Current Developments in Monetary and Financial Law, Volume 6
Front Matter

Front Matter

International Monetary Fund. Legal Dept.
Published Date:
February 2013
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Current Developments in Monetary and Financial Law

Volume 6


The Legal Response

International Monetary Fund

© 2012 International Monetary Fund

Joint Fund-Bank Library Cataloging-in-Publication Data

Current developments in monetary and financial law. – Washington, D.C.: International Monetary Fund, 1999-v.; cm.

Papers presented at seminars organized by the IMF Legal Department and the IMF Institute.

Includes bibliographical references.

ISBN 1-55775-796-8 (v. 1)

ISBN 1-58906-176-4 (v. 2)

ISBN 1-58906-334-1 (v. 3)

ISBN 1-58906-507-7 (v. 4)

ISBN 978-1-58906-773-8 (v. 5)

ISBN 978-1-61635-081-9 (v. 6)

1. Money – Law and legislation—Congresses. 2. Finance – Law and legislation—Congresses. 3. Monetary policy – Congresses. 4. International finance – Congresses. 5. Financial institutions – Congresses. 6. Banking law – Congresses. 7. Financial crises—Congresses. 8. Banks and banking—State supervision—Congresses. 9. Banks and banking, Central—Congresses. 10. Banks and banking, International—Congresses. 11. Economic and Monetary Union—Congresses. 12. Payment systems—Congresses. I. International Monetary Fund. Legal Dept. II. IMF Institute. K1066.A6 C87

Nothing contained in this book should be reported as representing the views of the IMF, its Executive Board, member governments, or other entity mentioned herein. The views in this book belong solely to the authors.

Please send orders to:

International Monetary Fund, Publications Services

P.O. Box 92780, Washington, D.C. 20009, U.S.A.

Telephone: (202) 623-7430; Fax: (202) 623-7201





The IMF Legal Department and the Ministry of Finance of Japan, the Financial Services Agency of Japan, and the Bank of Japan, with the assistance of the IMF Institute, co-hosted a seminar on Current Developments in Monetary and Financial Law in Washington, D.C., on November 30–December 3, 2009. The seminar’s theme was “Restoring Financial Stability—The Legal Response.” The seminar was the eleventh in a series that started in 1988 and was the first since the start of the recent global financial crisis.

Presentations were given by a range of individuals from the public and private sectors, including officials of the IMF, other international organizations, central banks, supervisory and regulatory agencies, and standard-setting bodies; private sector representatives; lawyers practicing in the fields of banking and financial law; and academics. The papers published in this volume are based on these presentations. Some have been updated by their authors to account for developments after the seminar. The views expressed by the authors should not be attributed to the IMF, the abovementioned agencies of Japan, or the institutions with which the authors are affiliated.

The participants of the seminar were senior officials of IMF member countries, most of whom were lawyers, with responsibilities in monetary and financial regulation. Reflecting the diversity of institutional structures, the entities these officials represented included ministries of finance, regional and national central banks, financial supervisory and regulatory agencies, and deposit insurance agencies.

I wish to express our profound gratitude to Mr. Rintaro Tamaki, Vice Minister of Finance for International Affairs, Ministry of Finance of Japan, and his staff, for facilitating organizational and financial support for the seminar by the co-hosting agencies in Tokyo. The financial support enabled the IMF Legal Department to invite more participants from developing countries than would otherwise have been possible. In Washington, D.C., Mr. Daisuke Kategawa, then IMF Executive Director for Japan, Mr. Hiromi Yamaoka, then Alternate Executive Director for Japan, and Mr. Nobuyuki Imamura, then Advisor to the Office of Executive Director for Japan, ensured timely and smooth communications between Japanese and IMF officials.

I also wish to acknowledge the invaluable contributions of various IMF staff teams, whose diligence and dedication made the seminar a success. The organization and structure of the seminar benefitted in particular from the ideas of Ross Leckow, Barend Jansen, Thomas Lar-yea, Isaac Lustgarten, and Roy Baban. External funding for the seminar was coordinated by the staff of the IMF Office of Technical Assistance Management, particularly Alfred Kammer and Harish Mendes. Budgetary and personnel management were provided by Cristina Hayashi and Sue Edwards of the IMF Legal Department, and Natalie Kerby-Lachnani of the IMF Institute. Interpretation services were arranged by Susana Eri and Sergei Chernov. Administrative support was provided by Maria Mercedes Hernandez, Kajal Jagatsing, Katherine Nelson-Indre, Olga Penova, Carolina Usandivaras, and Henry Wright. This volume was prepared by Roy Baban, under the oversight of Barend Jansen and with the assistance of Eric Robert, Myrtho Mercier, and Jacqui Wade of the Legal Department. Patty Loo of the External Relations Department coordinated its publication.

Sean Hagan

The General Counsel

Director, IMF Legal Department


The chapters in this volume are based on presentations made at the Seminar on Restoring Financial Stability—The Legal Response. For this publication, some chapters include references to developments that occurred after the seminar. This introduction provides an overview of the volume.

The papers in Section I deal with frameworks and regulatory reforms in the United States, European Union, and Japan that address systemic risk. In Chapter 1, entitled “What is the Right Response to the Too-Big-to-Fail Problem?” Professor Arthur Wilmarth of George Washington University Law School argues that the primary objective of reform must be to eliminate or greatly reduce explicit and implicit subsidies for “too big to fail” (TBTF) institutions. This would force large, complex financial institutions (LCFIs) to internalize their activities’ risks and costs. He proposes the following five-point program: (1) strengthen current statutory restrictions on the growth of LCFIs, (2) create a special resolution process to manage the orderly liquidation or restructuring of systemically important financial institutions (SIFIs), (3) establish a consolidated supervisory regime and enhanced capital requirements for SIFIs, (4) create a special insurance fund for SIFIs in order to cover the costs of resolving failed SIFIs, and (5) rigorously insulate banks that are owned by LCFIs from the activities and risks of their nonbank affiliates.

In “The Dodd-Frank Act and the Financial Crisis: A Retrospective Assessment of the Act’s Systemic Risk Regulation Provisions” (Chapter 2), Ms. D. Jean Veta and Mr. Michael Nonaka of Covington and Burling LLP examine certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 pertaining to systemic risk. While citing the perils of counterfactuals, the authors suggest that the Financial Stability Oversight Council established by the Act likely would have designated, based on the criteria set forth in the Dodd-Frank Act, Bear Stearns, Lehman Brothers, AIG, and other firms as systemically important financial firms because of large asset sizes, interconnectedness with other significant financial institutions, and important roles in the mortgage securitization markets. If designated, such firms would have been subject to limits on leverage and short-term indebtedness, increased oversight and monitoring, and requirements to disclose their risk profiles, capital adequacy, and risk management capabilities. The authors conclude that had this framework been in place before 2008, warnings of the deteriorating financial condition of systemically important financial institutions would have arisen earlier.

Professor Guido Ferrarini and Mr. Filippo Chiodini of the University of Genoa examine recent developments in European banking regulation from the point of view of multinational banks in “Regulating Multinational Banks in Europe: An Assessment of the New Supervisory Framework’ (Chapter 3). Noting the mismatch between national bank regulation and international operations of banking groups, they analyze the weaknesses of EU cross-border supervision with respect to both branch and subsidiary structures of multinational banks, the enhancement of consolidated supervision by the Directive 2009/111/EC(CRD II), the new European supervisory architecture (consisting of the European Systemic Risk Board, the European Banking Authority, and the European System of Financial Supervisors) to enhance macro- and microprudential supervision, and the crisis management tools available for European bank intervention and resolution. While recognizing the remarkable progress made, the authors believe that the reforms are insufficient and, going forward, prefer the approach of strengthening the infrastructures for supervision and crisis management, while further harmonizing and centralizing them, rather than limiting the size or scope of multinational banks.

In “The Legal Response to the Financial Crisis Between 2008 and 2010: The Role and Initiatives of the European Central Bank’ (Chapter 4), Dr. Chiara Zilioli of the European Central Bank focuses on the main instruments used by the ECB and the Eurosystem to increase liquidity in financial markets and thereby contribute to financial stability in Europe. These instruments consisted of: the temporary widening of Eurosystem rules for the eligibility of collateral; provision of liquidity in foreign currencies; the Covered Bond Program under which outright purchases of covered bonds in the primary and secondary markets could be done; and the Securities Markets Program under which the ECB and national banks could make outright purchases in the secondary market of eligible marketable debt instruments issued by central governments or public entities within the euro area and in the primary and secondary markets of eligible marketable debt instruments issued by private entities incorporated in the euro area. In addition, Dr. Zilioli examines European initiatives to strengthen the European micro- and macroprudential supervisory framework and to support a distressed euro area member State. Concerning the legal basis, she highlights the tension between, on the one hand, treaty clauses prohibiting “privileged access” by a member State to financial institutions and providing for “no bailout” and, on the other hand, the principle of “solidarity” toward a member State in distress.

In “The Legal Framework for Central Banking in a Crisis: Japan’s Experiences” (Chapter 5), Mr. Hiromi Yamaoka of the Bank of Japan (BOJ) describes the legal framework under which the BOJ may take a measure not specified in the Bank of Japan Act provided that it would achieve the purpose of the BOJ under the Act and is authorized by the Minister of Finance and the Prime Minister. The author underscores that such a framework provides the BOJ with flexibility to take extraordinary measures without new laws and yet remain accountable to the public. Measures taken with specific authorization by the Minister of Finance and Prime Minister have included purchases of stocks held by banks, and provision of subordinated loans to banks. Also, the BOJ may provide loans to financial institutions on an uncollateralized basis, if requested from the prime minister and the minister of finance.

In “Some Thoughts on Macroprudential Supervision” (Chapter 6), Mr. Toshiyuki Miyoshi of the Financial Services Agency (FSA) of Japan, points to instances of awareness since the late 1990s by national and international authorities of the need to address systemic risk and to adopt macroprudential supervision. However, the idea of macroprudential supervision had lost traction and warnings on the buildup of systemic risk, particularly from securitization, were treated lightly prior to the 2008 crisis. To make macroprudential supervision operational, it is essential to have robust analytical frameworks, a strong will to translate assessments into action, and consensus on the need for forward-looking prudential policies. For its part, the FSA has taken various supervisory measures since the time of Japan’s banking crisis in the 1990s with due consideration to their impact on the overall economy and financial stability. They include a blanket guarantee of bank deposits in the 1990s to prevent contagion and, in the absence of an effective bank resolution framework, a forward-looking response to a possible asset price bubble in 2006–07.

Section II focuses on the international dimension of financial stability. In “Toward a New Financial Order, What Are the Key Issues?” (Chapter 7), Mr. José Viñals of the IMF Monetary and Capital Markets Department underscores the need to improve cooperation and coordination across national borders and endorses a separate insolvency code for financial institutions and the greater use of supervisory colleges, which involve supervisors of key countries in which a given global institution operates.

Mr. Mark Sobel of the U.S. Treasury examines the G-20’s broad policy agenda in “Restoring Growth, the Role of the IMF, and Strengthening Financial Regulation and Supervision Globally” (Chapter 8). On growth, he pointed to the challenges facing G-20 countries of designing exit strategies from extraordinary governmental support during the crisis and cooperating to achieve durable, balanced growth, in part through mutual assessments. Economies with large and sustained surpluses must shift from exports to domestic demand as a source for growth. While noting IMF initiatives to create the Flexible Credit Facility and enlarge the New Arrangements to Borrow, Mr. Sobel encouraged examination of excessive reserve accumulation in certain countries and the desirability and feasibility of the IMF discouraging such accumulation by offering “insurance” to countries through contingent financing, swaps or other instruments. On the regulatory front, Mr. Sobel describes the sweep of regulatory reforms to include greater oversight over nonbank financial institutions, credit rating agencies, and hedge funds, building high quality capital, reducing leverage, mitigating pro-cyclicality in financial regulations, sounder executive compensation policies, improving over-the-counter derivatives markets, and strengthening national and cross-border resolution systems.

Mr. Sean Hagan of the IMF examines recent developments at the IMF in “Reforming the IMF” (Chapter 9). In response to the 2008 crisis, the IMF established the Flexible Credit Line (FCL). The facility was designed to provide funds to a member country facing liquidity pressures, but whose strong track record of policy performance did not require adjustment policies. In contrast to other IMF facilities, the FCL imposes ex ante rather than ex post conditionality and provides liquidity without phasing. Mr. Hagan examines other initiatives at the IMF, including a readjustment of quotas, an increase in the basic votes of low-income members, the sale of a portion of gold holdings, expansion of authority to invest IMF assets, an increase in the number of Alternate Directors from one to two that may be appointed by Executive Directors elected by at least 19 members, and country contributions for technical assistance.

In “Restoring Financial Stability: Japan’s Perspective” (Chapter 10), Mr. Toshiyuki Miyoshi of the Financial Services Agency of Japan argues that the evolution of the 2008 crisis has a number of commonalities to Japan’s banking crisis in the 1990s and that removing uncertainties about the soundness of financial firms’ balance sheets is vital to normalize financial markets. Regarding regulatory reform, Mr. Miyoshi warns against excessive emphasis on raising the level of capital, stressing the importance of enhanced risk capture. He also proposes a holistic approach in dealing with SIFIs. Rather than merely identifying such institutions and imposing a capital surcharge upfront, he argues for intensive supervision of risk management practices, more focus on liquidity, a robust resolution framework, and realistic burden sharing of the cost of the financial crisis.

Section III deals with the regulation of complex financial products. In Chapter 11, Professor Jerry Markham of Florida International University College of Law provides a paper entitled “Regulating Credit Default Swaps in the Wake of the Subprime Crisis.” The author reviews the role played by credit default swaps (CDS) in the subprime crisis and the financial crisis of 2008, described how the subprime crisis caused a sharp, probably unjustified, devaluation in the so-called “Super Senior” component of collateralized debt obligations (CDOs), which were at the heart of the crisis, and which in many instances were covered by CDS. The author also addresses ongoing governmental efforts to regulate the CDS market, noting the worldwide consensus on the standardization of instruments and establishment of clearinghouses. He argues that focus on CDS should not divert attention from the role of government housing and interest rate policies and fair value accounting requirements in the crisis.

Professor Toshiki Yotsuzuka of Waseda University, in “Complex Financial Products in Japan: Evolution of Structured Products and Regulatory Responses” (Chapter 12), identified the factors that mitigated dangerous excesses in Japan’s structured credit markets. First, traditional bank loans dominate Japan’s credit markets and crowd out corporate bonds and structured credit products. Second, investors unfamiliar with credit products favored relatively simple structures. Third, painful memories of the collapse of the real estate bubble in the 1990s made the Japanese investors wary of foreign and domestic securitizations. Fourth, highly leveraged institutions in Japan did not have large positions in Japanese credit products, thus limiting the damage from severe deleveraging during the global liquidity crisis. In search of higher yield in a low-interest rate environment, Japanese investors flocked to structured non-credit products (mainly currency-linked and equity-linked notes), rather than to structured credit products (such as CDOs), and this tendency had its own implications for the stability of the financial system.

Professor Linda M. Beale of Wayne State University Law School provides a paper entitled “Roots of the 2008 Financial Crisis, Fair Value Accounting, and Regulatory Reform” (Chapter 13). In the paper, she analyzes the various factors that led to the financial crisis. She argues that fair value accounting was not the villain and proposals to restrict or eliminate it are wrong. Rather, the off-balance sheet treatment of securitization vehicles was a genuine factor in the crisis. She examines proposals for reform in the United States and sets forth the case for democratic egalitarianism as a tempering restraint to address the structural flaws of the deregulated, financialized economy that developed over four decades of laissez-faire market capitalism.

Section V deals with cross-border banking supervision. Mr. Richard H. Neiman of PricewaterhouseCoopers provides a paper entitled “Effective Cross-Border Supervision: From Imperative to Implementation” (Chapter 14). On how to promote cross-border supervision that is conducted primarily by national regulators, he proposes a three-pronged strategy of harmonization of standards, expanded use of supervisory colleges, and a resolution process that provides for the orderly unwinding of systemically significant nonbank financial firms.

Professor Jeffery Atik of the Loyola Law School, in “Basel II and Extreme Risk Analysis” (Chapter 15), states that Basel II largely addressed risk as faced by individual financial institutions, not whether there was adequate capital across the banking system. Thus, regulatory capital may not be adequate to absorb a strong shift in the correlation of defaults, as in the 2008 financial crisis. However, in revisiting what bank capital is expected to do, it must be acknowledged that there are limits on the increase in the amount of capital that financial institutions could be required to hold. The effect of a low probability, high impact event may be so severe as to overwhelm any prudential measure.

Professor Naoyuki Yoshino and Mr. Tomohiro Hirano of the Keio University and the Financial Research and Training Center of the Financial Services Agency of Japan, and the University of Tokyo, respectively, provide a paper entitled “Counter-Cyclical Buffer of the Basel Capital Requirement and Its Empirical Analysis” (Chapter 16). The paper presents a general equilibrium model in which capital requirements are flexible and dependent on various macroeconomic factors, including land price, stock price, GDP, and interest rates. Using the model, the authors estimate how much capital requirements should have been countercyclically increased or reduced in expansionary and recessionary times, respectively, in Japan, U.S., and Canada.

In “Regulating the Credit Rating Agencies” (Section VII, Chapter 17), Ms. Rita Bolger (Standard and Poor’s) proposes goals that any new regulatory architecture for credit rating agencies should focus on. Among these goals are: effective management of conflicts of interest, transparency regarding the nature of rating opinions and information used in the ratings process, disclosure of ratings performance across asset classes and locales, disclosure of criteria and methodologies for assigning and updating ratings, differentiation of ratings on structured finance securities, avoidance of disclosure and misuse of confidential information, oversight of rating agencies’ regulatory compliance without interference in the substance of rating opinions, and a registration regime that follows globally consistent standards.

In Chapter 18 (Section VIII), Professor Friedrich Kübler of the University of Pennsylvania Law School provides a paper entitled “European Initiatives for the Regulation of Nonbank Financial Institutions: The EU Directive on Alternative Investment Fund Managers.” The Directive covers hedge funds, private equity funds, real estate funds, commodity funds, and other types of institutional funds and has, as its core elements, registration, rules on operating conditions, and disclosure and transparency requirements. The author examines the views and interests that shaped the public debate, the legislative reasons and policy objectives motivating the European Commission, the estimated costs of implementation, and the balance of costs and benefits.

Four papers in Section IX deal with corporate and household debt restructuring. In “Out of Court Corporate Debt Restructuring Framework in India–An Overview” (Chapter 19), Mr. Sumant Batra of INSOL International examines the pros and cons of recourse in India to out-of-court, nonstatutory corporate debt restructuring (CDR) in light of the failure of formal insolvency law to provide quick and timely restructuring. Providing the legal foundation of CDR in India are two agreements, the Debtor-Creditor Agreement and the Inter-Creditor Agreement. The edifice of the CDR mechanism stands on the strength of a three-tier structure consisting of the CDR Standing Forum in which all banks and financial institutions participating in the CDR system are represented, the CDR Empowered Group that decides individual cases, and the CDR cell entrusted with fact finding and making proposals for rehabilitation. Despite areas in which the process could be improved, CDR has worked well in India.

In Chapter 20, Professor Soogeun Oh of the Ehwa Womans University Law School contributes a paper entitled “Corporate Restructuring During Times of Crisis in South Korea.” The author compares uses of the Workout in the U.S. subprime mortgage crisis with the South Korean foreign currency crisis of 1997, explains the historical and economic background of the Workout, examines how the Workout evolved and its efficiency as an insolvency scheme, and views executive measures and judicial proceedings in Korea as demonstrating a learning curve of the rule of law in the market.

In Chapter 21, Dr. Shinjiro Takagi of Nomura Securities provides a paper entitled “Quasi-Governmental Special Purpose Vehicles to Restructure Ailing Business Corporations in Extraordinary Times: A Proposal Based on Japan’s Experiences.” A key feature of such special purpose vehicles in Japan is that the government contributes funds or guarantees, but the restructurings are run by eminent turnaround experts not related to the government. From Japanese experience, the author sets forth rules of organization and proceedings that may be useful for other countries.

In “Principles of Household Debt Restructuring” (Chapter 22), Messrs. Luc Laeven and Thomas Laryea of the IMF and SNR Den-ton, respectively, assess the case for government intervention in household debt restructuring and presents key principles for household debt restructuring that could be adapted to individual country circumstances. Such restructuring should incorporate a number of basic features: turning troubled loans into performing loans, selectivity in scope, proportionality of government intervention to the scale of the problem, voluntary lender participation, simplicity, and transparency and accountability. Additionally, a program may include incentives for borrowers and lenders. In light of these principles, the authors examine actual debt restructuring in a number of countries.

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