POLITICS, INSTITUTIONS,

CONSTRUCTIVISM and the EMERGING

INTERNATIONAL REGIME for FINANCIAL

REGULATION

53

Tony Porter McMaster University

The Review of Policy Spring 2002 19:l

54

ABSTRACT

This article examines the growing number of interconnected international groupings that have been built to regulate globalJinance over the past quarter century. It suggests that the rationalistic approaches focusing on egoistic actors that have dominated scholarly s M y of this issue area have contributed to the underestimation of the strength of the regime for regulatingglobalflnance. It examines, as an alternative, constructivist approaches that stress the importance of institutions.

he international financial crises of the 1990s have made the T need for scholarly analysis of the challenges and prospects for the establishment of a capacity for regulating global finance more pressing than ever. Despite the importance of establishing effective international regulatory institutions, the prospect of doing so is often regarded with skepticism. For some scholars cross- border capital flows are so large and fluid that they cannot be controlled by regulators at the state or the international levels. For others the problem is the competitive sovereign state system in which national authorities are reluctant to build any significant autonomous capacity in international institutions.

This article argues that much more has been accomplished in the construction of international regulatory institutions than has generally been acknowledged. One reason that these accomplishments have not been recognized is that these institutions are often relatively informal, technical, and therefore rarely make it to the front pages of newspapers. Moreover many are small and a key element of their capacity is the less easily discerned set of links between them. A goal of this article is to identifl these interconnected institutions--this emerging regime for financial regulation--and thereby better assess their capacity.

Existing theoretical approaches to international institutions have also contributed to an underestimation of the significance of the regime for financial regulation. As well as dismissing the possibility of constructing international institutions for the reasons given above, much analysis of the regulation of

Porta: P o l i h Institntions, c- 'vism and the Ern-

global finance is based on rationalistic approaches which start with the assumption that the fundamental constituent elements of the social world are egoistic actors who only cautiously collaborate when it is clearly in their self-interest. There is a virtual absence of explanations of the development of international regulatory capacity based on constructivist approaches (Ruggie, 1998) that by now have become well established in the study of other international institutions. These constructivist approaches focus on the norms and other shared understandings between actors that contribute to the strength of institutions. A second goal of this article, then, is to examine the relevance of constructivist approaches for understanding global financial regulation.

The article starts by discussing prevailing approaches and their implications for understanding international regulatory institutions. A constructivist alternative will then be sketched out. Subsequently, the international institutions for regulating global finance are examined. It will be demonstrated that substantial regulatory capacity has been built over the past 25 years. As well, it will be argued that the present character and the future trajectory of the regime for international financial regulation cannot be adequately understood without paying careful attention to the institutional considerations highlighted by a constructivist approach.

PREWAILING APPROACHES

In prevailing approaches there is a widespread tendency to downplay the relevance of the types of institutional factors upon which constructivists focus.[ 11 This is especially the case for those approaches that implicitly or explicitly dismiss the possibility or relevance of international regulatory institutions altogether by focusing heavily on the autonomy of individuals (McKenzie and Lee, 1991 ; Cerny, 1994) or powerful states (Strange, 1986). Even those who incorporate structure into their analyses (Andrews, 1989; Strange, 1990; Gill and Law, 1993) treat structure as a relatively static artifact rather than exploring the complex

55

The Redew of Policy aesearch, Spring 2002 19:l

institutional factors that work together to produce a structural effect. We shall see below in examining the evolution of the regime for financial regulation that much more autonomous institutions can be created than would be predicted by these approaches.

56

The downplaying of the role of institutions is even characteristic of those approaches which have tried to explain the institutions involved in the regulation of global finance. These approaches make heavy use of rationalistic models that seek explanations in the ability of actors to systematically choose between alternative actions, including the decision to construct institutions, based on conscious calculation of costs and benefits. In this view states and other actors are able to anticipate benefits from collaboration and to self-interestedly agree to cooperate to achieve these.

Simmons (1 993) applies such an approach to the creation of the Bank for International Settlements (BIS) in 1929: doubts about the credibility of Germany’s commitment to pay its reparations led to levels of‘lending to Germany that were suboptimal from the point of view of both Germany and its creditors. The creation of the BIS enhanced the capacity of creditors to monitor and enforce their loans thereby solving this collective action problem. Similarly, Kapstein suggests that international bank capital regulation that developed around the Base1 Committee on Banking Supervision (BCBS) in the 1980s involved a collective action problem in which states sought to provide a competitive advantage for their banks by reducing regulation to levels that in aggregate were suboptimal. This “tension between domestic interests and international public goods” (1992: 287) was solved by the “power capabilities and shared political purpose of the United States and Britain” (1 992, 265) which brought about an international agreement to raise regulatory standards. The independent role of the international institution itself was minimal: the central bankers involved did not form an epistemic community and were rather “a group of bureaucrats who were trying to serve several conflicting public

Porter: Politics, Institutions, Constructivism and the Emerging

and private sector interests in an effort to maintain if not enhance their positional power in their domestic political structures” ( 1992: 267). Oatley and Nabors (1 998) see the same process as due to a powerful US, in conjunction with the UK, self-interestedly constructing international institutions to redistribute income to their own citizens from the citizens of Japan and other countries.

These approaches suffer from limitations that stem from the rationalistic assumptions upon which they are built. They have difficulty explaining the degree to which institutions are shaped by the institutional context within which they develop, leading to the persistence of suboptimal institutional features, but also more continuity than one would expect if arrangements were the outcome of deliberate initiatives on the part of states. The types of contracting problems discussed by Simmons have often existed without institutional solutions such as the BIS being devised. Simmons’ rationalistic approach downplays the critical impact of the collaborative institutions associated with Germany’s defeat in World War I beginning with the Versailles peace treaty. As will become apparent below, the rationalistic approaches to the BCBS have difficulty explaining the systematic development of the BCBS and associated institutions over time.

A Constructivist Alternative

In contrast to rationalistic approaches, which build theories on the assumptions that actors calculate costs and benefits in seeking to maximize their interests, constructivist approaches stress the way in which institutions and shared beliefs can shape actors’ conceptualization of their interests. Moreover actors, even powehl ones, need to work through institutions, defined broadly as norm-guided social arrangements, since the rules and norms which constitute institutions are the medium that makes communication and coordinated action possible. Institutions are thus, a starting point and are not simply consciously built by self- interested actors.

57

The Review of Policy &sear&, Spring 2002 19:l

The following are elements consistent with a constructivist approach which together are inconsistent with the rationalistic approaches discussed above. A constructivist perspective suggests that institutions will be heavily shaped by a developmental trajectory that can be traced back through the institution's history rather than by a constantly changeable configuration of national interests. Evidence of this historical inertia will appear in idiosyncratic institutional designs that do not match the clean lines that one would expect based on rationalistic theories. Political power will be deployed through existing institutions and will take a form that is shaped by them. Institutional innovations respond not just to concerns of individual states but to problems that emerge from the regime itself or from the institutional setting in which it is embedded, including the character of market institutions.

58 THE EMERGING REGIME FOR INTERNATIONAL FINANCIAL REGULATION

In this section I examine the development of the regime for international financial regulation with the aim of assessing the various approaches discussed above. This examination is carried out in two stages. In the first the strength of the regime is assessed. This has bearing on those theories that dismiss the possibility of significant regulatory capacity at the international level and on the assumption of rational choice theories that international regulatory institutions respond relatively directly to the interests of individual states. In the second stage I assess the degree to which the role of politics in the regime fits with rationalistic and constructivist approaches.

THE S'IXENGTH OF THE REGIME

Five measures of regime strength that have been developed will be used here: compliance with regime rules; the specificity of rules; the capacity to learn by building on solutions to earlier

and the Emerging Porter: Polities, Institutions, Consdrnctrmsm . .

problems; complexity ( (the degree of integration across bodies carrying out differentiated functions); and autonomy (the degree to which the regime can develop initiatives free of external influences)(on measuring strength, see Porter, 1993: 38). I will examine the fvst three and then the remaining two.

Compliance, Specificity and Learning

Regulation of international banking has centred around a set of committees established by the Group of Ten Central Bank Governors (G-10) with secretariats at the Bank for International Settlements (BIS) in Basel. International securities regulation has been primarily based in the International Organization of Securities Commissions (IOSCO) with its secretariat in Montreal.

The most prominent of the BIS-based G-10 committees was the Basel Committee on Banking Supervision (BCBS), formed in 1974 in the wake of the evident systemic dangers associated with banking crises in that year. Over the years the BCBS has developed an agreed division of responsibilities between home and host country regulators, codified in a 1983 Concordat and updated in 1992, and its 1988 risk-based capital accord, which established agreed minimum levels of bank capital, a key instrument in forcing shareholders to provide a cushion against bank insolvency (Porter, 1993). By 1992 compliance with the accord, despite its costliness to banks needing to raise more capital, had been carried through into virtually all major banking markets. In the 1990s the Basel Committee continued to develop the 1988 capital accord and to address new issues of concern to regulators. Refinements to its treatment of the risk it was intended to address--credit risk (the risk that a borrower will fail to pay)-- were made and procedures for addressing an increasingly important risk--market risk (the negative effects of changes in market prices overall)--were built into the accord in a 1996 revision to it. Studies and recommendations were made on other topics, including for instance highly-leveraged institutions, disclosure and transparency, derivatives, interest rate risks, and deposit protection, among others.

59

The Review of Policy Research, Spring 2002 19:l

By the end of the 1990s two other G- 10 committees with BIS secretariats had also established a significant track record. The Eurocurrency Standing Committee (ECSC), which was formally established in 197 1 with the aim of monitoring the rapid growth of Euromarkets had substantially increased the capacity to monitor and understand the growth and development of the Euromarkets. In 1999 the ECSC was renamed by the G-10 the Committee on the Global Financial System, with a clarified mandate, which includes monitoring short and long term developments relevant to monetary and financial stability and proposing policies to enhance the functioning of financial markets.

The Committee on Payments and Settlements Systems (CPSS), which had its origins in more informal G-10 groups in the 1970s, has focused on the danger that the failure of a bank to settle an agreed transaction could lead to knock-on effects that could seize up the payments system through which an estimated $6 trillion passes daily (Giles, 1996: 1). The emphasis has been on netting schemes which could reduce payments-systems risk by more quickly cancelling but offsetting obligations and by supplementing the creditworthiness of an individual participating bank with the guarantee of a netting institution. The CPSS’s work has contributed to a greatly heightened awareness on the part of banks of the problem, and to a series of private initiatives, although “much remains to be done” (CPSS, 1998: 2). Private sector multilateral netting had been slow to develop, reducing overall estimated settlement flows by only 0.8 percent (up from 0.7 percent in 1996) (CPSS, 1998: 5). The CPSS therefore decided to reemphasize individual bank management of foreign exchange settlement risks and asked the BCBS, which has stronger and more global standard-making capacity, to work on this.

60

Unlike the G- 10 committees international securities regulation developed from a regional organization, the Inter- American Association of Securities Commissions and Similar Organizations (Porter, 1993: 185 fn 7) which moved to take on a global mandate and membership when it changed its name to

Porter: Politics, Institutions, Comtruch ‘vism and the Emerging

IOSCO in 1984. Unlike the G-10 committees IOSCO included developing countries in its membership, although its most powerful committee, the Technical Committee on International Transactions, was dominated by G-10 countries. In the 1990s IOSCO’s capacity grew significantly. Membership increased from 80 in 1990 to 159 in 1998. Accomplishments included an IOSCO- wide agreement on, and follow up to, a series of resolutions, including the 1994 “Resolution on Commitment to Basic IOSCO Principles of High Regulatory Standards and Mutual Cooperation and Assistance” and the 1998 “Objectives and Principles of Securities Regulation”, described by IOSCO as “one of the most significant documents in the Organization’s history” (IOSCO, 1998: 2). Compliance, while ostensibly required of members, remains uneven but is encouraged by a regular Report on the Implementation of IOSCO Resolutions with implementation broken down by member and resolution.

Overall the above institutions displayed significant strengthening with respect to compliance, specificity and learning. Most notable is the fact that none of them existed before the 1970s. The most impressive case of compliance is with the BCBS’s capital accord. The other groupings have, however, also brought about changes in the conduct of member states, ranging from the production and publication of more specific data on financial flows to changing of internal rules to comply with IOSCO resolutions. The BCBS, the CPSS and IOSCO have all increased the specificity of expectations with regard to state practices, although these range in formality from recommendations for technical practices to more serious commitments to explicit standards. Each of the groupings has pursued projects, such as capital standards, netting arrangements, the collection of data, or securities fraud, in processes extending over several years and iterations, with the evolutionary character of the resulting products an indication of the existence of learning.

61

Complexity and Autonomy

The Review of Policy aesearch, Spring 2002 19:l

One of the most striking developments in the 1990s was the degree to which the groupings described above became more integrated with each other, with regulators from outside the G- 10, and with political authorities. This development, which will be discussed in this section, substantially strengthened the regime by increasing its complexity. Changes in autonomy are more ambiguous.

The first type of integration was between banking and securities regulation. By the end of the 1980s weakening of the division between banking and securities at an industry level was well advanced. In jurisdictions where the two industries had been separated legal barriers to integration were being removed and banks were increasingly involved in securities transactions. At the level of international institutions, however, there was almost no contact between the banking regulators meeting in Base1 and the securities regulators at IOSCO. Collaboration between banking and securities regulators was stepped up at the beginning of the 1990s with an ongoing series of meetings between representatives of the BCBS and IOSCO’s Technical Committee. A Tripartite Group was formed in 1993 at the initiative of the BCBS, including securities and insurance regulators, to address concerns about the regulation of conglomerates involving activities crossing these industry boundaries. In response to the group’s conclusion, which noted that “any further progress that can be made by the Tripartite Group seems certain to be restricted by the informal nature of this group” (Tripartite Group, 1995 in Compendium, p. 7 l), the Joint Forum on Financial Conglomerates (JF) was formed in 1996 by the BCBS, IOSCO, and the International Association of Insurance Supervisors (IAIS), with a secretariat at the BIS. The JF produced its final report in 1998. Despite its use as a vehicle for increased collaboration between its three member organizations the JF was limited by its specific mandate and by its lack of authority to proactively coordinate responses (interview).

62

The second type of integration was between G-10 and

Porter: Politics, Institutions, Constractivism and the Emaging

non-G- 10 countries. IOSCO, as noted above, had integrated developing countries into its structure by welcoming them as members and by establishing, in 1989, the Development Committee as a representational mechanism within IOSCO. The BCBS has sought to expand its reach in two ways. The first was to establish relations with--and in some cases actively foster-- regional groupings of bank supervisors. By the end of the 1980s these included the Offshore Group (formed 1980), the Commission of Supervisory Authorities of Latin America and the Caribbean (which first met in 1981); the Gulf States' GCC Committee of Banking Supervisors (formed 198 l), the Caribbean Banking Supervisors Group (formed 1982), as well as groups with bank regulatory responsibilities in the European Community. During the 1990s a set of new regional groupings was added to this list. They included the Arab Committee on Banking Supervision (formed 199 l), the Caribbean Bank Supervisors Group (formally established in 1996), the Group of Banking Supervisors from Central and Eastern Europe (formed in 1990), the East and Southern Afiica Banking Supervisors Group (formed 1993), the Executives Meeting of East Asia and Pacific Central Banks Working Group on Banking Supervision (formed as a study group in 1996 and upgraded to a Working Group in 1998), the SEANZA (South East Asia, New Zealand and Australia) Forum of Banking Supervisors, formed 1995, and the Transcaucasia and Central Asia Supervisors Group (formed 1995) (BCBS, 1998). The second way of integrating non-G-10 countries was through the BCBS's biennial International Conferences of Bank Supervisors which began in 1979.

In the 1990s the BCBS also began incorporating non-G- 10 countries more directly in its own activities with the group working on the 1997 Basel Core Principles for Eflective Banking Supervision, which included representatives from seven developing countries. Nine other emerging market countries "were also closely associated with the work" (BCBS, 1997) . The Core Principles Liaison Group was established by the BCBS to institutionalize this collaboration. While the BCBS's links with

63

The Review of Policy &sear&, Spring 2002 19:l

non-G-10 countries are the most developed of the G-10 committees, the other committees are also working on making such connections (interview). Also important were initiatives to begin to enhance the links of the BIS more generally with developing countries, including the admission to membership in 1996/97 of an additional nine central banks; strengthened relations with regional organizations of central banks; and the opening of the first BIS office outside Basel, in Hong Kong.

64

IOSCO similarly moved to enhance the involvement of emerging markets in its policy process in 1996 by aligning the structure of the Emerging Markets Committee more closely with that of the Technical Committee: the former’s Working Groups “shadow the work of the Technical Committee Working Groups, in particular by attending meetings of the corresponding group. The level of coordination has steadily increased and is now allowing systematic transfer of expertise to take place” (IOSCO, 1996).

Perhaps the most striking example of integration of non- G- 10 countries into policy processes formerly monopolized by the G-10 was the creation of the ad hoc G-22 process which ran fiomApri1 to October 1998 and the permanent Group of 20 which was established in September 1999. The G22 process began with officials representing the G-7 countries, Australia, and 14 emerging market countries called together by the US and it culminated in the release of three lengthy Reports on the International Financial Architecture. Each of the three Working Groups which produced the Reports was jointly chaired by one developed and one emerging market representative, although the lead in the Working Groups’ discussions tended to be taken by the G-7 participants (interview). The G20, created by the G7, brings together finance ministers and central bank governors from the G7 countries, from 12 large emerging market countries, including Russia, China and India, along with representatives from the European Union, the IMF and the World Bank. It is envisioned as a way to reach consensus on policies and to obtain commitments

Porter: Politics, Iastitutions, Constructivimn and the Emerging

on their implementation in an informal setting in which meaningful discussion can take place.

With regard to political authority, a more intensive involvement of G-7 leaders with international financial regulation and reform began with the Halifax Summit of 1995 that took place in the wake of the outbreak of the Mexican peso crisis in December 1994. The 1996 Lyon summit and all subsequent ones have reviewed progress on the recommendations of the previous summits and reiterated their importance. The meetings of G-7 finance ministers, which have been integrated into the G-7 process since 1986, have played a particularly prominent role in the G- 7’s post-Halifax consideration of financial governance. The intensity of the collaboration is evident, for instance, in the plan for implementation of the Global Financial Architecture presented to the G-7 Heads in December 1998 by the G-7 Finance Ministers and Central Bank Governors. The plan includes 35 goals, and although some are vague, many involve very specific commitments and deadlines (G-7, 1998). 65

Changes in the BIS and IMF have also been important in integrating the regulatory institutions with political processes. The U.S. decided to begin, starting in 1994, to take up the position reserved for it on the BIS Board of Directors. Previously, since the creation of the BIS in 1930, the US had declined to do this due to scepticism about the organization (Federal Reserve Board, 1994). This 1994 US decision marked the increased importance of the BIS in the multilateral governance of international finance and brought the BIS more in line with the current underlying international configuration of political power. Since 1994 the membership of the BIS Board has coincided with the membership of the G- 10. Since the G- 10 is a well-established institution with strong links to the G-7 process this further integrates the BIS into that key global political arrangement. The presence of Canada and Japan on the Board further reduces the vulnerability of the BIS to criticisms of being overly Eurocentric. With respect to the IMF there have been two politically significant changes. The first

The Review of Policy &sear&, Spring 2002 19:l

has been the more prominent leadership role played in the IMF by the G-7, evident in the many G-7 directives to the IMF issued since the Halifax summit. The second is the integration into IMF practices, such as conditionality, of standards devised by the G- 10 committees, especially the BCBS’s Core Principles. AS a formal universal international organization the IMF has much greater political legitimacy, authority, and capacity to bring about compliance, than do the G-10 committees, and thus this development was a significant strengthening not just through increased complexity but due to increased capacity to bring about compliance as well.

Another key development was the creation of the Financial Stability Forum (FSF) in 1999 which aims to “meet regularly to assess issues and vulnerabilities affecting the global financial system and to identify and oversee the actions needed to address them” (Tietmeyer, 1999). Mandated and approved by the G-7 the forum brings together 14 high level representatives from key international committees and organizations, including all those discussed above, and 2 1 G-7 national representatives. “Participation could over time be extended to include representatives from a small number of additional (i.e. non-G7) national authorities that could contribute substantially to the process, or to invite them to attend meetings as guests” (Tietmeyer, 1999). The FSF will have a small secretariat at the BIS. This initiative was a rather dramatic step in the direction of greater integration among the international institutions involved in it, and between them and the more politically authoritative G-7 process.

66

The evolution of the regime during through the 1990s displayed a very substantial strengthening on the dimension of complexity. Integration intensified links among differentiated subunits, including banking, securities, insurance, regional groupings, and politically more authoritative bodies including the FSF and the G-7. Autonomy was more ambiguous however. During the 1980s the ambiguous structure and highly technical focus of the G-10 Committees contributed to their autonomy.

Porten Politics, Insdtutions, coaetroetmism ' audtheEmexging

None of the committees had explicit public constitutions or decision-making procedures. Although they were created by, and report to the G-10 their highly proficient secretariats are funded by the BIS and are staffed by BIS employees (interview). This arrangement, combined with the distance between the highly technical nature of their work and the already full agenda of the G10 gives the committees a significant degree of autonomy. The closer integration of the committees with the more politically authoritative G-7 process through the FSF could be seen as involving a decline in autonomy. It should be noted, however, that the G-7 process itself has developed some degree of autonomy from national orientations. Consultations among G-7 ministers are detailed and sustained and involve considerable commitment to the G-7 process itself. Thus on balance the integration of the more technical groupings with the G-7 political process can be seen as a strengthening of the regime.

Regime Stmngthening: Conclusion

On each of the five measures of regime strength set out at the beginning of this section there has been significant development over the course of the 1970s, 1980s and 1990s. Clearly, those approaches which do not envision any construction of regulatory capacity at the international level are not much use for understanding the character of institutions in this issue area. The consistent development over 25 years of this regime strength also undermines the rational choice approaches that stress the conscious and strategic decisions of individual states to engage in collaboration. One can always treat this history as involving a sequence of tacit agreements among states to continue to collaborate but this would add unnecessary analytical complexity and obscure the frequency with which one course of action grew out of an initiative that arose from a relatively autonomous international institution rather than an independent nation-state.

67

THE ROLE OF POLITICS IN THE INTERNATIONAL FINANCIAL REGULATION REGIME

The Review of Policy Research, Spring 2002 19:l

In this section I examine the role of politics in this emerging international regime for financial regulation to determine the degree to which it matches the expectations of rationalistic and constructivist approaches as set out above. This will involve looking at three things: the prevalence of idiosyncratic institutional features; the degree to which political factors are modified by institutions; and the degree to which political conflict and mechanisms for resolving it derive from the regime and its institutional setting rather than directly from the conflicts and interests of states.

The Regime& “Organizational Chart’’: Rational or Idiosyncratic?

The G-10 committees were built on a tradition of collaboration of central bank governors that put its distinctive stamp, with both positive and negative features, on their institutional character. This tradition of collaboration was based on maintaining a degree of autonomy from political authority; a shared set of intellectual and highly technical understandings about the workings of the monetary system; and consequently an enthusiasm for pragmatic and often informal forms of organization. Additionally the legacy of the G- 10 itself determined the membership of the committees, bringing with this the advantages in terms of efficiency of working with a restricted number of representatives from the world’s most developed financial markets and the disadvantages of not having the organizational reach and legitimacy that would have accompanied a larger membership. The system of committees was anchored organizationally in the central bankers’ bank, the BIS. As noted previously, the disjuncture between BIS funding and administration of the committees’ expert staffs, and the G-lo’s mandating and approval of the committees’ policies contribute to the ability of the committees to develop autonomy from the G- 10, national governments and the BIS. The capacity of the BIS to generate its own revenues from its monetary operations was an additional distinctive institutional factor that was beneficial for

68

Porter: Politics, Institutions, Constructivism and the Emerging

the committees and enhanced their autonomy from political influences.

While some of the results of the imprint of G- 10 traditions on the G- 10 committees, including autonomy, pragmatism, collegiality and expertise were beneficial others were disadvantageous. The tradition left the committees disconnected from the type of political authority that is useful in fostering legitimacy, solving political problems, and adopting binding and enforceable regulations. This was exacerbated by the restricted membership of the committees. The Finance Ministers from the G-10 countries continue to engage in only perfunctory collaboration in brief meetings at the margins of the World-Bank IMF meetings (interview).

During the 1990s the increased involvement of the G-7 in the governance of global finance provided an opportunity for the G- 10 committees to develop closer links with an institutional process with political authority. Nevertheless there is a mismatch between the membership of the G-7 and the G- 10. There is also some mismatch between the G-10, consisting of central bank governors, and the membership of the committees which may include oficials, such as bank regulators, which may not be located in or report to central banks.

69

Efforts have been made to correct the deficiencies of the G- 10 committee system, including, in addition to the closer links with the G-7 political process, devising mechanisms for integrating non-G10 countries and the creation of the Financial Stability Forum. These correctives have an ad hoc and sluggish quality to them given the atmosphere of crisis of the 1990s. Moreover even with the creation of a more hierarchical and integrated structure of authority in the 1990s the G-10 system has no agreed system of accountability or representation linking its levels of authority as would formal international organizations or domestic political arrangements. This makes it less than ideally suited for the increased political challenges which, as discussed below, it is currently facing.

The Review of Policy lkear&, Spring 2002 19:l

It would be hard to trace these significant but idiosyncratic features of the regime for international financial regulation to the ongoing decisions of rational and conscious states acting in their self-interest.

70

Are Political Factors Modified by the Regime?

Yet firrther examination of the role of politics in the regime indicate that its character is inconsistent with rational choice approaches.

Both Kapstein and Oatley and Nabors through their study of the capital adequacy standards provide evidence of very conventional inter-state bargaining. In these approaches the agreement only came about because of the deployment of US threats to exclude other countries fiom the provisions of a bilateral agreement with the UK. This interpretation of the 1988 agreement can be challenged by pointing to the leadership role played by the Europeans on risk-based capital standards prior to US enthusiasm for it (Porter, 15193: 69-70). However even if their interpretation of this event were correct it would appear to be the exception. Politics is present but it is strongly shaped by the institutional character of the regime.

The intermingling of politics and institutional factors is evident in the way in politics intersect with the use of relatively informally organized and ad hoc committees that is a legacy of the G-10 tradition. An example is the ad hoc G-22 process and the creation of the G20, which brought together the G-7 and emerging market countries. It might seem odd that this key crisis- driven response to the need for a new financial architecture took place not at the BIS or the IMF, both of which have well established capacities and track records, but in an ad hoc grouping with no capacity to carry through on implementation. Unfortunately the structures of the IMF’s policy making Interim Committee and the BIS were not well suited to the task because of their rigidity and the high representation of European countries

P e Politics, Institutions, Constracdvism and the Emerging

relative to developing countries and non-European G-7 countries (interview). This institutional rigidity is consistent with a constructivist approach. It should be stressed that the G-22 itself was ad hoc but not the idea of relying on an ad hoc committee-- indeed, as noted above, the ad hoc committee is a central feature of the G-10 tradition. Similarly the G20 has been consciously organized along the lines of the G7 with its minimal level of bureaucratization (interview). Politics is present in the regime but it is pursued through institutional arrangements that are consistent with the regime’s traditions.

This feature of the regime was evident as well in the process by which the FSF, with its very limited accessibility to non-G-7 countries, was created. The FSF consolidates the political authority of G-7 over the regime without acknowledging doing so. Ostensibly the FSF is simply a logical extension of the development of the G-10 BIS based committees and IOSCO that seeks to bring more coherence to the relationships between a set of technical committees. Thus the political dimension of the G- 7’s initiative is present but is expressed through and shaped by the past trajectory of the regime’s institutions.

71

The ambivalent significance of this informal and tacit authority was evident in the February 20, 1999 post G-7 press conference given by US Treasury Secretary Robert Rubin. Rubin (1999) noted that “our second major focus, reform of the international financial architecture, took up a good part of our discussions. This is, as you know, and extremely complex issue and will it will take a long time to resolve in all of its facets.” Yet Rubin disclosed nothing new about the FSF, devoting a mere 228 words of the 2448 he uttered at the conference to the FSF despite three questions about it. This discretion, which is consistent with the traditional norms and practices of the G- 10 committees, also allows the G-7 to exercise a remarkable degree of monitored influence in developing the constitutive rules of the institution which is supposed to be the world’s principle organizational innovation in response to two years of financial crisis.

72

The Review of Policy aesearch, Spring 2002 19:l

The ambivalence of this informality with its interplay between political and technical factors is evident as well in the mechanisms established by the BCBS for integrating non-G- 10 regulators. The system of regional committees with informal links to the BCBS has certain positive features. The committees can consider regulatory and supervisory questions that are of particular concern to their region, problems from cultural and language differences can be reduced, and the lack of direct control by the G-10 reduces the danger that non-G-10 countries will feel that the G-10 policies are being imposed on them (interview). The large number of regional committees has extended the geographic reach of the system in an impressive way. According to one official from a G-10 country there is a widespread sense of ownership among non-G10 regulators with regard to the Core Principles. The desire to consult with non-G-10 regulators appears to be genuine and irreversible (interview). Nevertheless, the structure also leaves the intensity and frequency of this consultation at the discretion of the BCBS and lurking behind the collegial feel of the relations with regional committees is the potential threat that could be posed by the G-1O'working through the home-office based consolidated supervision of the G- 10 banks.

In short, political power is very much present in the international regime for financial regulation, but it is not the type of competitive and individualistic use of power that is portrayed by rationalistic approaches or that is present in other issue areas, such as trade negotiations, where political threats are used vigorously and loudly. Rather it is a type of power that works through the structure of the international institutions which have been developed.

To What Degme is Political Conflict Originated by States?

There are indications that the development of the regime has brought with it an increased potential for political conflict which stems more from other features of the contemporary institutional setting in which it is embedded than from the competitive state system.

Porten Politics, Institutions, Constmct~ 'vism and the Emerging

Three developments in the structure of the financial system have important implications for the politicization of the regime. First, there has been a growth in importance of securities markets, which impose risks on investors, relative to bank intermediated finance, in which the bank manages risk. Second, there is increased involvement of citizenry in the G-10 countries in investing and in international financial markets, either directly or through pension or mutual funds. Third, there has been a growth in importance of securities markets in developing countries relative to G-10 markets and to bank-intermediated inflows. These well-recognized structural changes, which cannot be further explored here, have embedded risks more deeply and widely in the fabric of citizens' daily lives. They have also undermined the basic principle on which the emerging international regulatory regime has been based: the focus on regulating the international operations of banks headquartered in the G- 10 countries through consolidated supervision.

73 As a consequence the regime has been drawn into conflicts from which it was previously able to remain isolated. For instance, during the debt crisis of the early 1980s the BCBS was careful to keep its focus on prudential bank regulation and to leave resolution of the debt crisis to other actors, including the IMF and finance ministries. But it has become far more directly involved in the crises of the 1990s. In these latter crises the high interest rates used to defend currencies against speculative attack put extraordinary pressures on domestic banking systems with large numbers of loans becoming problematic. The possibility of banking collapse therefore became one of the most serious dangers associated with the crises. Additionally the crises highlighted the inadequacies of emerging financial markets with respect to the disclosure and assessment of information. In G- 10 markets information is forced into the public sphere by such regulations as those governing disclosure or prohibiting insider trading. The regulatory issues addressed by the G- 10 committees and IOSCO thus began appearing more prominently on G-7 agendas, in IMF conditionality processes, and in the wider debate about the new financial architecture.

74

The Review ofPolicy Resear& Spriug 2002 19:l

Similarly the G- 10 committees and IOSCO had, fiom the beginning, managed to remain autonomous from the more politically conflictual process governing cross-border access to financial markets which took place primarily in the NAFTA and the WTO-related negotiations on financial services. By the end of the 1990s this separation between cross-border access and prudential regulation was being thrown into question, however. In part this was due to the expanded and more ambitious agenda of those promoting liberalized cross-border access through the WTO, the ill-fated campaigns for a Multilateral Agreement on Investment and to revise the IMF Articles of Agreement to give it a mandate for promoting liberalization of the capital account. With the East Asian crisis there was intense debate about the wisdom of liberalizing cross-border access given the consequences for domestic financial stability, directly linking the previously separated questions of prudential regulation and cross- border access (G-22,1998: 40).

The regime for financial regulation has become more vulnerable to political conflict as a result of these developments. Successful strengthening of prudential regulation is increasingly counterposed as an alternative to politically conflictual measures such as capital controls or default. Critics have begun questioning whether the types of regulation promoted by the regime are sensitive to the institutional conditions outside the G-1 0, in which other mechanisms for promoting stability may be optimal (eg. Wade and Veneroso, 1998). The increased prominence of charges that financial liberalization was being promoted by the US government at the expense of other countries and in the interests of its own financial sector (e.g. Kristof with Sanger, 1999) are likely to increase the sensitive related issues in the work of the G-10 committees and IOSCO, such as the question of whether the move towards acceptance of the internal risk models of banks by Basle regulators will confer a competitive advantage on the G- 10 banks which have developed a capacity for such modelling. The effort to involve the private sector more heavily in the resolution of crises, currently on the policy making agenda, is

Portel? Pollti* Instituti- construetrmsm . . and the Emcrgiug

likely to increase the entanglement of the regime for financial regulation in political controversies--how would an IMF sanctioned right of governments to impose emergency standstills on capital outflows, or clauses in bond contracts that commit investors to work collectively with borrowers in debt crises be dealt with by the regulatory regime?

Additionally there are certain areas in the ongoing work of the regulatory regime which resist quantitative and other technical solutions and are thus vulnerable to political conflict over interpretive practices. For example, the BCBS’s chair has noted that in today’s complex setting “supervisory activities, such as examinations, will become, if anything, a more important complement to capital regulation, and will be necessary to extract the true meaning of capital ratios and other analytical tools”. This is especially the case for stress-testing, which seeks to estimate the risks of rare but catastrophic events: “stress-testing is fundamentally a qualitative and judgemental process, usually superimposed on a more formal, statistical approach to risk measurement. As such, it is not susceptible to codification in quantitative capital requirements.” (McDonough, 1998).

While elements of inter-state competition are present in this growing potential for political conflict, as with the questions of competitive advantage, overall they relate much more directly to other institutional linkages between the regime and its environment which have entangled the regime in a range of controversies and to the developmental logic of the regime itself.

CONCLUSIONS

The above account of the development of the international regime for financial regulation has demonstrated that the regime has become consistently stronger over the past 25 years and that its institutions have had an impact on political dynamics in this issue area by bequeathing an idiosyncratic institutional structure with policy-relevant effects; by structuring power relations in patterns

75

The Review of Policy Research, Spring 2002 19:l

of institutional inclusion and exclusion rather than open state-to- state conflicts; and by entangling those engaged in the regime’s policy process in areas with increased potential for political conflict arising not directly from inter-state competition but from risks associated with the process of economic and political integration. These features of the regime contradict those approaches which do not envisage a possibility for the construction of significant international institutions in this issue area and those rationalistic approaches which minimize the independent significance of institutions.

76

This account of the regime also provides insight into the likely form that institutional change will take in this issue area. Developments in the regime and in its connection to the structural changes in financial markets have escalated the potential for political conflict. Yet the legacy of its developmental process makes forms of inter-state bargaining common in other issue areas ill-suited to the resolution of these conflicts. Potential political conflicts are only indirectly connected to inter-state conflicts. The regime’s strength is inseparabIe from its foundation in a particular tradition of highly technical practices the effectiveness of which have been essential for the regime’s development. Political conflicts are inextricably tangled up with the complex technical questions in which the regime has specialized. Thus institutional change is likely to be incremental, building on the G- 10 tradition rather than simply reflecting the distribution of state capabilities in bargaining processes. The Financial Stability Forum and the G20, the most significant outcomes of the debate that followed the East Asian financial crisis of 1997 and 1998, are consistent with this constructivist emphasis on institutional continuity.

NOTE

Nine interviews with officials who have been involved in the institutions discussed in this article were invaluable and the author wants to express his gratitude for them and for comments on an earlier draR by Bill Coleman. In addition to the sources cited,

Port= Politics, Institutions, ConstroctiviSm and the Emerging

information on the organizations discussed is available from the BIS and IOSCO websites and annual reports.

[ 11 The literature on global finance is vast and impossible to summarize here. This essay focuses on regulatory institutions and only peripherally on other financial institutions like the IMF for which institutionally-sensitive approaches are better developed. For an exception to the rationalistic approach to regulatory institutions which this essay criticizes see Underhill, 1997.

REFERENCES

Andrews, David. 1994. Capital Mobility and State Autonomy: Toward a Structural Theory of International Monetary Relations. International Studies Quarterly 38: 193-218.

Basel Committee on Banking Supervision. 1998. Report on International Developments in Banking Supervision. Basel: BIS.

Basel Committee on Banking Supervision. 1997. Press Statement. September 22. At www.bis.org/press/p970922.htm.

Cerny, Philip G. 1994. “The Dynamics of Financial Globalization: Technology, Market Structure and Policy Response,” Policy Sciences 27(4): 3 19-42.

77

Committee on Payment and Settlement Systems. 1998. Reducing Foreign Exchange Settlement Risk: A Progress Report. Basel: BIS.

Federal Reserve Board. 1994. “The Bank for International Settlements and the Federal Reserve,” Federal Reserve Bulletin 80 (lo), October: 900-906.

Franck, Thomas M. 1995. Fairness in International Law and Institutions. Oxford: Clarendon Press.

Giles, Martin. 1996. “A Survey of International Banking,” The Economist. April 27. Special Section.

Gill, Stephen and David Law. 1993. “Global Hegemony and the Structural Power of Capital,” Stephen Gill, ed., Gramsci, Historical Materialism and International Relations. Cambridge: Cambridge University Press: 93- 124.

Group of 7. 1998. “Global Financial Architecture: A Plan for Implementation as Presented to the Heads in December 1998,” Available as an Annex to the Communiquk of (3-7 Finance Ministers and Central Bank Governors February

The Review of Policy &sear&, Spring 2002 19:1

20, 1999, Bonn, available at www.ustreas.gov/press/releases/pr2964.htm

Group of 22. 1998. Report of the Working Group on Strengthening Financial Systems. Available at www.bis.org.

Helleiner, Eric. 1994 States and the Reemergence of Global Finance: From Bretton Woods to the 2990s. Ithaca and London: Cornell University Press.

Interview. Nine interviews with individuals who have worked with one or more of the institutions discussed in this article. Conducted in Washington, Ottawa, Toronto and Base1 in 199 1 (one), 1998 (three), 1999 (four), and 2000 (one).

International Organization of Securities Commissions. 1996. “Report from the Chairman of the Emerging Markets Committee,” IOSCO Annual Report. IOSCO: Montreal.

International Organization of Securities Commissions. 1998. Final Communiquk of the 23rd Annual Conference of the International Organization of Securities Commissions. September 18. Available at www.iosco.org/press/ presscomm9809 18-eng.htm1.

Kapstein, Ethan Bamaby. 1992. “Between Power and Purpose: Central Bankers and the Politics of Regulatory Convergence,” International organization 46( 1) Winter: 265-87.

78

Kristof, Nicholas D. with David E. Sanger. 1999. “How U.S. Wooed Asia To Let Cash Flow In,” New York Emes February 16, p. Al, A10-All.

McDonough, William J. 1998. Issues for the Basle Accord. Remarks at the Conference on Credit Risk Modeling and Regulatory Implication, London, Sept. 22. Federal Reserve Bank of New York, www.ny.frb/pihome/news/ speeches/mcd980922.html.

McKenzie, Richard B. and Dwight R. Lee. 1991 Quicksilver Capital: How the Rapid Movement of Wealth has Changed the World. New York The Free Press.

Oatley, Thomas and Robert Nabors. 1998. “Market Failure, Wealth Transfers and the Basle Accord,” International Organization. 52( l), Winter: 35-54.

Rubin, Robert E. 1999. Post-G-7 Press Conference. February 20, Bonn Germany. Available at www.ustreas.gov/press/releases/pr2966.htm.

Portem Politics, Institutioos,

Ruggie, John Gerard. 1998. "What Makes the World Hang Together? Neo- utilitarianism and the Social Constructivist Challenge," International Otganization 52(4), Autumn: 855-85.

and the BmcrBty

Simmons, Beth. 1993 "Why Innovate? Founding the Bank for International Settlements," World Politics 45(3) April: 361-405.

Strange, Susan. 1986. Casino Capitalism. Oxford: Basil Blackwell.

Strange, Susan. 1990. "Finance. Information and Power," Review of International Studies. Vol. 1 6 259-74.

Tietmeyer, Hans. I 999. Report. February I I. In BIS Review, 2 1, at www.b~org.

Tripartite Group. 1995. "The Supervision of Financial Conglomerates. Executive Summary," July. In BCBS Compendium of Documents Produced by the Bade Committee on Banking Supervision Basle: BIS, 1997: 64-71.

Underhill, Geoffrey R.D. 1997. "Private Markcts and Public Responsibility in a Global System: Conflict and Co-operation in Transnational Banking and Securities Regulation," in Geoffrey R.D. Underhill. ed. The New World order in International Finance Basingstoke: Macmillan: 17-49. 79 Wade, Robert and Frank Venemso. 1998. "The Asian Crisis: The High Debt Model Versus the Wall Street-Treasury-IMF Complex," NmL@Rm'm. 228. MarcWApril: 3-23.

ABOUT THE AUTHOR

Tony Porter is an Associate Pmfessor of Political Science at McMaster University. Hamilton, Ontario, Canada. He is the author of &&J&&&

bal F m (Basingstoke: Macmillan, 1993) and coeditror. with A. Claire Cutler and Virginia HaufleK of Private

(Albany: SUNY Press, 1999).