made in Australia’ and, therefore, foreign to foreigners.
We also see others’ adherence to standards as being of benefit to us. Over the past couple of decades, Australia has sought to have a financial system that is open to foreign competitors – many of whom have brought a strong competitive impetus, not to mention a healthy degree of innovation, to the benefit of the Australian community. Adherence to well-established international standards by those foreign-owned participants allows us to place a much greater degree of (although not total) reliance on home country prudential requirements, and correspondingly less need for duplicative or restrictive domestic regulation, than might otherwise be the case.
So in summary, Australia has natural inclination towards common standards and cooperation as a key means of solving cross-border challenges that come from both needing and wanting to be part of the international financial system. And we seek to actively and constructively participate in the development of those standards – even if it does mean more long journeys to join international negotiations than any of us would like - since we have to live with their consequences.
Not everyone will have the same incentives that Australia does for promoting international standards. On either side of the Atlantic, the US and European interests are typically less concerned with, for example, market access and more concerned with issues of a level playing field. But there is no doubt that all countries are keen to have their financial institutions follow and be available to service their corporate businesses as they reach beyond their home base to engage in cross-border trade. So the maintenance of genuinely international financial markets, facilitated by internationally-active financial institutions providing essential support for trade and commerce, is still firmly seen as an important prerequisite for economic growth and well-being. International financial standards help to make this happen.
The peak of the cycle?
The financial crisis spawned a range of new and improved international financial standards. Most prominently, the Basel III framework (albeit still to be totally completed) was designed to make banks safer, and more resilient to shocks. Additional rules were developed to impose even higher standards on globally systemically important banks, recognising the extra risk that they posed to the financial system. And, amongst other things, international standards were developed to promote central clearing of derivative activities, and consistent margining of non-cleared derivatives.
There is no doubt that as memories of the global financial crisis are fading, and national priorities become more diverse, international standard-setting is getting tougher. International financial standards are built on consensus, and consensus is becoming harder to find. In the immediate aftermath of the crisis, consensus on international standards was much easier: the problem was obvious, national and international interests were highly aligned, and big broad brush responses were the order of the day. Now, we are asking more subtle and nuanced questions about the design of the framework, its impacts and its incentives. That the answers to these questions are less obvious than the ones we were answering in 2009 and 2010 is unsurprising.
There is no better example of this than the ongoing efforts to finalise the Basel III reforms. Although the core components of Basel III – a strengthening of the framework for bank capital, liquidity and funding – was agreed in 2010, the final points of detail still remain to be agreed. This is frustrating for regulators and banks alike. A decade on from the onset of the financial crisis, I don’t think anyone could say it is being rushed! And with a number of bank failures just in recent weeks in Canada, Italy and Spain, at a time when economic conditions are not particularly volatile, I also don’t think anyone could say the need to be vigilant about strengthening the financial system has diminished.
Although the finishing line for Basel III is in sight, we still haven’t yet found the alignment of interests that will allow the drafters to put down their pens and publish the final version. What is at the heart of the delay? Ultimately, it is the difficulty in aligning national interests with the common good. To have a common standard, all jurisdictions – and there are 27 of them at the Basel Committee table, represented by 45 individual agencies, who operate by consensus – are essentially agreeing to give up some degree of freedom as to their own domestic standard-setting. In many cases, this won’t be problematic since – as I will come back to in a minute – the minimum standard produced around the table in Basel will be lower than one would want to apply domestically. But in others it may involve a genuine trade-off between domestic considerations and the benefits of consistent international practice. Those trade-offs can be hard, even for experts, to measure and assess, let alone explain to non-experts.
The good news, though, is that the effort to find agreement continues. And it was pleasing to see the US Treasury, in its first report in response to the President’s Executive Order on financial regulation, acknowledge that ‘U.S. engagement in international financial regulatory standard-setting bodies remains important’ and that it ‘supports efforts to finalise remaining elements of the international reforms at the Basel Committee…to strengthen the capital adequacy of global banks.’ At a time when there is genuine concern about the potential for fragmentation of global financial markets, such statements can only be welcomed.
Nevertheless, I think the current work in Basel will largely mark the end of the cycle, and we are largely done when it comes to major new international standards. There will, of course, continue to be maintenance of the regulatory system required – as the financial system evolves, the regulatory framework needs to be reviewed to make sure its stays fit for purpose. Loose ends will continue to be tidied up. But wholesale reform seems to be at an end for now. Feedback from the financial sector is also that they want less international standard-setting, albeit they also want more consistent rules for doing cross-border business. That might seem logically inconsistent, but my interpretation is that they are asking the standard-setters to devote more time to promoting the consistent implementation of the standards that have been agreed before too much more time is devoted to devising new ones. That is not bad advice, in my view.
Balancing Australia’s interests with international standards
As I’ve already noted, the Australian banking sector is heavily reliant on international financial markets for funding, equity investment, and trading and hedging activities. Without international standards, and Australia’s clear compliance with them, all this business would at least become more difficult and more expensive, and in some cases may not happen at all. That, in turn, would flow through to more expensive debt for borrowers, lower returns for equity investors, and less safety in the banking system overall.
As a result, APRA does not see any case for implementing a domestic regulatory framework that is less robust than the international norms. Australia cannot simultaneously rely more than most on cross-border funding, and seek to be exempted from some or all of the regulatory requirements applying in other parts of the world. In any event, even if we attempted to implement a weaker set of domestic rules, international markets and counterparties would hold Australian banks to the international standards and measures anyway. So we see little value in trying to stand apart from the rest of the world, claiming to know better.
But it is also true that international standards are not always settled in the exact form that we would prefer if we had complete freedom to write the rules ourselves. We have a seat at the table, and seek to use our influence to shape the final form of any agreement, but compromise is inevitably necessary.
So how do we balance the resulting international standards with our own statutory mandate to look after Australian domestic interests?
First, as I have already made clear, we start with the fundamental premise that adhering to international financial standards is usually, all things considered, clearly in our national interest.
Second, even within international standards, there are often areas in which national discretion is granted. That is, the standard allows a choice, usually on narrow technical issues, that is deliberately and explicitly left to the domestic authority. In these cases, we can make a decision we think works best for Australian circumstances and, regardless of the decision taken, still be seen as in compliance with the international standard.
But the most important factor in balancing international standards and national interests is that, at least in the financial regulatory world, international standards are minimum standards. It is quite open to us to improve upon them, reflecting our own circumstances. In Australia, we have long taken the view that we should aspire to a higher standard of safety than provided by solely adhering to minimum Basel standards. In part that reflects the nature of our highly concentrated banking system, and also the lack of pre-funded deposit insurance. We seek to ensure that Australia’s banking system is considerably more resilient than has generally been the case for international banking in recent decades. It is all too evident that the incidence of banking crises has been too frequent, their costs have been extraordinarily high, and many communities around the world are still wearing the consequences. We think we should try to do better.
So let me quickly sum up. Although the political and economic debate in some parts of the world today seems increasingly dominated by narrow domestic interests, and a disregard for broader global perspectives, it is important we do not lose sight of the benefits that international trade and engagement brings all of us. Well-functioning international financial markets, underpinned by international financial standards, help us harness those benefits. On-going cooperation and engagement on the ‘rules of the game’ is therefore important to economic well-being, and too strong a focus on purely domestic interests is likely to deliver sub-optimal outcomes.
Australia is more dependent on preserving those benefits than many. We therefore see little misalignment between internationals standards and our own national interests in the area of financial regulation. We have consistently sought to adhere to internationals financial standards and, where it is appropriate, exceed them. That strategy has delivered a relatively stable financial system, reliable access to international financial markets, and major financial institutions that are highly rated by debt and equity investors alike. It is therefore a strategy we are likely to continue for quite some time to come.
- I would like to acknowledge my former colleague at APRA, and now Inspector of Banks and Trust Companies in the Bahamas, Charles Littrell, for his contribution to these remarks.
- US Treasury Report to President Donald J Trump, A Financial System That Creates Economic Opportunities Banks and Credit Unions, June 2017, p55.
- ibid, p16.
- Australia is not alone internationally in taking this approach. Countries such as Singapore, Hong Kong, and Canada are also recognised as following a generally conservative strategy.