Jean-Claude Trichet: The international financial architecture - where do we
stand?
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the Conference
"Dollars, Debt and Deficits - 60 Years after Bretton Woods", Madrid, 14 June 2004.
* * *
It is a great pleasure to be here in Madrid at the invitation of the Banco de España and the
International Monetary Fund. The 60th anniversary of the Bretton Woods institutions is indeed an
important opportunity to take stock of key events, developments and issues that have shaped and are
shaping the international financial system. Let me thank the organisers, and especially our host
Jaime Caruana, for setting up a very interesting programme for this conference that encompasses all
these key topics. Tonight, I would like to offer some thoughts on the question "the international
financial architecture - where do we stand?" In my remarks, I will first have a short look back at the
changes to the international architecture over time, before concentrating on reform efforts that have
been undertaken in four areas, namely the institutional setup, transparency and best practices,
regulation of financial markets and crisis prevention and resolution.
Let me briefly look at the changes to the international financial architecture over time. The key
aim of today's policy makers has not changed compared to those at the Bretton Woods times - it has
been, and still is, global prosperity and stability - but the environment in which we are acting has
changed profoundly. The founders of the IMF and the World Bank wanted to create institutions that
prevent countries from falling back into autarky and protectionism and that help them to raise growth
and increase stability in a world of fixed exchange rates with still a large degree of capital controls.
Today we are striving for stability of the international financial system in a world of free capital flows
with a growing importance of private flows and increasing trade and financial integration. Among the
major factors that we have to take into account, I would like to mention in particular:
• The financial globalisation phenomenon: capital market liberalisation, both domestically and
internationally, technological advances and buoyant financial innovations have contributed to
set up a totally unknown degree of financial globalisation - with great benefits, but also new
risks.
•
The policy responsibility which still lies mainly with sovereign states; thus, the challenge is to
promote global financial stability very largely through national actions enlightened and
co-ordinated through a larger degree of intimate international co-operation.
•
A very large consensus on giving the private sector and markets a central role on the one
hand, and relying upon sound public institutions to provide market participants with the
appropriate environment on the other hand. This shift from direct public involvement to
private activities is particular striking when looking at financial flows to emerging markets: in
the 1980s, official flows were dominant, reaching on average over 60% of total flows to
emerging markets. By contrast, the 1990s saw a dramatic increase in private flows, which on
average accounted for around 85% (in the period from 1990 until 2003). Equally striking is
the shift from bank loans to negotiable securities as the major financing tool for the
developing countries.
• The integration of the European Union, reinforced with the introduction of the euro, has
increased the economic, monetary and financial stability of a region that constitutes today
the world's largest trading partner and the second largest economy. The EU has also been
crucial in anchoring the transition process in central and eastern Europe, and in fostering
stability and prosperity in this region.
The dynamics of today's world call for continued adjustment at a global level. New challenges have
been added to existing ones, such as poverty reduction. New actors gained prominence on the
international scene, with developing and emerging markets becoming progressively full participants in
the globalised economy. The financial crises of the 1980s and the 1990s, characterised by large and
sudden private financial flow reversals, marked by a very powerful contagion phenomenon and
demonstrating some of the potential and actual vulnerabilities of the newly globalised financial system,
led to an ambitious reform agenda to strengthen the international financial architecture.
Let me focus on the lessons from the crises in the 1990s and the ensuing work on the international
financial architecture.
On the basis of the experience with the Mexican crisis in 1994/95, the G7 summit in Halifax in June
1995 initiated work on improved crisis prevention and management. It called for improved
transparency, both at the level of individual countries and at the IMF, and for strengthened IMF
surveillance. The Halifax summit also pointed to the importance of effective financial regulation,
market-reinforced prudential supervision and enhanced international co-operation among regulators
and supervisors. As for crisis management, concrete proposals were presented in the Rey report to
G10 Ministers and Governors in May 1996.
Work was stepped up in the aftermath of the Asian crises, which revealed further vulnerabilities in
national and international financial systems. But most importantly, the crises in the later 1990s showed
that the systemic changes in the world's financial markets required systematic changes in the policy
framework that underlies the international financial system. Almost a decade later, we can say that
many of these proposals have been implemented. Let me now focus on four different areas, which I
consider most important:
The first area concerns the international institutional set-up, which, in my view, has been
strengthened significantly since the 1990s. The existing international financial institutions, in
particular the IMF, the World Bank and the BIS maintained their central role in the system. But they
were subject to several changes to sharpen their respective focus, to reinforce their policy advice and
financial support, to enhance their transparency and accountability and to strengthen their
governance. The Bretton Woods institutions, and particularly the IMF, underwent profound changes to
adapt to the new environment. In addition, new fora have been created in response to the widening of
the number of actors in the global economy and the growing importance of international financial
markets. The creation of the G20 in 1999 constituted in my view a decisive and highly welcomed step
to reflect adequately the newly globalised economy. The G20 has turned into the international forum
for appropriate dialogue and consensus building between all economies that have a systemic
influence, whether industrialised, emerging, or in transition. Equally important is the Financial Stability
Forum, which is the first informal grouping to fully recognise the existence of a global integrated
economic and financial system. It is also the first forum to set the goal of systemic optimisation of each
of the subcomponents of the system, whether it is banking surveillance, insurance surveillance,
securities market control, accounting rules, good practices of public and private sectors, functioning of
the major market places, governance of the IFIs etc. At the regional level, the European Union has
established a whole universe of arrangements for co-operation that is constantly being adjusted to its
changing needs and European institutions are becoming increasingly involved at the international
scene, for instance with the EU-US regulatory dialogue.
Overall, improving the governance of the international institutions and optimising the work of the
informal groupings will always remain a moving target given that these entities permanently will have
to adapt to a changing environment. However, with the changes introduced in the recent years, the
foundations of the international financial system have been strengthened considerably.
The second area I would like to highlight regards the work to enhance transparency and
promote best practices, where significant progress has been achieved in a number of fields.
Indeed, a wide-spread consensus has developed, which considers reliable and timely information on
economic and financial data as a precondition for well-functioning markets, since it facilitates better
risk assessment and management and hence strengthened market discipline. The IMF's special
standard for dissemination of economic and financial data has become a widely recognised
benchmark to which a large and increasing number of countries have subscribed. There is now a
presumption that IMF papers on Article IV consultations and on Fund programmes are published.
International codes of good practices have been agreed upon, such as the ones on transparency in
fiscal policy and on transparency in monetary and financial polices. Moreover, countries' compliance
with the 12 most important standards and codes are regularly examined by the IMF and the World
Bank in so-called ROSCs (Reports on the Observance of Standards and Codes), many of which are
made publicly available and have a positive impact on the market's assessments of the countries
concerned.1 I consider that the progress made in the field of transparency after the Asian Crisis is one
of the main explanations for the absence of contagion in the emerging world when the Argentine crisis
erupted.
Transparency in the private sector is also crucial for well-functioning international financial markets.
Reliable and timely company information are one key element to transparency, which is provided
mainly through financial statements. Recent corporate scandals have again brought to our minds the
crucial role that accounting standards play in this respect. In this context, I attach great importance to
the reform of the International Accounting Standards (IAS) and the key role of these standards in
advancing the European single market. The IAS, which will apply to all listed companies in the EU, are
expected to have a major impact on the European banking system. The banking sector will particularly
be affected through the proposed valuation rules for financial instruments and through the rules on
disclosure.
The ECB has a strong interest in this debate mainly from its focus on contributing to the maintenance
of financial stability. Thus, the primary objective of this reform has our full support as it aims to
minimise the gap between the reported information and the true risk profile of a company. I am also
fully aware of the complexities stemming from the interrelation of accounting standards with other
reporting schemes for supervisory and statistical purposes. However, some proposals have given rise
to concerns also within the ECB. In particular, those proposals relating to an extensive use of fair
values raised concerns about the possible adverse implications on the volatility of bank income and,
eventually, on bank behaviour and on financial stability. As a consequence, the ECB contributed to
this debate, highlighting the concerns and showing their relevance. The more recent proposals from
the IASB moved into the direction of limiting the use of fair values for those items that can be reliably
measured. The revised proposals should help to avoid undesirable consequences such as an artificial
increase in income volatility. At the current juncture, the ECB is carrying out an exercise to check the
likely impact of the new standard.
While these issues apply to all financial markets, the EU faces a particular challenge relating to the
advancement of the single market. The introduction of harmonised EU rules regarding the setting-up
of financial statements are considered to be a crucial step towards the further integration of the
financial markets in the euro area and the European Union. Indeed, improved comparability of
disclosed information would facilitate cross-border investment and further market integration. Thus, in
2002 the European Parliament and Council adopted a Regulation requiring listed companies to
prepare consolidated financial statements in accordance with IAS from 1st January 2005. A specific
endorsement process is in place to ensure legal certainty and consistency with EU public policy
concerns. This process already allowed to endorse all IAS with the exception of the two standards
concerning recognition, measurement and disclosure of financial instruments. Recently, in order to
deal with the remaining controversial issues, the Commission took the initiative to establish a
high-level dialogue between all the constituencies interested in high quality accounting principles. I
remain confident about the positive impact of prudently implemented International Accounting
Standards on the stability and efficiency of financial markets in the EU.
The third area relates to the strengthening of financial regulation in industrialised countries.
Here, let me recall that recent crises exposed weaknesses in the risk management practices on the
part of creditors and investors in industrial countries, pointing to the importance of financial market
regulation and supervision.
We all are aware of the importance of effective financial regulation and supervision to maintain
financial stability and protect consumers, also in light of the increased complexity of financial services
and products. Let me say one word on one important aspect of financial regulation, which is the reform
of the Basel Capital Accord, coined Basel II. I am convinced that our host, Mr. Caruana, who is the
chairman of the Basel Committee on Banking Supervision, could off hand fill the evening by
elaborating over the main features of this reform. From what I gather, your efforts are bearing fruits
and we may expect a final text to be hopefully endorsed by the G10 Governors and the Heads of
banking supervisory authorities in the forthcoming weeks.
The Basel II reform is of key importance. New and bold developments in the banking industry are the
ultimate reason for engaging in this reform.
The ECB has expressed on various occasions its supportive stance to the new framework. The ECB
was also among the first to point out the possible macro-financial implications of any banking
prudential scheme, highlighting the potential procyclical effects that might be induced by any
framework relying on a comprehensive real time risk analysis. These concerns have been taken into
account in the final version of the new framework which aims at being neutral over the cycle. Looking
ahead, we have to recognise that we stand at the beginning of the road. The success of this reform
will crucially hinge on a sound implementation of the new framework requiring strong co-ordinating
efforts among the supervisory authorities on a global basis. With regard to the EU context, the new
institutional setting based on the Lamfalussy framework comprising a two-tier structure of regulatory
and supervisory committees is expected to play an important role in ensuring a more uniform and
flexible EU regulation and consistent implementation resulting from convergence in supervisory
practices.
As fourth and last area, I would like to mention crisis prevention and management. Of course,
the various efforts I mentioned so far should be conducive to prevent crises from happening. However,
crisis prevention primarily rests with every single country with strengthened macroeconomic policies
and financial systems. In that context, the experience of the past decade has highlighted the crucial
importance of well-functioning domestic rules, regulations and institutions namely the legal framework,
the regulatory system, the enforcement mechanisms, and authorities that shape and permit the
optimal functioning of a market economy with its financial markets. This includes, in particular, central
bank independence, rules for monetary policy and for fiscal policies, appropriate supervisory
frameworks and authorities. There is strong evidence linking well-functioning institutions and good
governance to positive economic and social outcomes. Institutional factors appear to be as important
as productive factor endowments or any other explanations in determining cross-country differences in
the overall level of development.
I am confident that these lessons feed into improving domestic policy-making in emerging market
economies, making them more resilient to withstand shocks. The continued efforts to strengthen IMF
surveillance play also a crucial role in that respect.
It is clear that crisis prevention must remain the key area of all our efforts. Crises are costly for the
countries concerned and also for the international system. Given the increasing economic and
financial importance of emerging markets, major events in these countries are bound to have spill-over
effects to the rest of the world. Let me underpin this argument with some figures: In the last four years,
major emerging markets contributed to about half of global real GDP growth (in PPP terms),
accounted for roughly 30% of world exports and received about 20% of global FDI.
Turning to crisis management, important lessons have been learnt. There has been a growing
recognition that more predictability is required on the side of the official sector in order to set the right
incentives for all the actors involved. Moral hazard concerns and the limited availability of official funds
also led to increasing discussions about the appropriate involvement of the private sector in crisis
management. Of course, every single crisis is different and hence there is in each case the need to
find the appropriate balance in the triangle of domestic adjustment, private sector involvement and
official support. Therefore, crisis management in practice still has to struggle with the inherent tension
between rules and clarity on the one hand and discretion and flexibility on the other.
However, considerable progress has been achieved. First, specific criteria and procedures have been
set up last year to make exceptional access to Fund resources subject to rules and hence more
predictable. We in Europe have been very much in favour of setting such clear rules and clear limits to
Fund financing in view of the very large financing packages provided to countries in the 1990s. The
IMF's debt sustainability analysis will play an important role in that context, since clear limits to official
financing must be respected especially when a country faces an unsustainable debt burden and hence
requires a debt restructuring. All IMF shareholders now need to stick by these rules, not least in order
to provide the right signals to the markets and to avoid the impression that the official sector suffers
from time inconsistency between the approval of policy principles and their actual implementation.
Second, following Mexico's bond issue with Collective Action Clauses (CACs) in February 2003,
several emerging markets included CACs in bonds issued under New York law. More than 70% of
new bond issues since early 2004 include CACs. As you probably know, no discernible impact on
borrowing costs could be detected. In order to help making CACs a standard feature in sovereign
bond contracts, the EU Member States committed themselves to include CACs when issuing new
bonds under foreign jurisdiction. All this progress is very remarkable, especially when comparing it to
the rather sceptical stance many countries and many private sector representatives had taken in the
past vis-à-vis the recommendations in the Rey report after the Mexican crises. Of course, so far these
clauses have not been tested in practice and it will take some time until CACs are included in the
entire stock of debt.
Finally, work is proceeding on a so-called Code of Good Conduct, which I suggested myself at the IMF
Annual Meetings in September 2002. Such a Code would define best practices and guidelines for the
behaviour of debtor countries and creditors regarding information-sharing, dialogue and close
cooperation in times of financial distress. While the IMF and the G7 encouraged further work and the
G20 is closely following the process, at present the official sector confines itself to a catalysing role
and leaves the floor to the true stakeholders in the process, i.e. emerging market issuers and private
sector representatives. I understand that currently intensive discussions are taking place on the main
elements of such a Code. I would like to encourage all parties to be as active and constructive as
possible in working out what could be a significant new tool to prevent and help solving potential
crises.
Closing remarks
We have the unique chance of living in a world which is full of opportunities, very inspiring and very
complex, very rewarding and very demanding, full of chances and of risks. We have all been the
witness of two incredible transformations of the global economy over the last twenty five years. The
technological surge which has permitted to compute and to transfer information at practically no cost.
The globalisation process which aims at connecting all economies and finances of the world within the
same market-economy based framework. So that goods, services, capital, technologies, concepts,
ideas are moving very rapidly or even instantaneously all over the globe, expanding considerably, in
quality and in quantity, the domain of the Ricardian comparative advantage. The significant surge of
labour productivity in a number of industrialised economies, the taking off of India, China and a very
large number of emerging countries, the rapid race of global growth. These are great successes of
today's economic world of which global finance, mirror-image of a global economy, is both the emblem
and the very powerful tool. But there is no economic success without risks. We have been living
permanently in a risky environment over the last twenty-five years. Amongst many risks, we might
mention: the debt crisis during the 1980s, starting with Poland and Mexico and spreading to Latin
America, Africa, the Middle East and the Soviet Union; the stock exchange fall in 1987; the Mexican
crisis in 1994; the bond market crash in 1994; the Asian crisis starting in 1997; the LTCM and Russian
crises in 1998; the recent stock exchange fall and the collapse of the technology bubble in 2000. We
have surmounted all these crisis episodes. We have learned a lot and we have improved a lot in these
occasions. One of my friends used to say: "Good management comes out from experience and
experience comes out from bad management!" I think we are pretty experienced now and I take it that
thanks to the lessons drawn we have now achieved a level of crisis prevention which is much better.
But we should never forget that the risks are still there because they are intimately associated with the
structural transformation of the global economy. This is not, in any respect, a time for complacency.
If I had to sum up what should be our today's mottos, I would make the following five
recommendations:
•
Let us not forget the crucial role of the IFIs, in particular the Bretton Woods institutions, in the
management of the present global economy. The constant improvement of their
management and instruments is key;
• Let us tirelessly improve transparency in all fields: it is the best recipe for avoiding both
misallocation of capital and global crisis contagion;
•
Let us continuously improve the flexibility of our economies through bold structural reforms.
Not only because it improves efficiency but also, all the more, because it improves resilience
in a world where shocks are to be expected;
•
Let us reinforce our methodology to ensure that we do not amplify "pro-cyclical" phenomena:
the best envisaged at a local or sectoral level can be the enemy of the good at a global
systemic level. In this respect such informal groupings like the G20 and the Financial
Stability Forum are of the essence;
•
Let us join efforts to improve our scientific knowledge of the new world economy. Still today,
academics and practitioners are observers and actors within the environment of largely
uncharted territories. The more profoundly we understand the functioning of today's global
economy, the more efficient we will be to weather stocks, to prevent crisis, and to pave the
way for continental and global job creation, steady growth and overall stability.