In 2004, the IMF issued a working paper WP/02/46, Regulatory and Supervisory Independence and Financial Stability, asking, “Should Financial Sector Regulators Be Independent?” The paper argued that political interference in regulatory decisions during a crisis “made a bad situation worse.” However, the paper also noted the downside of regulators and the notion of “regulator capture” by pressure groups that can manipulate agendas. Financial regulation is an essential mechanism that provides the framework to build robust financial systems. But as the digitization of banking and payments crosses borders, can localized regulations remain effective? Or is regulatory cooperation essential in a global financial marketplace?
The seeds of change within a crash
Four years after the 2004 IMF paper, the world reeled from the 2008 banking crash. Globalization of banking meant that aftershocks from the crash were felt worldwide. In April 2009, the G20 agreed to principles for dealing, at the global level, with the damaged financial system to rebuild trust and fund and reform international financial institutions. These measures were set against the backdrop of the banking crash, exacerbated by the globalization of banking. The G20 recognized that banks, having a global presence and global partnerships, had to deal with varying jurisdictional financial regulations. Out of the maelstrom of the 2008 crash and the mosaic regulatory geo-landscape, The Financial Stability Forum recommended extending and strengthening “international standards of prudential regulation” and “to avoid creating new opportunities for regulatory arbitrage by firms.” Dr Jon Danielsson of the London School of Economics added weight to this notion. Dr Danielsson described the idea of “supervisory colleges” to establish regulatory cooperation.
Why is regulatory cooperation needed?
Standardization of protocols and messaging systems for interoperability is a form of cooperation that drives payment innovation. The latest messaging development, ISO20022, is a messaging standard that facilitates cross-border payments and allows FIs to compete globally.
Regulatory divergence has also been shown to have material impacts on the global economy. A paper by the OECD and IFAC (International Federation of Accountants) found that regulatory divergence in the financial sector costs around 5-10% of annual turnover. The paper also points out that over half of all FIs (51%) have had to divert resources from risk management because of regulation variances.
A 2020 joint report from the Carnegie Endowment for International Peace and the World Economic Forum, “International Strategy to Better Protect the Global Financial System against Cyber Threats,” developed in collaboration with the World Economic Forum, highlights that increased collaboration between government agencies, financial firms, and tech companies is needed to reduce the risks of the digitization and globalization of banking.
Cooperation leads to collaboration, which reduces risk. Regulations themselves are beginning to incorporate the notion of cooperation into the scope of requirements. For example, the EU’s DORA (Digital Operational Resilience Act) seeks to enhance cooperation between authorities in the financial sector.
The advancement in AI is already seeing high-profile collaboration between regulators in an attempt to enforce global controls. Like information sharing on cyber-threats or interoperability, regulatory authorities are being pushed towards a more cooperative future.
Financial regulation cooperation today
Fast-forward to 2023, and alliances between countries and jurisdictions have already formed or are forming; some examples include the following:
2016 saw the inauguration of the EU-Asia Pacific Forum on Financial Regulation. The forum is an opportunity to discuss financial regulatory and supervisory developments in cross-border cooperation between EU and Asia Pacific authorities.
In 2018, the UK-U.S., The Financial Regulatory Working Group was formed to “deepen bilateral regulatory cooperation with a view to the further promotion of financial stability; investor protection; fair, orderly, and efficient markets; and capital formation in both jurisdictions.”
In June 2023, the EU and UK signed a memorandum of understanding (MoU) on enhancing regulatory cooperation in financial services. The MoU creates a Joint EU-UK Financial Regulatory Forum that will establish regulatory standard compatibility and encourage the exchange of information between the two parties.
The EU has established MOUs with global bodies and overseas jurisdictions; the FCA holds a list of MOUs in place.
The Middle East is another progressive location promoting regulatory cooperation. Abu Dhabi’s ADGM Financial Services Regulatory Authority (FRSA) is based on progressive, collaborative relationships across jurisdictions. The FRSA has signed numerous multilateral and bilateral MoUs with international regulatory authorities and financial centers.
Underpinning cooperation amongst financial regulators is the sharing of information. Numerous bodies exist to provide a legal framework to facilitate information sharing. These include the IOSCO (International Organisation of Securities Commissions), the BCG (Basel Committee Consultative Group), and the WAIFC (World Alliance of International Financial Centres).
Cooperation is unlikely to result in universal financial regulations, as cultural differences must be acknowledged. However, cooperation on the themes of regulation and enforcement can result in effective enforcement systems and more efficient cross-border financial activity.
The future of regulatory cooperation
Banking benefits from cross-border collaboration, with innovations such as fast payments, real-time payment rails, and standards such as SWIFT and ISO20022, helping to build foundation stones for international payments. But cross-border business can also lead to complex environments of operation. One of the latest challenges to a complex financial landscape is the regulation of crypto assets. A 2022 paper from the FSB concludes that global authorities must “prioritize cross-border and cross-sectoral cooperation.” The paper notes that enhanced monitoring and the minimization of regulatory arbitrage through cooperation and information sharing are needed to do this.
Having regulatory cooperation does not mean a stifling of innovation; it can result in better conditions for banking by ensuring that controls are standardized. Fifteen years after the 2008 bank crash, greater global collaboration is now urgent; banks, FIs, government, and tech vendors must work together to ensure that regulations work across borders and can be enforced in the global marketplace.
Eastnets has developed intelligent monitoring solutions that can keep pace with the change in market and regulatory conditions. Working with regulations, our solutions can provide the technology to enforce requirements, even with cross-jurisdictional complexities.
Read Eastnets reasearch paper: Cross-border collaboration: A game-changer in the fight against financial crime?