Task Force on International
On 22 October 1998, the Australian Prime Minister announced that he had commissioned a Task Force, chaired by the Federal Treasurer, to advise on how Australia can contribute to international financial reform. The Task Force was specifically requested to draw on the expertise of public and private sector members to provide suggestions for reform that Australia could pursue in appropriate international forums.
Peter Costello, MP, Treasurer (Chair)
Peter Boxall, Secretary, Department of Finance and Administration
Ashton Calvert, Secretary, Department of Foreign Affairs and Trade
Ted Evans, Secretary, Department of the Treasury
Malcolm Irving, Director, Telstra Corp Ltd
Ian Macfarlane, Governor, Reserve Bank of Australia
Max Moore-Wilton, Secretary, Department of the Prime Minister and Cabinet
David Murray, Managing Director, Commonwealth Bank of Australia
John Phillips, Chairman, IBJ Australia Bank Ltd
Bill Shields, Executive Director, Macquarie Bank Ltd
George Trumbull, Chief Executive Officer, AMP Ltd
The Task Force presented its report to the Prime Minister in December 1998. Following is a summary of the key findings of the Task Force.
Reform will require a global response
The volatility in international markets was the result of policy shortcomings in both emerging and developed markets, along with inappropriate risk assessments and investment decisions by the private sector. The required policy adjustments do not rest solely with the emerging markets. Achieving greater stability in the international financial system will ultimately depend on the extent to which all countries pursue sound economic and regulatory policies. While reform will depend on policy responses by every government, the increasing internationalisation of financial systems emphasises the need for a coordinated response.
Support should be given for the continuation of the movement towards open international capital markets. For those countries which lack the macroeconomic and regulatory arrangements necessary for dealing with large flows of mobile capital, liberalisation will need to be gradual and consistent with the development of a countrys financial infrastructure. In some cases, there may be a need for temporary measures to ensure stability and to protect the domestic financial system from potential disruption from large short-term capital flows until the foundations are in place. At the same time, they should be encouraged to continue to put in place the necessary conditions for further gradual moves towards liberalisation. The overall aim of efforts to reform the international financial system should not be to restrict capital flows, but to make them more soundly based and more stable.
Reform will need to be progressed through an international grouping with a wide representation, such as the G22, and will require the active involvement of the private sector. The continuation of the G22 process should be supported, for it has been a constructive step towards reforming the international financial system. Maintaining the momentum for reform is crucial.
Improved transparency by corporations, governments and international financial institutions (IFIs) is needed. However, the focus should not merely be on calling for borrowers to disclose more information. It is important to ensure that the incentives are there for information to be used and incorporated in appropriate risk assessments, which will, in turn, result in more soundly based investment decisions. In particular, this will involve minimising implicit or explicit guarantees on the part of governments. Increasing the incentives for the use of information by the investor or lender will increase the market demand for greater transparency.
Internationally accepted standards and codes of conduct with respect to transparency need to be improved, extended and implemented. Standards must be practical and meet the needs of the private sector; for this reason, direct input by the private sector in the development of standards is important.
Appropriate technical assistance should be provided to the emerging markets to allow standards to be implemented, if necessary on a phased basis. In addition to Australias own efforts, including the major package of bilateral assistance recently announced by the Prime Minister, there is a need for the international community to improve the coordination of the provision of assistance. It is important to ensure that assistance is directed to areas that will achieve maximum effectiveness and that the interrelated and reinforcing nature of steps towards transparency and improved corporate governance is recognised. The World Bank, in close cooperation with other IFIs, could take the lead in improving the coordination of technical assistance.
The benefits from greater transparency should be the strongest incentive for compliance with standards. However, monitoring has a role to play. To this end, the IMF should prepare a Transparency Report for each country but, in addition, countries could prepare and publish a report on the extent to which they meet recognised disclosure standards. Australia should consider the preparation of a Transparency Report and provide a format for other countries to follow.
All countries should be encouraged to meet the Basle Committee on Banking Supervision (BCBS) standards for banking supervision, particularly in the area of capital adequacy, loan valuation and provisions. However, these standards need to be regularly reviewed and this should be conducted in a collaborative manner with non-G10 countries. This review should consider how the standards could be modified to encourage supervised institutions to maintain and apply adequate risk management procedures. Australia could offer to act as a regional coordinator for submissions to a BCBS review of capital standards.
External surveillance of a countrys supervisory arrangements should be encouraged, and this could be part of the IMFs Article IV consultations. There is, however, a role for more targeted and in-depth surveillance, and the concept of peer reviews should be developed. This could be facilitated by the establishment of a new international secretariat which would provide detailed expertise in monitoring supervisory arrangements.
Australia is providing substantial technical assistance and training to countries in the region that are looking to develop their financial systems and supervisory arrangements. This is an important contribution to the recovery of these economies. Improvements are necessary in the international coordination of such assistance to the emerging markets. While overseas financial institutions exposure and business in Asia may be reduced as the economies recover, many have found it commercially useful to take a long-term view of providing technical assistance in the region. Consideration could be given to increasing the level of cooperation between the Australian Government, Australian financial institutions and private sector organisations in the provision of such assistance.
The emergence of highly leveraged macro and other hedge funds, along with other large institutional investors, has created a new source of system instability. These institutions pose a risk to market integrity, through their potential to distort prices in the markets where they operate, as well as posing a risk to the stability of these markets and, in turn, the solvency of other institutions. Steps are necessary to ensure adequate disclosure by hedge funds and other highly leveraged institutions and to ensure appropriate risk management on the part of creditors and counterparties in their dealings with such investors. In particular, supervisors will need to ensure that banks and other regulated bodies have adequate systems for managing exposures to hedge funds. Higher capital weights or exposure limits on dealings with hedge funds may be necessary when systems or practices are inadequate to deal with those who do not meet adequate disclosure standards. A suitably constituted task force, as recently called for by the APEC Leaders Meeting, should progress this matter as soon as possible.
While every effort needs to be made to avoid crises, they will occur. Recent events highlight that the management of crises could be improved with the effective involvement of the private sector at an early stage. There is a need to have more flexible mechanisms to deal with fire sales and the resulting rapid depletion of reserves and/or depreciation of currencies. In particular, it would be desirable if an improved mechanism could be developed for a country to consult with creditors and reschedule repayments and, in dire circumstances, implement a temporary payments suspension (standfast) while rescheduling arrangements are put in place. In practice, this is likely to require some involvement of the IMF to reassure creditors that the action is genuinely necessary.
Effective crisis management requires creditors to be quickly identified and contacted. This is becoming increasingly difficult given the number and variety of creditors. The introduction of majority voting or collective action clauses would, however, provide an incentive for creditors to register with a suitable forum so as to ensue that they would have input into any proposal to vary payment terms. Such clauses would need to be included in loan documentation and there would be advantages if they were to become the accepted norm for sovereign foreign bond issues. In doing so, this would provide some degree of protection to creditors in terms of their fiduciary obligations to their shareholders and beneficial owners, which may be necessary if creditors are to become willing participants in debt standfasts.
Bank debt is best handled through a cooperative rescheduling, which would be facilitated with the early establishment of a contact group of bank creditors. This could be achieved if, when a country approached the IMF, it also appointed a suitable commercial bank with a large exposure to coordinate a bank creditor contact group. Such a contact group could facilitate the provision of information to creditors, as well as facilitating a rescheduling, if required. In return for including bank creditors at an early stage of the negotiations, agreement could be sought for them to maintain existing exposures, including through the endorsement of letters of credit for financing trade, for a fixed period during which negotiations can be finalised. The fact that a creditor contact group has been established should not be seen as signalling that a country is likely to be rescheduling its debts, thereby adversely affecting the supply of new capital. Rather, the formation of such contact groups should become the normal procedure for countries seeking an IMF program and the renegotiation of existing debts could, where appropriate, become a condition of the program.
The standard use of collective action clauses and improved procedures for creditor-debtor consultations will depend on developing arrangements that are acceptable to private sector lenders. This will require extensive consultation between sovereign borrowers and private sector lenders. Some of the issues that will need to be considered include the specification of collective action clauses, such as the rules for majority voting; the legal status of such clauses and actions taken; the mechanism for central registration of contact groups to speed implementation of debt restructuring; the relationship between any new arrangements for restructuring with the Paris and London Clubs; the procedures for a standfast; and the role of the IMF and other IFIs in a standfast.
The APEC Leaders Meeting endorsed the establishment of a properly constituted working group to develop suggestions for improved crisis management, including through involving the private sector at an early stage. Such a working group should comprise sovereign bond issuers, private sector lenders and the IFIs. It should aim to explore the adoption of collective action clauses, arrangements for debt standfasts and other mechanisms to facilitate early consultations between creditors and debtors. The focus of this group should be a practical one, seeking, in particular, the input from lenders as to the practicality of such arrangements and the details that need to be considered.
Since most sovereign borrowers in international markets are emerging economies, they need to play an integral role in any discussions on this issue. A G22 grouping would provide the appropriate degree of representation although an APEC working group would also maintain the momentum for reform.
Maintaining trade finance
It is important to support trade finance during a period of crisis management so as to preserve the ability of a country in crisis to maintain its trade. Ultimately, ensuring a solvent banking system is the key to facilitating the flow of finance to importers and exporters. Encouragement should be given to international efforts to increase trade financing for the crisis economies, as well as to accelerating the pace of bank and corporate restructuring. An important contribution Australia can make is providing technical assistance to facilitate bank and corporate restructuring.
To assist emerging economies with the adoption of effective national insolvency regimes, it could be proposed that the United Nations Commission on International Trade Law undertake the development of an international model law on insolvency and participate in monitoring implementation. The emerging economies will continue to need well-targeted technical assistance on insolvency matters.
Improving the composition of capital flows
Heavy reliance on short-term capital flows increases the vulnerability of the emerging economies to a sharp withdrawal of such finance. Where the domestic financial system may have difficulty coping with large short-term inflows and outflows, market-based restrictions, such as reserve requirements on short-term overseas borrowing, may assist in promoting greater stability for domestic institutions. Where short-term overseas borrowing reflects a lack of domestic borrowing opportunities, countries should be encouraged to develop domestic bond markets to help achieve a more appropriate balance in the composition of their domestic and foreign currency exposures. The emerging markets should be offered assistance in developing their domestic bond markets. This technical assistance should be directed at the supervision of markets and provision of efficient registry and settlement systems. A working group (G22 or APEC) could also be established to consult on issues relating to debt management in emerging economies. This could draw on the outcome of the Organisation for Economic Cooperation and Development (OECD)/World Bank Workshop on the Development of Fixed-Income Securities Markets in the Emerging Market Economies.
Foreign direct investment is more stable than short-term flows and also has the advantage of bringing with it technology and expertise. To enhance the environment for foreign direct investment, consideration could be given, perhaps within APEC, as to how greater transparency with respect to foreign investment laws and policies can increase a countrys attractiveness to foreign direct investment.
To facilitate a larger proportion of stable portfolio investment and foster the development of domestic share markets, support should be given to general improvements in corporate governance, including through current work in the APEC Finance Ministers context, and through bilateral assistance.
With the benefit of hindsight, the IFIs could have done better in handling the crisis. They will, however, remain integral players in crisis prevention and management. Support should continue to be given to efforts by the World Bank and IMF to achieve closer collaboration, especially as it relates to reforming national financial systems. More innovative and flexible financial support packages should be encouraged, and proposals for an enhanced IMF facility to provide a contingent short-term line of credit to countries pursuing appropriate policies should be supported. The World Bank, in close consultation with other IFIs, should be the basis for improved international cooperation (that is, a clearing house) for the provision of technical assistance.
To enhance international cooperation and provide a standing mechanism to respond to future international financial issues, consideration should be given to convening a Financial Sector Policy Forum. This forum, which would have a wide representation similar to that of the G22, would facilitate financial sector policy discussions between officials from national authorities, international regulatory bodies, the IFIs and, as appropriate, representatives from the private sector. Consideration should be given to the forum coordinating peer reviews of countries financial sector supervisory arrangements.
This new forum would, like the G22, include representatives from the IMF, World Bank and BIS, but would not form part of any of these institutions. These bodies could, however, sponsor the establishment of the forum and its work could provide a valuable input into the activities of the IMF and World Bank, which are both enhancing their country specific work in the area of financial markets and supervision.
The following diagram outlines suggested arrangements for enhanced international efforts on financial supervision and coordination of financial policy issues.
Figure 1: Enhanced international efforts on financial supervision/policy
Click on the image to view it enlarged
Countries should continue to work actively in regional economic forums, such as APEC, EMEAP and the Manila Framework Group, to advance reform initiatives and cooperation on financial policy issues. Such a grouping as the Manila Framework also provides the capacity to be convened at relatively short notice in order to address hot issues. The Manila Framework Group meeting in the first half of 1999 provides the opportunity to advance some of the reform proposals, such as the concept of countries preparing Transparency Reports and improving the composition of capital flows.