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Ref no:13/2009

The Financial Stability Forum (FSF) issued reports today covering: 

  • Recommendations for Addressing Procyclicality in the Financial System; 
  • Principles for Sound Compensation Practices; and 
  • Principles for Cross-border Cooperation on Crisis Management. 

The Forum also published today an update on the implementation of the recommendations contained in the FSF’s April 2008 Report on Enhancing Market and Institutional Resilience.

These recommendations and principles, and the other work underway since April 2008, support key aspects of the Action Plan adopted by the G20 Leaders at their November 2008 Summit and have fed into the preparation of today’s London Summit. Brief descriptions of the four reports are presented below.  

Addressing procyclicality in the financial system

The present crisis has demonstrated the disruptive effects of procyclicality – mutually reinforcing interactions between the financial and real sectors of the economy that tend to amplify business cycle fluctuations and cause or exacerbate financial instability. Addressing procyclicality in the financial system is an essential component of strengthening the macroprudential orientation of regulatory and supervisory frameworks.

The recommendations set out in this report mitigate mechanisms that amplify procyclicality in both good and bad times. They encompass a mix of quantitative/rules-based and discretionary
measures that are interrelated and reinforce one another. They will be implemented over time once conditions in financial markets return to normal.

The recommendations are in the following three areas (see Annex 1):

  • The bank capital framework. These recommendations were developed with the Basel Committee on Banking Supervision (BCBS) and are intended to mitigate the risk that the regulatory capital framework amplifies the transmission of shocks between the financial and real sectors. They include the development of countercyclical capital buffers and a supplementary non-risk based measure to contain bank leverage. An integrated package of measures covering the recommendations will be issued for consultation before the end of 2009.
  • Bank loan loss provisions. These recommendations reflect the view that earlier recognition of loan losses could have dampened cyclical moves in the current crisis, and that earlier identification of and provisioning for credit losses are consistent both with financial statement users’ needs for transparency regarding changes in credit trends and with prudential objectives of safety and soundness. Recommended accounting and capital measures seek to achieve these objectives while encouraging sound provisioning practices and enhancing their transparency. The recommended measures result from dialogue among regulators, supervisors and accounting standard setters. 
  • Leverage and valuation. These recommendations, which were developed with the Committee on the Global Financial System (CGFS), are intended to reduce procyclicality that has arisen from the interaction of leverage, funding mismatches and fair value accounting. They call on regulators and supervisors to obtain a clear and comprehensive picture of aggregate leverage and liquidity, and to use quantitative indicators and/or constraints on leverage and margins as macroprudential tools for supervisory purposes. Accounting standard setters are encouraged to improve approaches to valuation and financial instruments, in cooperation with prudential supervisors, so as to dampen adverse dynamics potentially associated with fair value accounting. 

The FSF will monitor the implementation of these recommendations and continue to examine aspects of procyclicality in the system.

Principles for Sound Compensation Practices

The Principles require compensation practices in the financial industry to align employees’ incentives with the long-term profitability of the firm. The Principles call for effective governance of compensation, and for compensation to be adjusted for all types of risk, to be symmetric with risk outcomes, and to be sensitive to the time horizon of risks. Implementation by firms will be reinforced through supervisory examinations at the national level (see Annex 2).

The Principles are intended to apply to all significant financial institutions but are especially critical for large, systemically important firms. Authorities expect evidence of material progress in the implementation of the Principles by the 2009 remuneration round. Full implementation should proceed as rapidly as possible and be sustained. Authorities, working through the FSF, will ensure coordination and consistency of approaches across jurisdictions.

Principles for Cross-border Cooperation on Crisis Management

Through these Principles, relevant authorities, including supervisory agencies, central banks and finance ministries, commit to cooperate both in making advanced preparations for dealing with financial crises and in managing them (see Annex 3).

The principles also commit national authorities from relevant countries to meet regularly alongside core supervisory colleges to consider together the specific issues and barriers to coordinated action that may arise in handling severe stress at specific firms, to share information where necessary and possible, and to ensure that firms develop adequate contingency plans. The FSF will act as clearinghouse for experiences in information sharing and contingency planning for the benefit of all its members.

Update on the Implementation of the April 2008 FSF Recommendations

The update on progress in implementing the recommendations of the April 2008 Report on Enhancing Market and Institutional Resilience covers actions in five areas: (i) strengthening capital, liquidity and risk management in the financial system; (ii) enhancing transparency and evaluation; (iii) changing the role and uses of credit ratings; (iv) strengthening the authorities’ responsiveness to risks; and (v) putting in place robust arrangements for dealing with stress in the financial system.

The report summarises progress since October 2008, when the FSF published a follow-up report reviewing progress until then. The FSF notes that implementation progress since October 2008 has been extensive. In particular:

  • Banking supervisors have published proposals for improving risk capture under Basel II, especially with regard to credit-related risks in the trading book. They have also published revised capital charges for liquidity commitments to off-balance sheet entities and for the re-securitised instruments. 
  • The BCBS published in January 2009 the standards for firm-wide risk management that supervisors will assess under Pillar 2 of the capital framework. 
  • Central counterparty clearing for over-the-counter credit derivatives has been launched in the US and in Europe. 
  • Consistent guidance has been issued by the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) for fair valuation when markets are illiquid, and for the transfer of assets between valuation categories in rare circumstances. The IASB has also proposed revised standards for the consolidation and disclosure of off-balance sheet entities and related exposures. The IASB finalised in March 2009 an amendment to IFRS 7 setting forth enhancements to required risk and valuation disclosures for financial activities, including for complex financial instruments.
  • The 2008 revisions of the International Organization of Securities Commissions (IOSCO) Code of Conduct Fundamentals for Credit Rating Agencies have been substantially implemented by several rating agencies including the three largest ones. IOSCO has also developed a model examination module to be used by the authorities that regulate and inspect credit rating agencies. 
  • Supervisory colleges have been established for most of the financial institutions identified by the FSF and many of them held face-to-face meetings by end-2008. ` 
  • The International Association of Deposit Insurers and the BCBS issued in March a set of Core Principles for Effective Deposit Insurance Systems. 

Notes to editors

The four publications issued today reflect collaborative work by FSF members, including central banks, supervisory/regulatory authorities, finance ministries, the BCBS, the Bank for International Settlements (BIS), the CGFS, the International Monetary Fund (IMF), IOSCO, the IASB, and the Organisation of Economic Co-operation and Development. Non-members have also been involved in the certain aspects of this work. Insights have been gained, as well, from discussions with experts from the financial industry, analysts, audit firms, standards setters, the public sector and academia.

The FSF brings together national authorities responsible for financial stability in significant international financial centres, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts. It was established by the G7 Finance Ministers and Central Bank Governors in 1999 to promote international financial stability through enhanced information exchange and international cooperation in financial market supervision and surveillance. The FSF decided in March 2009 to expand its membership to all G20 countries, as well as Spain and the European Commission.

The FSF is chaired by Mario Draghi, Governor of the Bank of Italy. The FSF Secretariat is based at the BIS in Basel, Switzerland.