Information requirements for the stable and efficient operation of international financial markets including the provision of information by governments and disclosure by market participants, especially by large market participants including highly leveraged institutions.
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Events over the past two years have highlighted the need for governments to do more to realise the benefits and minimise the risks inherent in the dynamism of the international financial market place. Central to this objective is creating an environment in which markets operate efficiently through informed decision-making and appropriate risk management.
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The recent crises have revealed shortcomings in the way investors and creditors have evaluated and priced the risk of their investment and lending decisions. In particular, an absence of adequate, reliable, and timely information is now widely accepted as one of the factors which exacerbated the severity of the East Asian financial crisis. A lack of information makes it difficult for investors to assess risk and distinguish between firms and financial institutions that are sound and those that are not, leading to many borrowers being grouped equally relative to risk. This in-turn, at a time of crisis, can exacerbate any indiscriminate withdrawal of capital.
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Such an event reflects an underlying failure on the part of market-based mechanisms to adequately provide and assess information. The increasing sophistication and integration of financial markets over the last two decades, such as the growth of derivative markets, have compounded the difficulty faced by the market in addressing information requirements. In particular, the information requirements, which underpin the efficient allocation of resources and identification of risks, are continually evolving as the global environment itself changes. This development and its implications for macroeconomic stability imply a greater role for public policy at the national and international levels, policy that balances the costs and benefits of increased information, and takes into account the changing underlying environment.
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To address this, governments and the international community have placed a priority on greater transparency, improving the quality of information through codes and standards, and more effective surveillance - as an integral part of the wider effort to strengthen the international financial system.
Greater transparency
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There is widespread recognition of the importance of greater transparency. The Treasurer in his opening address to the Manila Framework Group meeting on 26 March 1999 identified improved transparency as one of the key elements in working towards an improved international financial system. The IMF Managing Director Michel Camdessus commented in a recent address to the International Organisation of Securities Commissions (IOSCO) that greater transparency in international finance held the key to world economic stability.
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By improving transparency, policy makers and markets will have at their disposal more readily available information on which to base policy and commercial decisions. For the public policy-maker this allows the timely identification of emerging policy and institutional fragilities, and facilitates their correction before they become embedded and more difficult to remedy. For private sector participants, greater transparency promotes (but does not guarantee) market efficiency by allowing participants to better identify and price risk.
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Transparency is more than simply the availability of information. In particular, an environment of greater transparency has the added benefit of enhancing accountability. Ultimately, policy makers and private sector participants are accountable either to the market and shareholders, or to the ballot box, to deliver sound policies and good governance. This imposes a discipline on players to deliver sound policies and good governance from the outset, and a strong incentive to respond promptly to any weaknesses that may arise.
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A number of fora, including the G-22 Transparency and Accountability Working Group, have considered what measures the international financial institutions and governments can take to improve transparency. In the G-22 Working Group there was consensus on the need to improve policy transparency and data provision, including on foreign exchange reserves, external debt and financial sector soundness. The Working Group recommended that consideration should be given to compiling data on international exposures of investment banks, hedge funds and other institutional investors.
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The G-22s recommendations have served as a basis for further work by the IMF and other international institutions, and considerable progress is being made. The Bank for International Settlements (BIS) has established a Working Group (the Patat Group) on transparency regarding aggregate positions to look at what aggregate data could be collected to enhance the efficient operation of markets. The IMF Executive Board, in March 1999, approved an expansion of the Special Data Dissemination Standard (SDDS) to include data in the areas of debt and international reserve positions. At present, about one-quarter of the IMFs membership comply with the provisions of the SDDS. Australia subscribed to the SDDS in April 1996. The IMF, in conjunction with the OECD, World Bank and BIS, has also put in place arrangements to facilitate access to creditor side external debt data.
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The G-22 Working Group also recommended that the IMF, in the context of its Article IV consultations, prepare transparency reports for economies summarising the degree to which the economy meets internationally recognised disclosure standards. The recommendation was endorsed by a Task Force on International Financial Reform commissioned by the Prime Minister in October 1998 to advise on how Australia could contribute to international financial reform. The Task Force, chaired by the Treasurer, recommended that Australia take the lead in preparing a self-assessment transparency report, providing a format and methodology that other countries may choose to follow.
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The report, released by the Treasurer on 26 March 1999, benchmarks Australias practices against a wide array of best practice international standards and gives an example of how economies can explain their economic policies and institutional arrangements. Ensuring that such policies are comprehensively understood in the global market place establishes credibility and, as indicated earlier, allows investors to make a more informed risk assessment. This not only promotes market efficiency, but may also reduce the risk of contagion, at a time of crisis, as lenders are able to distinguish between the financial circumstances facing different countries.
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Following on from the Australian example, the IMF launched a pilot project of experimental case studies on transparency practices. The transparency reports are to be used on a trial basis as part of the IMFs surveillance activities. To-date, case studies have been prepared by IMF staff for the UK and Argentina and a second round of case studies is shortly to be undertaken.
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Those countries that have adhered to standards and been more transparent in their policy-making have fared relatively better in the face of the turbulence of the past two years.
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Nevertheless, transparency alone will not solve or forestall financial crises. Improving the availability of data is an important step, but if the risk of financial instability is to be reduced, transparency must be taken a step further and integrated into an assessment of the market. The failure of external ratings agencies to downgrade the debt of many of the East Asian crisis countries until after the onset of the crisis demonstrates a weakness on the part of some private participants to adequately assess available information. Ministers at the Sixth APEC Finance Ministers meeting in Langkawi, Malaysia, May 1999, tasked their Deputies to survey the codes of conduct and practices currently in use by various credit rating agencies with a view to encouraging greater accountability.
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This is, largely, an issue for the private sector to address. Competitive pressure in the supply of advice, on issues such as credit risk, is growing. However, there is an onus on governments to strengthen their own information and disclosure standards and to communicate more effectively with the market place. In this regard, greater transparency can play an important role in building trust and strengthening the partnership between government and the private sector.
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Good public policy aims at ensuring an appropriate balance between costs and benefits for any particular measure or set of measures. This applies also to transparency. Apart from the direct resource costs involved in collecting and disseminating information, there may also be instances where greater transparency becomes counterproductive to its objectives. Governments and international financial institutions need to consider carefully the economic variables they choose to highlight. Release of too much data could serve to obfuscate rather than inform. Release of certain data, not set within an appropriate context, runs the risk of an adverse market reaction, regardless of whether it represents fundamentals.
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For example, the Thai authorities, in the midst of the crisis, were required to release data on the central banks forward foreign exchange positions. This was intended as a step towards greater transparency, in line with the Fund programme, but its timing weakened the impact on confidence that the announcement of the programme could have otherwise had. By contrast, it can be argued that if transparency on net official reserves had been in-place prior to the crisis, much of the run down in reserves may have been avoided. While the above illustrates that greater transparency needs to be carefully considered, as a general rule, exceptions to full transparency should be well justified and only occur at a time of particular market sensitivity. Once the period of market sensitivity has passed, the rationale for the exception should be re-examined.
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Efforts to improve transparency are normally associated with the public sector. In particular, this involves increasing public accountability in an environment where public agencies are generally not subject to the same degree of discipline as exists in the private market place. However, recent problems in Asia, especially weaknesses in the corporate and financial sectors, have drawn attention to the issue of greater transparency (and disclosure) in the private sector. Participants at both the Manila Framework Group meeting (Melbourne, March 1999) and Sixth APEC Finance Ministers meeting (Langkawi, May 1999) emphasised that attention must be focused on both if we want to lift efficiency in the financial market place. There is a strong case for greater disclosure by the private sector. Developments in this area are discussed in the following section.
Private sector disclosure
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The role of the private sector in forestalling and resolving crises is one of the most complex issues being considered in moves to strengthen the international financial system.
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The report of the G-22 Working Group on Transparency and Accountability, in October 1998, highlighted the importance of improving data on the international exposures of banks and institutional investors. The Group identified an absence of principles and standards to guide disclosure practices and recommended further work in this area. In response to these recommendations and more widespread concerns among the international financial community, work on enhanced transparency and disclosure of financial market participants, including highly leveraged institutions (HLIs), is being progressed in a number of specialised fora.
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The role of HLIs and other large institutional investors in financial markets is a topic that has attracted considerable attention. In particular, there is a concern that the profit seeking behaviour of global macro hedge funds may lead to market manipulation and destabilisation of small-medium sized economies. The near collapse of Long-Term Capital Management in September 1998, also heightened concern about the potential for these institutions to introduce new sources of instability. A Working Group on Financial Markets, established at the initiative of President Clinton, recommended, in April 1999, improvements in disclosure and risk-management practices for HLIs, which would, if implemented, help to constrain excessive leverage in the system and contribute to a reduction in systemic risk.
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The report of the Group builds on a growing consensus that HLIs, like other financial institutions, should comply with appropriate transparency, disclosure and regulatory requirements. To this end, the Financial Stability Forum (see also paragraph 187), created by the G-7 to strengthen cooperation among the international groups involved in financial regulation and oversight, recently established a working group to prepare a report on HLIs by September 1999. The Reserve Bank of Australia (RBA) is represented on the HLI Working Group.
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Treasury and the RBA have shared views on matters related to HLIs and we refer the Committee to the submission prepared by the RBA for further detail on this issue.
International codes and standards
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There is a widespread consensus among policy makers and regulators that more widely accepted rules and standards need to be put in place to promote greater market efficiency and facilitate the integration of global financial markets.
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The development and implementation of codes and standards has three principal objectives:
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First, to serve as a benchmark for economic performance. This will assist policy makers and regulators to identify instances of poor performance and take corrective action.
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Second, to provide for the dissemination of relevant, accurate and timely information by governments, financial institutions, and the private sector. High-quality standards, especially in areas such as accounting, assist in the accurate interpretation of information. In the absence of standards, information being disclosed may mislead the market resulting in less than optimal resource allocation and uncertainty.
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Third, to facilitate the comparability of data - allowing informed comparisons of the financial and economic performance of firms and economies.
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Developing and implementing standards and codes of good practice that meet these three objectives will, together with greater transparency, play an important
role in building stronger, more resilient and more efficient financial systems at the national level - systems in which investors and creditors are better able to make knowledgeable decisions, and supervisors are able to judge the soundness of commitments by their financial institutions. The global acceptance, and credible and rigorous implementation, of appropriate standards and codes will in-turn strengthen the international financial system - helping to prevent future crises. -
Codes of good practice or their equivalent now exist, or are at advanced stages of preparation for: releases of economic data; fiscal transparency; monetary and financial policies; banking supervision; securities market regulation; insurance regulation; accounting standards; auditing standards; corporate governance; payments and settlement systems; and bankruptcy. Countries are being strongly encouraged to adhere to these standards and codes. The codes will apply both to the public sector (eg the conduct of monetary and financial policy) and to the private sector (eg codes of corporate governance, accounting and auditing).
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Of particular interest are codes and standards being developed to strengthen risk management and prudential regulation. Events in Asia reminded us that investors and lenders have a tendency to underestimate risks in good times and overestimate them in bad times. Financial market participants need to strengthen their practices of managing credit and market risk - and supervisors need to increase their oversight in this area. One important step is the updating of the 1988 Basle Capital Accord risk weighted capital system so that it better reflects the credit risks associated with different activities. The Basle Committee on Banking Supervision (BCBS) has undertaken a review of the Capital Accord and on 3 June 1999 released a consultative paper on a new capital adequacy framework.
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The BCBS paper identifies three pillars in the new Accord: minimum capital requirements, which seek to develop and expand on the standardised rules set forth in the 1988 Accord; supervisory review of an institutions capital adequacy and internal assessment processes; and effective use of market discipline as a lever to strengthen disclosure and encourage safe and sound banking practices. While the focus of the Accord is on internationally active banks, its guiding principles are applicable to banks more widely and it will play an important role in strengthening prudential regulation.
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The recent crises have also demonstrated the risks associated with excessive short-term borrowing, particularly in foreign market currencies. The bias in favour of short-term financing has arisen as a result of distortions at both the national and international level. At the national level these include tax or regulatory arrangements, while at the international level it has become apparent that the current Basle risk-based capital requirements favour the use of short-term interbank credit lines. The Interim Committee (IC) of the IMF in April 1999 endorsed further work to eliminate this regulatory bias and the BCBS, as part of its review of the Capital Accord, is considering ways to factor maturity more explicitly into the assessment of credit risk.
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With the development of many codes and standards at an advanced stage, the focus is now shifting to implementation. Since countries are often at different stages of development, individual countries must, according to their domestic circumstances, turn the principles being formulated at the international level into more precise standards. This will be a complex, and at times politically sensitive, task and a number of countries are likely to require technical assistance in adopting the new standards.
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Codes are not compulsory - rather they are examples of best practice-and if the international financial system is to be strengthened, governments will need to be encouraged in their use. Peer review through organisations such as the OECD and APEC will play a valuable role, and the IMF in carrying out its Article IV surveillance activities will also be examining adherence to international standards. The report of G-7 Finance Ministers to Leaders on 18 June 1999 recognised the challenge of implementation and called for country adherence to be used in determining IMF conditionality. Perhaps the greatest inducement for governments to adopt codes and standards will be the use of conformity with international best practice by markets in their assessments of the sustainability of a countrys policies and economic performance. This in-turn is likely to impact upon borrowing costs and flows of investment and should prove a strong incentive for countries to voluntarily implement best practices.
The role of surveillance
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A key element of crisis prevention is better surveillance. That the Asian financial crisis came as a surprise indicates that surveillance has been inadequate. Surveillance requires having in place the necessary processes for identifying risks to economic management at the national and global level. To be effective, surveillance must be much more than identifying emerging problems. It also requires the development of options, assessment of downside risks, and ensuring the implementation of remedial action.
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Surveillance will continue primarily to be the role of the IMF and World Bank. The IMF through its Article IV consultations conducts an annual assessment of the monetary, fiscal and structural policies in individual member economies. The recent financial crises, however, have led to calls for the IMF to enhance its surveillance activities to include the broad range of policies now understood to be crucial to financial stability, in particular the health of financial and corporate sectors. In this regard, the IC in April 1999 requested the IMF and other relevant fora to move forward expeditiously with efforts under way to improve data on capital flows, and supported the establishment of systems for high frequency monitoring of private external liabilities.
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In addition to a focus on the capital account, the IMF, as indicated earlier, will be extending its surveillance role to monitor the updating of standards, principles, and codes of good conduct in member states. This will particularly be the case where a member requests access to the newly established Contingent Credit Line (CCL) - where included among the five criteria for access to the CCL is the countrys progress in adhering to relevant internationally-accepted standards.
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Australia is supportive of the IMF, in consultation with other international financial institutions, continuing to take the lead in surveillance. In executing these new tasks, it is evident that the IMF will have to supplement its in-house expertise and draw on the skills, resources and advice of the many agencies engaged in developing and defining standards. In this regard, the establishment of the Financial Sector Liaison Committee should help improve coordination between the Bank and Fund and contribute to high quality surveillance and the provision of sound advice.
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In the context of transparency, IMF members are now being encouraged to voluntarily release the results of the surveillance undertaken by IMF staff. The aim of this development is to promote better decision-making and economic performance by further improving transparency in the policies and practices of member countries. However, an issue that needs to be considered is whether the effectiveness of surveillance may be undermined if the publication of Ar
ticle IV reports inhibit the openness and candour with which national authorities deal with IMF staff. -
As noted earlier, to be effective, surveillance must lead to the implementation of remedial action. In this context, peer review processes such as in the OECD, ASEAN and APEC can be influential in shaping the direction of a governments policies. One further step, to which Australia attaches particular importance, is the establishment of the Manila Framework Group in November 1997.
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The Group comes together every six months and has proven to be a useful forum for frank discussion of the economic issues impacting upon our region. In hosting the most recent meeting of the Group in March 1999, Australia/Treasury actively engaged participants in discussions about the macroeconomic outlook, policy issues (particularly in regard to the design and implementation of the IMF-supported programs in Asia), and reform of the international financial system.
51 For instance, the turnover of futures contracts traded on international exchanges increased almost three-fold between 1990 and 1995 from 288 million to 774 million. International Finance 2nd Edition, Pilbeam, MacMillan Press, 1998, p. 337.
52 Opening Address at the Manila Framework Group Meeting, The Hon Peter Costello MP, 26 March 1999, available on-line at http://www.treasury.gov.au.
Stable and Efficient Financial Systems for the 21st Century: A Quest for Transparency and Standards, Address of Michel Camdessus, Managing Director of the International Monetary Fund, at the XXIVth Annual Conference of the International Organisation of Securities Commissions (IOSCO), Lisbon, Portugal, 25 May 1999.
53 The report of The G-22 Working Group on Transparency and Accountability, 5 October 1998, is available on-line at the Bank for International Settlements website at http://www.bis.org.
Background on the SDDS is available on the IMF web site at http://dsbb.imf.org.
54 The statistics are located at http://www.oecd.org/dac/debt. Information about this initiative is also available from the IMF web site at http://www.imf.org.
55 Making Transparency Transparent: An Australian Assessment, Department of Treasury, March 1999, available on-line at http://www.treasury.gov.au.
Underpinnings for a Stable and Equitable Global Financial System: From Old Debates to a New Paradigm, Stiglitz and Bhattacharya, Paper prepared for the Eleventh Annual Bank Conference on Development Economics, 28-30 April, 1999, p. 8.
56 Sixth APEC Finance Ministers Meeting - Joint Ministerial Statement, Langkawi, Malaysia, 15-16 May 1999, paragraph 33.
IMF-Supported Programs in Indonesia, Korea and Thailand: A Preliminary Assessment; Lane, Ghosh, Hamann, Phillips, Shulze-Ghattas and Tsikata, International Monetary Fund, January 1999, pp. 43-44.
57 The Bank for International Settlements (BIS), Basle Committee on Banking Supervision (BCBS), Committee on the Global Financial System (CGFS), International Association of Insurance Supervisors (IAIS), International Accounting Standards Committee (IASC), and International Organisation of Securities Commissions (IOSCO) are undertaking ongoing work on disclosure requirements. The BCBS and IOSCO published recommendations in February 1999 on disclosure of trading activities of banks and securities firms - see http://www.bis.org/wnew.htm.
58 Hedge Funds, Leverage, and the Lessons of Long-Term Capital Management, Report of the President's Working Group on Financial Markets, US Treasury, April 1999.
59 The Financial Stability Forum was established on the recommendation of the President of the Bundesbank, Hans Tietmeyer. More information on the Forum can be obtained from the BIS web site, http://www.bis.org.
60 Agencies involved in developing and or refining new standards include: the IMF; the World Bank; the OECD; the International Organisation of Securities Commissions (IOSCO); Basle Committee on Banking Supervision (BCBS); the International Association of Insurance Supervisors (IAIS); the International Accounting Standards Committee (IASC); the International Federation of Accountants (IFAC); the United Nations Commission on International Trade Law (UNCITRAL); and the Committee on Payment and Settlement Systems (CPSS).
61 The Consultative Paper on a New Capital Adequacy Framework is available on-line at http://www.bis.org. The BCBS seek comments on the proposals by 31 March 2000.
62 The risk weight for short-term interbank lending is 20 per cent, compared with 100 per cent applying to longer-term interbank lending.
63 See the Communiqué of the IMF Interim Committee meeting, 27 April 1999.
64 Report of the G-7 Finance Ministers on Strengthening the International Financial Architecture, 18 June 1999.
65 See also IMF Annual Report 1998, Chapter VI 'Surveillance'.
66 The Financial Sector Liaison Committee was established in September 1998.
67 See 'A Guide to Progress in Strengthening the Architecture of the International Financial System', 28 April 1999, available on-line at http://www.imf.org.
68 The Manila Framework Group brings together Finance and Central Bank officials from: Australia, Brunei, Darussalam, Canada, China, Hong Kong SAR, Indonesia, Japan, Korea, Malaysia, New Zealand, the Philippines, Singapore, Thailand and the United States. APEC Economic Leaders endorsed the Group on 25 November 1997.