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Following is the speech by the Executive Director (Banking Policy) of the Hong Kong Monetary Authority, Mr Simon Topping, at the Institute of International Finance and the Financial Supervisory Commission / Financial Supervisory Service IIF-FSC/FSS Regional Regulatory Forum "Strategic Dialogue on Effective Regulation in Asia" in Seoul on "Introduction to the Proposal for a Strategic Dialogue on Effective Regulation" today (May 10) (English only):
Let me start by saying that this initiative is certainly very welcome. It is always worth exploring ways in which the process of regulatory policy-making can be improved.
The "Guiding Principles" set out by the IIF are ones that everyone in the regulatory community should have no difficulty in endorsing. They make explicit what has been best regulatory practice for some years. In the HKMA, for example, we approach the policy-making and rule-making process as very much a dialogue with the private sector and we try to be responsive to private sector concerns. During our implementation of Basel II, for example, we set up a Consultation Group, comprising representatives of a cross-section of the banks in our jurisdiction, which had the opportunity to contribute ideas and help shape our implementation plans from an early stage. Similarly, we have an Industry Working Group on anti money laundering and terrorist financing, which has helped ensure that our AML guidelines are practical and address the real-world issues faced by banks.
Thus, rather than talk about the Principles - on which there is broad agreement - I think it would be more valuable to spend time discussing the concerns that have given rise to this initiative.
The IIF Principles are a reaction to what is perceived by the industry to be the growing complexity and uncertainty of the current regulatory environment. There is also a concern about the burden of regulation and inconsistent treatment across jurisdictions, and there is a sense that regulators are not consulting sufficiently well.
Regulators must always balance the benefits of regulation against its costs and should only make rules to correct market failures that the private sector cannot itself correct. All this is common ground and is reflected in the IIF's Principles.
However, there is a saying that the devil is in the detail. We have to examine how we apply this broad agreement to actual problems.
First, the growing complexity of the regulatory environment. There is little doubt that regulation has become more complex over the past twenty years - but so too has the industry. Regulation has become more complex in large part because the activities that we are trying to regulate have become more complex. For example, in 1988, when Basel I was agreed, securitisation hardly existed. However, a significant part of the Basel II document is devoted to rules on securitisation; this was necessary to ensure that the capital adequacy regime remained relevant in today's financial markets. Another lengthy section of Basel II deals with credit risk mitigation, such as credit derivatives. Although they are complex, these rules were actually designed to with the aim of giving banks a capital benefit from these risk-reducing innovations.
The question is, then, whether all this complexity is necessary. Given the complexity of the products and markets that regulators are dealing with, some complexity is going to be inevitable.
This leads me to the second issue - about the regulatory burden. Whether the current regulatory regime strikes the right balance between costs and benefits is a debate that is worth having. We need to make sure that the regulatory burden does not become too great - not least because regulation could then become self-defeating as more and more business shifts to unregulated sectors. The rise of hedge funds might possibly be an indication that we haven't struck the right balance in some areas.
One response to this problem - which some in the industry seem to favour - is to have broad principles rather than detailed rules. The principles vs rules debate is one that would take too long to go into fully here. But, personally, I am not persuaded that a principles-based approach would necessarily be an improvement. One concern relates to the possibility of inconsistent treatment between different financial institutions. This is far more likely under a principles-based approach than under a rules-based one. Another consideration is that for a principles-based approach to work it requires an infrastructure of good corporate governance, internal control and organisational culture. In many emerging markets the appropriate infrastructure is still under construction and for this reason the private sector generally looks to the official sector for quite detailed guidance. A principles-based approach is unlikely to work in this environment. On the contrary, what many banks often tell us is that they want more certainty, and clear standards and benchmarks to give them a good idea of what supervisors expect of them, rather than high-level principles which may mean different things to different people.
Rather than pursuing a principles-based approach we should look instead at the regulatory burden and make sure that the rules we set are proportionate to the problems being addressed. As I've said, that is a debate worth having. But inevitably such a debate has to be conducted case-by-case and regulation-by-regulation. We cannot identify and solve the problems through a high-level strategic dialogue.
Concern about the regulatory burden also has another dimension. This relates to the rapid succession of new initiatives. The fact that banks had to work on Basel II and new International Accounting Standards like IAS 39 at the same time was a particular concern. The regulatory community is aware of this problem and we are making best efforts to ensure that not so many new initiatives are crowded together in future. The key to this is dialogue, particularly between the various standards-setting bodies. This is more extensive than in the past.
Let me turn to the third issue - that of consultation. It is necessary to distinguish between consultations at two levels. The first is at the domestic level. At the HKMA we pride ourselves on the extent to which we consult the private sector and our responsiveness to private sector concerns. While I like to think that we are one of the leading jurisdictions in this respect, I also know we are not alone in the importance we set on consultation.
At the international standard-setting level there has also been extensive consultation with the private sector. The Basel Committee was proactive in seeking industry views when developing the new Basel II framework. The resulting framework reflected industry input to a much greater degree than its predecessor.
Where there does seem to be scope for improving consultation is in bringing a more diverse range of countries, experiences and expertise into the standard setting process. At the HKMA we find that our policy of adhering closely to international standards means that we are sometimes committed to following standards which we have not been able to influence to any substantial extent. This view is shared, I believe, by many of my colleagues throughout Asia and by private sector institutions in the region. Thus it seems to me that giving a greater voice to Asia - both official and private sector - in the standards setting process is a goal worth pursuing. It would also be a way of furthering the objectives of the IIF's Guiding Principles.
Ends/Thursday, May 10, 2007
Issued at HKT 17:40
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