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Examining global financial regulatory reform in the G20 and the FSB

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Examining global financial regulatory reform in the G20 and the FSB

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Examining Global Financial Regulatory Reform in the G20 and the FSB

A dissertation
submitted in fulfillment
of the requirements of the degree
of
Doctor of Philosophy
at
University of Southern California
by
Peter Knaack

2016
2

Table of Contents
Table of Figures .................................................................................................................................4
List of Acronyms ................................................................................................................................5
Chapter 1: Introduction ......................................................................................................................6
The pattern of global financial reform progress ....................................................................................... 7
Competing explanations ......................................................................................................................... 12
Outline of the dissertation ...................................................................................................................... 18
Chapter 2: Theoretical approaches to global financial regulation ....................................................... 21
Global Governance.................................................................................................................................. 21
Competing Approaches to Global Financial Governance ....................................................................... 24
Hegemony à la Simmons ......................................................................................................................... 26
Hegemony à la Drezner ........................................................................................................................... 28
Epistemic communities ........................................................................................................................... 33
Redistributive Concerns .......................................................................................................................... 35
Regulatory Capture ................................................................................................................................. 37
Cooperative Decentralization ................................................................................................................. 49
Sector differences ................................................................................................................................... 50
Government networks ............................................................................................................................ 51
Chapter 3: Methods ......................................................................................................................... 56
Chapter 4: Basel III ........................................................................................................................... 68
Regulatory Hegemony ............................................................................................................................ 71
Epistemic communities ........................................................................................................................... 73
Redistributive Concerns .......................................................................................................................... 79
Regulatory Capture ................................................................................................................................. 83
Cooperative decentralization.................................................................................................................. 92
Sector differences ................................................................................................................................... 93
Government networks ............................................................................................................................ 93
Shades of Golden: over-compliance with Basel III .................................................................................. 98
Conclusion ............................................................................................................................................. 112
Chapter 5: OTC Derivatives ............................................................................................................. 114
Coordination failure in OTC derivatives regulation .............................................................................. 114
Regulatory Hegemony .......................................................................................................................... 118
3

Epistemic Communities ........................................................................................................................ 118
Redistributive Concerns ........................................................................................................................ 119
Government Networks ......................................................................................................................... 121
Cooperative Decentralization ............................................................................................................... 133
Regulatory Capture ............................................................................................................................... 134
Sector differences ................................................................................................................................. 136
Conclusion ............................................................................................................................................. 136
Chapter 6: The never-ending too-big-to-fail story ............................................................................ 138
Early progress in ending too-big-to-fail ................................................................................................ 139
Implementation gaps ............................................................................................................................ 151
Bail-in ................................................................................................................................................ 152
Crisis-Management Groups (CMG). .................................................................................................. 154
Cooperation Agreements .................................................................................................................. 156
Temporary Stay on Early Termination Rights ................................................................................... 158
Competing explanations ....................................................................................................................... 159
Epistemic Communities ........................................................................................................................ 159
Redistributive Concerns ........................................................................................................................ 162
Regulatory Capture ............................................................................................................................... 165
Cooperative Decentralization ............................................................................................................... 169
PLAC, GLAC, TLAC – The Sound of Basel ............................................................................................... 176
Conclusion ............................................................................................................................................. 185
Chapter 7: State versus network ..................................................................................................... 187
The institutional pathways of reform ................................................................................................... 188
Globalization: From hierarchy to network ............................................................................................ 195
The rise of the regulatory state ............................................................................................................ 198
The rise of government networks ......................................................................................................... 200
The FSB as a government network ....................................................................................................... 206
Quality indicators of government networks ......................................................................................... 209
Effectiveness ......................................................................................................................................... 211
Legitimacy ............................................................................................................................................. 218
Conclusion ............................................................................................................................................. 230
References ..................................................................................................................................... 232
4

Table of Figures

Figure 1.1 Measuring reform progress ......................................................................................................... 7
Figure 1.2 Financial Stability Board members .............................................................................................. 9
Figure 1.3 The progress of global financial regulatory reform ................................................................... 11
Table 1.1 Competing explanations.............................................................................................................. 15
Figure 2.1 Changes in global financial governance .................................................................................... 28
Table 3.1 Systematic Process Analysis ....................................................................................................... 59
Figure 4.1 Basel III reform progress ........................................................................................................... 70
Figure 4.2 Basel III capital shortfall and average core capital ratios (CET1) .............................................. 71
Figure 4.3 Basel III innovations .................................................................................................................. 75
Figure 4.4 Share of foreign-related institutions in US banking market, percentage of total assets .......... 82
Table 4.1 Basel capital requirements ......................................................................................................... 84
Figure 4.5 GDP growth, selected G20 countries ...................................................................................... 103
Table 4.2 Over-compliance with Basel III ................................................................................................. 105
Table 4.3 Regression Results 1 ................................................................................................................. 109
Table 4.4 Regression results 2 .................................................................................................................. 111
Figure 5.1 OTC derivatives reform progress ............................................................................................ 116
Figure 6.1 Bank Mergers and Acquisitions, United States 1990-2009 ..................................................... 141
Figure 6.2 Asset concentration in the US banking market, 1990-2014 ................................................... 142
Figure 6.3 Degrees of Cross-Border Cooperation .................................................................................... 145
Figure 6.4 SIFI Framework and Progress 2010 ......................................................................................... 148
Table 6.1 2014 List of G-SIB ...................................................................................................................... 149
Figure 6.5 SIFI Framework and Progress 2013 ......................................................................................... 152
Figure 6.6 Ending TBTF reform progress .................................................................................................. 156
Figure 6.7 Number of Subsidiaries, G-SIB (Selection) .............................................................................. 173
Figure 6.8 SIFI Framework and Progress 2015 ......................................................................................... 179
Figure 7.1 Regulatory process .................................................................................................................. 193
Figure 7.2 State cooperation decision tree .............................................................................................. 202
Figure 7.3: Evolution from state to network ............................................................................................ 204
5

List of Acronyms

BCBS Basel Committee on Banking Supervision
BIS Bank of International Settlements
BRRD EU Bank Recovery and Resolution Directive
CET 1 Core Equity Tier 1
CFTC Commodity Futures Trading Commission
CMG Cross-Border Crisis Management Group
COAG Cooperation Agreement
CPSS Committee on Payment and Settlement Systems
CRD Capital Requirements Directive
ECB European Central Bank
ESMA European Securities Market Authority
FDIC Federal Deposit Insurance Corporation
FSA Financial Services Authority (United Kingdom)
FSB Financial Stability Board
FSF Financial Stability Forum
G20 Group of 20 (countries)
GDP Gross domestic product
IGO Inter-governmental organization
IIF Institute of International Finance
IMF International Monetary Fund
IOSCO International Organization of Securities Commission
IPE International political economy
ISDA International Swaps and Derivatives Association
MoU Memorandum of Understanding
MPE Multiple Point of Entry
NGO Non-governmental organization
NPR Notice of proposed rulemaking
OCC Office of the Comptroller of the Currency
ODRG OTC Derivatives Regulators’ Group
ODWG OTC Derivatives Working Group
OECD Organisation for Economic Co-operation and Development
OLA Orderly Liquidation Authority
OTC Over-the-counter
OTS Office of Thrift Supervision
RCAP Regulatory Consistency Assessment Programme
RRP Recovery and Resolution Plan
SDR Swap Data Repository
SEC Securities and Exchange Commission
SIB Systemically important bank
SIFI Systemically important financial institution
SPE Single Point of Entry
TARP Troubled Asset Relief Program
TBTF Too-big-to-fail
UN United Nations
6

Chapter 1: Introduction

The global financial crisis of 2007-9 reached a scope and level of severity that can only be
compared to the Great Depression of the 1930s. Estimates of the social cost caused by this crisis range
from $100 billion (US government bail-outs) to $200 trillion (accounting for immediate and persistent
reduction in world output) (Haldane, 2010). Facing the magnitude of this disaster, policymakers in the
leading economies pronounced their willingness to overhaul the global regulatory framework, increase
bank resilience, end too-big-to-fail, and bring financial markets under tighter regulatory control. They
designated the G20 and the Financial Stability Board (FSB) to be the main organizational sites of this
reform project. Yet in the six years that have passed since the crisis, global financial reform progress has
been uneven. Some items of the G20 financial reform agenda have seen the rapid evolution of globally
coordinated regulatory standards and their implementation by all member states, sometimes even
ahead of the stipulated timelines. In contrast, other reform initiatives have stalled at different stages of
the policymaking process, global coordination is lacking, deadlines have been missed, and it is currently
unclear when G20 members will meet their reform commitments, if ever.
This dissertation analyzes global financial regulatory reform by tracing the global policymaking
process in three major issue areas: banking regulation, over-the-counter (OTC) derivatives, and ending
too-big-to-fail (TBTF). Through a combination of careful process tracing, statistical analysis, and rigorous
testing against alternative explanations, it reveals the relevance of institutional pathways of
policymaking as the main predictor of reform progress. Contrary to conventional wisdom, the greatest
impediment to state-led reform is the state. More specifically, empirical work undertaken in this
dissertation shows that legislation and legislators represent the foremost obstacle to financial regulatory
reform progress. The phenomenon of legislative recalcitrance becomes understandable when situated
in the context of a wider turf battle between branches of government over the authority to govern
7

economic activity. This perspective provides new insight into the tension between nation-states and
transnational government networks in global economic governance. Furthermore, it locates this tension
between different governance structures in a greater theory of globalization and generates new
hypotheses regarding global governance in the 21
st
century.
The pattern of global financial reform progress
Measuring and analyzing the progress of global financial reform is not an easy undertaking. Any
type of progress needs to be measured against a benchmark, but it is far from obvious what this
benchmark should be. Some scholars measure global financial reform progress by the extent to which
new policies depart from the pre-crisis status quo (Helleiner, 2014b; Moschella & Tsingou, 2013b).
Others focus on the difference in authority and capacity of the FSB and its pre-crisis predecessor, the
Financial Stability Forum. Similar comparisons are made regarding the G20 as a forum for finance
ministers and central bank governors before the crisis and state leaders afterwards (D. W. Arner &
Taylor, 2009; Kirton, 2013). This dissertation takes a different approach. It uses the reform goals in
particular areas of financial regulation as they are stated in G20 summit declarations as benchmarks.
The reform commitments for all issue areas under analysis here were clearly pronounced at the G20
summits in London and Pittsburgh in 2009. That they were agreed upon by the same group of state
leaders in a relatively short time period facilitates comparison across issue areas. In sum, reform
progress is measured in this dissertation as the gap between reform commitments as stated by G20
leaders and de facto implementation by end-2014.
Figure 1.1 Measuring reform progress

status quo
implementation by end-2014
reform commitment

DV
Dependent Variable
8

The subsequent question for this investigation concerns the selection of reform areas. At the
height of the global financial crisis, G20 leaders were eager to show their determination to overhaul the
global financial system and protect taxpayers. They launched a wide range of policy initiatives, including
governance reform of the international financial institutions and measures to improve citizens’ access to
financial services. Over the years, new initiatives were added and the G20 agenda has expanded
continuously (Knaack & Katada, 2013). This dissertation concentrates on G20 agenda items that strictly
concern financial regulation. But even in the narrower field of financial regulatory reform, the list of
policy measures is long, including issues such as the reform of credit rating agencies, insurance
companies, and executive compensation. Moreover, as the financial sector adjusts to the new rules and
standards, new issues appear on the regulatory agenda such as shadow banking. The sample of issue
areas examined in this dissertation is based on the importance and temporal evolution of reform agenda
items. Banking regulation, OTC derivatives, and ending TBTF are the three most important reform issues
on the G20 agenda. Policy areas such as credit rating agencies, hedge fund supervision, and executive
compensation remain on the sidelines of global regulatory reform although they certainly deserve
scholarly attention. Other initiatives such as the global introduction of a bank levy were removed from
the agenda because they failed to garner support from important G20 members. All three reform issues
selected in this study appeared on the G20 agenda in 2009. It is thus possible to undertake a more
rigorous comparison among these three issues rather than incorporating policy items that were
removed from the agenda or that appeared more recently. Moreover, reform progress across issue
areas differs substantially, allowing for important variation in the dependent variable. The following
section presents the three regulatory issue areas examined in this dissertation and describes the
differences in reform progress.
9

Figure 1.2 Financial Stability Board members

The first item on the reform agenda is prudential banking regulation. Banks were at the center
of the global financial meltdown, exposing the serious shortcomings of prudential regulation around the
globe. G20 leaders were quick to commit to a thorough overhaul of prudential regulation to make banks
more resilient. They put a government network, the Basel Committee on Banking Supervision (BCBS) in
charge of devising a new global prudential standard that builds on the lessons learned from the crisis.
Ahead of the end-2010 deadline set by the G20, the BCBS published Basel III, a new standard of capital
requirements. All Basel Committee member states implemented Basel III domestically two years later. In
spite of a generous phase-in period that extends to 2019, banks have adjusted quickly and most meet
the new capital requirements to date. Furthermore, 89 non-member states have taken regulatory action
to adopt Basel III standards in their jurisdiction. The Basel Committee has also developed global
standards for novel regulatory tools, but they were of secondary importance and policy deliberations
started at a later stage. The liquidity coverage ratio was finalized in January 2013 and will be introduced
in 2015. The development of a global leverage ratio and a net stable funding ratio started even later,
and the final standard was not published until January 2014. The dissertation thus does not cover these
I IN NT TL L S ST TA AN ND DA AR RD D- -S SE ET TT TI IN NG G B BO OD DI IE ES S
Banking (Basel Committee)
Insurance (IAIS)
Securities (IOSCO)
Accounting (IASB)
CGFS, CPSS
2 24 4 C CO OU UN NT TR RI IE ES S/ / J JU UR RI IS SD DI IC CT TI IO ON NS S
G7
United States
United Kingdom
France
Germany
Italy
Canada
Japan
BRICS
Brazil
Russia
India
China
South Africa
Other G20
Argentina
Australia
Indonesia
Mexico
South Korea
Saudi Arabia
Turkey
Others
The
Netherlands
Spain
Switzerland
Hong Kong
Singapore
10

three standards, but the current stage of progress in this area suggests that it follows the trajectory of
capital requirement (BCBS, 2014e).
The second area of global financial reform contrasts with the success of prudential banking
regulation. Turmoil in OTC derivatives markets exacerbated the global financial crisis, complicating state
efforts to stabilize financial markets. Even though it had attracted regulatory concern before, this multi-
trillion dollar market was largely unregulated before the crisis. In 2009, G20 leaders declared their joint
decision to bring the OTC derivatives market under regulatory control. They committed to having all
eligible OTC derivatives contracts traded on platforms, centrally cleared, and reported to so-called trade
repositories. Those contracts that were not centrally cleared would be subjected to higher capital and
margin requirements. Five years after these commitments were made and three years after the
implementation deadline has passed, not a single jurisdiction has fully realized the reform goals. Global
standards for platform trading, central clearing, reporting and margin requirements are non-existing.
Instead, the United States and the European Union, the two leading jurisdictions with the biggest
market shares are embroiled in a political negotiation over extraterritorial authority and the mutual
recognition of standards that each side developed unilaterally. In an environment of uncertainty and
absence of global harmonization other jurisdictions have adopted a wait-and-see approach, trying to
minimize the expected incongruence between the domestic rules and whatever emerges as a dominant
global standard. It is unclear at this point when regulators will be able to assess the concentration of
systemic risk in global OTC derivatives markets and undertake prudential interventions, if ever.
The following figure shows the uneven reform progress among the 24 member jurisdictions of
the FSB as extracted from the most recent progress report in each issue area. By end-2014, all FSB
members have adopted and implemented capital rules in line with Basel III. In other areas, reform
progress is mixed. Jurisdictions are in an implementation phase when regulators are requesting
11

comments on rule proposals or when rules are partially effective. Finally, jurisdictions fall into the “no
action” category when rules have not been proposed and published for consultation yet.
Figure 1.3 The progress of global financial regulatory reform

Source: Carney (2014a), BCBS (2014e), FSB (2014c), FSB (2014f)
The third and final reform area examined here concerns systemically important financial
institutions (SIFI), and banks (SIB) in particular. The financial crisis revealed that the bankruptcy of some
financial institutions has negative repercussions for the entire financial sector because they are large,
complex, embedded in an intricate web of contracts with financial counterparties, and hard to replace –
in short, they are too big to fail (TBTF). Because financial market actors expect them to be bailed out by
the government in a future crisis, SIBs can finance themselves at lower cost and they are able to engage
in riskier behavior, a phenomenon that is called moral hazard. G20 leaders declared their willingness to
identify global SIFIs, subject them to higher loss absorbency requirements, and engage in global
cooperative efforts to facilitate their orderly wind-down if necessary. Reform progress in this issue area
24
13
2
1
20
4
11
10
15
12
10
4
20
9
1
7
11
14
4
0% 20% 40% 60% 80% 100%
capital requirements
trade reporting
central clearing
platform trading
margin
G-SIB requirements
resolution powers
resolution planning
Basel
III OTC derivatives Bank Resolution
effective implementation phase no action
12

is mixed. Regulators agreed on a global standard to measure systemic importance and on corresponding
additional capital requirements for global SIBs ahead of an end-2011 deadline. In the same year, the FSB
published a global standard on effective resolution regimes for TBTF banks. It requires member
jurisdictions to work together in crisis management groups, share information and supervise plans for
the recovery or resolution of banks. Four years later, global SIBs are identified and additional capital
requirements are implemented in most jurisdictions ahead of the end-2015 deadline. On the other hand,
member jurisdictions are lagging behind in implementing the global standard on effective resolution
regimes. Crisis management groups are not effective at sharing information and coordinating credible
resolution plans. In sum, regulators have forced large global banks to adhere to globally coordinated
requirements that increase their resilience against shocks, but they have not convinced anyone that
cross-border bank resolution would not be a messy uncoordinated process that makes bail-out a
preferred option, again. In other words, banks are less likely to fail but still too big to fail.
Competing explanations
State-of-the-art theories of global governance, cross-border cooperation and regulatory politics
cannot explain this peculiar pattern of global financial reform progress. This dissertation tests a novel
approach of government networks and legislative recalcitrance against the following seven competing
explanations.
The first two competing explanations focus on the uneven distribution of power in global
regulatory networks and the unaltered hegemony of the largest economies. They come in two varieties.
The original theory of regulatory hegemony as developed by Simmons (2001) distinguishes
between the leading economies as regulatory innovators and the rest of the world. The author argues
that global harmonization around the regulatory standards proposed by the dominant states is a
function of two factors: market incentives to emulate and the existence of negative externalities of non-
adherence. In line with this theory we can expect global financial regulatory reform to progress in areas
13

where market incentives to adhere to the dominant standard exist, and this prediction fits the empirical
record. However, the global financial crisis made it painfully clear to regulators that due to global
financial market integration, non-negligible negative spillovers can exist in any sector. Thus, dominant
states are expected to employ club institutions such as the G20 and the FSB to push for global
harmonization of standards even in areas that were hitherto not considered to entail significant cross-
border externalities, such as securities regulation and accounting standards. In spite of their concerted
efforts and the strategic use of club standards however, reform falls short of commitments in central
areas such as OTC derivatives markets and bank resolution.
Building on Simmons’ approach, Drezner (2007) develops another theory of regulatory
hegemony. His version focuses on market size and the cost of adjustment to a new global standard that
the regulated sector has to bear in each jurisdiction. When the great powers differ in incentives and
adjustment costs, they are unlikely to establish effective global standards. On the other hand, low
divergence in interest among the great powers facilitates the formulation of club standards or even
global harmonization, depending on the degree of resistance by other international actors. The global
financial crisis has hit the developed economies of North America and Western Europe hardest. In line
with Drezner’s theory we can thus expect low divergence of interest among the great powers and the
successful promotion of club or even global standards. Indeed, policymakers on both sides of the
Atlantic have expressed unanimity in promoting the G20 reform agenda. Even the disagreements about
OTC derivatives rules for example are not the consequence of divergence in regulatory philosophy or
adjustment costs. Moreover, there is no evidence that developing member states of the G20 and the
FSB have expressed resistance to the financial regulatory reform program. Nevertheless, reform
progress falls short in areas where the establishment of an effective club standard (at least) is of clear
importance to the great powers.
14

The third contender to explain the uneven progress of global financial regulatory reform builds
on studies of epistemic communities (Haas, 1989; Kapstein, 1989). In a variant of what historical
institutionalists call relative sequencing, this theory posits that global cooperation advances in those
fields where an epistemic community of experts had the time to develop a global technocratic
consensus. From an epistemic community perspective we can thus expect global financial reform to be
successful in those areas where financial regulators have a history of deliberation and interaction. In
turn, reform progress is expected to be insufficient in new areas of regulation where an expert
consensus has not been formed yet. In reality, epistemic community consensus is neither a necessary
nor a sufficient condition for reform progress. Central pieces of the Basel III framework such as the
counter-cyclical buffer and other macroprudential measures were at the margins of prudential
regulatory debate prior to the crisis. Similarly, the most successful element of ending TBTF reform – SIFI
identification and loss absorbency requirements – are in place because regulators agreed to a novel
definition of systemic risk and unprecedented policy measures to address it. This was unfathomable
prior to the crisis, and scholars such as Baker (2013b) describe this rapid shift as an “insider’s coup d’état”
in the regulatory community. Conversely, members of the Basel Committee have reached consensus
about the need for cross-border information sharing and joint supervision of global banks at least two
decades ago, yet this reform initiative falls short of G20 commitments.

15

Table 1.1 Competing explanations
Expectation Critique
1. Hegemony à la Simmons
Dominant countries push for
global harmonization,
concerned with externalities
Reform failure in some areas with clear
negative externalities such as OTC
derivatives, TBTF
2. Hegemony à la Drezner
Dominant countries with
convergent interests develop
club standards
Reform failure in some areas in spite of
convergent interests such as OTC
derivatives, TBTF
3. Epistemic Communities
Technocratic consensus
promotes coordination but
takes time
Reform success in novel
macroprudential areas, failure in areas
of decade-old consensus
4. Redistributive Concerns
Concerns about adjustment
costs and competitiveness
impede global cooperation
Basel III full of redistributive effects
but successful, failure in areas with
unclear adjustment costs
5. Regulatory Capture
Industry defends status quo,
race to the bottom
Global firms support harmonization
because fragmentation is costly
6. Cooperative Decentralization
Politicization leads to
fragmented regulation
Advances in Basel III and TBTF loss
absorbency in spite of politicization
7. Sector differences
Banks easier to regulate than
insurance, capital markets
Basel III and TBTF both deal with
banks, but different outcomes
8. Government networks
Reliance on government
networks and soft law
facilitates global cooperation
Matches reform pattern, highlights
legislative recalcitrance as major
obstacle to government networks

The fourth competing explanation highlights the importance of redistributive concerns. It is
based on the recognition that global standard-setting is never a mere coordination game, and that any
standard entails redistributive consequences among jurisdictions. Representatives of those states where
the regulated sector faces high adjustment costs are thus reluctant to agree to a global standard (Oatley
& Nabors, 1998; Oatley & Winecoff, 2011). In line with this theory, global financial reform progress is
expected to falter where redistributive concerns are salient and successful where they are negligible.
There is indeed plenty of evidence that negotiations in the Basel Committee and the FSB were fraught
with acrimonious discussions between regulators who are worried that the new standards would
negatively affect the competitiveness of the financial industry in their jurisdiction and the national
economy as a whole. However, those reform areas where adjustment costs were clear and vastly
16

different across jurisdictions, such as bank capital requirements and loss absorbency for SIFIs, are those
that have reached successful implementation. In other areas where redistributive concerns are much
more diffuse such as OTC derivatives regulation however global financial reform has stalled.
Concern about adjustment costs is the point of departure of a fifth competing explanation.
Theories of regulatory capture argue that the private sector mobilizes the vast financial, personal, and
intellectual resources it commands to derail global regulatory reform and return global financial
standards to the pre-crisis status quo as much as possible (Baker, 2010; S. Johnson & Kwak, 2010; Mattli
& Woods, 2009). Again, there is evidently no shortage of attempts by the financial lobby to convince
policymakers at the national and international level that the new regulatory standards would suffocate
the financial sector, dry up credit supply to the real economy and thus destroy economic growth for
years to come. However, the private sector never lobbied against the global harmonization of financial
standards. Indeed, financial trade associations have repeatedly called on regulators to live up to G20
commitments, helped regulators in forging a derivatives-related agreement among systemically
important banks where officials failed to implement one, and sued one regulator for allegedly violating
G20 commitments of global harmonization.
The sixth competing explanation draws a causal connection between reform shortcomings and
the politicization of financial regulation in the wake of the crisis. Regulators were able to take the lead
on the formulation of financial standards and their harmonized implementation before the global
financial meltdown because they were much more isolated from political pressures. This changed when
politicians took initiative, responding to popular pressures as financial regulation started attracting
widespread attention in the electorate. This theory predicts the weakening of transnational regulatory
networks and the rise of regulatory divergence, albeit combined with efforts at interstate cooperation in
regulatory matters (Helleiner, 2014b; Helleiner & Pagliari, 2011). There is evidence of such “cooperative
decentralization”, for example in the post-crisis reduction of cross-border credit flows and jurisdictional
17

fragmentation as the consequence of unilateral structural measures such as ring-fencing. However, in
the issue area that put politicians under greatest political pressure, that of banking regulation, a globally
harmonized standard has been implemented. And even after implementing a series of uncoordinated
policies designed to end TBTF banks regulators and finance ministers decided to refrain from further
unilateralism and endow the FSB with the authority to develop a novel loss absorbency standard for
those same banks.
The seventh and final competing explanation highlights the differences between financial
market sectors. It posits that regulation of the banking sector has a longer history and that global
standards governing the banking sector are easier to develop than those needed to regulate the
insurance sector and financial market infrastructures. Indeed the regulatory reform agenda has
advanced much slower with respect to the latter two sectors, often corresponding with later deadlines.
The verdict regarding the global reform of financial market and insurance regulation is thus still open.
But banks are at the center of both the success in Basel III implementation and the patchy progress in
ending TBTF.
This dissertation shows that none of the theoretical approaches outlined above provide
sufficient inferential leverage to explain the empirical pattern of global financial regulatory reform
progress. It presents an alternative approach that highlights the importance of institutional pathways. In
issue areas where transnational government networks take center stage in the negotiation of standards
and where domestic implementation largely eschews legislative interference, global regulatory reform is
advancing successfully. In contrast, wherever domestic legislative bodies attain protagonism in
regulatory issues, global financial reform falls short of G20 commitments. Thus, the foremost obstacles
to global financial reform are legislation and legislators. Recalcitrant domestic legislative bodies fail to
remove existing legislative obstacles and do not endow regulators with sufficient authority to engage in
effective cross-border cooperation. That the state is the biggest impediment to a state-led reform
18

project appears to be a contradiction at first sight. However, a disaggregation of the state reveals the
turf battle between different branches of government over the authority to govern finance in particular
and the economy in general. The tension between regulators and the executive on one side and
legislators on the other can be understood when situating it in the greater structural shift from
nationally bound hierarchies to transnational networks (Castells, 2000). With the rise of globalization,
financial firms started restructuring themselves in a horizontal cross-border fashion, taking advantage of
emerging globally networked markets that thwart the regulatory authority of any single nation-state. In
the same period, a complex governmental transformation gave rise to the regulatory state (Majone,
1997). Regulatory agencies gain autonomy vis-à-vis the territorially bound institutions of the traditional
Weberian nation-state, developing transnational networks with their counterparties abroad. While
regulators and the executive branch are increasingly capable of developing transnational policy
responses to global problems, thereby empowering government networks (Slaughter, 2004), legislators
are left behind. Bound to the nation-state by design, the institutional myopia of parliaments prevents
legislators from engaging in government networks in meaningful ways. The FSB is a prime example of an
emerging government network that has gained power in financial governance, wresting authority away
from domestic legislative bodies. This dissertation situates legislative recalcitrance in this context,
arguing that legislators have no incentive to facilitate a global financial reform that further erodes their
policymaking authority.
Outline of the dissertation
This introduction is followed by six chapters. Chapter two lays out the theoretical foundations of
this study. It discusses scholarly work on the evolution of global governance and the emergence of
government networks. Furthermore, it provides an in-depth discussion of all relevant approaches to
global financial governance that serve as competing explanations.
19

Chapter three develops the methodological approach to the empirical work undertaken in this
dissertation. It discusses the respective advantages and shortcomings of quantitative and qualitative
methods and makes the case for a combination of the two where productive.
The empirical work is presented in three subsequent chapters. Chapter four analyzes the
evolution of prudential banking regulation. It shows how a government network, the Basel Committee,
was able to forge consensus on macroprudential issues that were barely debated prior to the crisis.
Furthermore, the chapter argues that the main reason for the successful implementation of Basel III is
that it largely eschews legislative interference. In fact, the one jurisdiction that provided parliament with
a major role in implementing Basel III, the European Union, has failed the regulatory consistency test
that is part of the Basel Committee peer review process. The empirical record is then tested against
alternative explanations. In addition, chapter four presents a quantitative analysis of the divergence in
state preferences for the new global standard, identifying the predictors of over-compliance with Basel
III.
Chapter five turns to OTC derivatives regulation. It shows how the FSB failed to forge a
government network with the composition and powers necessary to facilitate the development of global
standards in this issue area. Instead, the United States and the European Union developed standards
unilaterally. The chapter traces the growing political tension between the two jurisdictions and shows
why post-hoc harmonization of standards is fraught with difficulties. It connects the absence of an
effective government network to reform failure in OTC derivative regulation and tests this hypothesis
against competing explanations.
Chapter six covers two reform initiatives that fall under the same rubric of ending TBTF. It shows
how a government network succeeded in finding global consensus on a definition of systemic risk and
unprecedented policy measures to address it. The rapid advances in identifying SIFIs and subjecting
them to higher loss absorbency requirements contrast with a second bundle of policy measures: bank
20

resolution. Even though the FSB forcefully promotes global cooperation to facilitate the orderly wind-
down of global banks, reform progress in this area is lagging behind. Again, this hypothesis is tested
against competing explanations. The chapter also covers a recent initiative to end TBTF by developing a
new global loss absorbency standard for failing banks. It shows how the FSB is imitating the institutional
pathways that make the Basel Committee effective, but it fails in the face of the same obstacle that
limits the operations of the BCBS: legislative recalcitrance.
The final chapter summarizes the findings of the three empirical chapters and subjects them
once more to a test against competing explanations. Furthermore, it situates the government network
approach and the phenomenon of legislative recalcitrance in a greater theoretical framework. This
dissertation combines scholarly work on the structural properties of globalization, the regulatory state,
principal-agent theory, international organizations, and the legal theory of government networks to
present a novel approach that explains the tension between the emerging institutions of global
networked governance and the vestiges of the old Weberian nation-state. The second half of chapter
seven discusses two quality indicators of government networks: effectiveness and legitimacy. It argues
that the FSB as a government network is more effective than widely believed and a better alternative to
the intergovernmental financial authorities several scholars suggest. The subsequent section reviews the
debate on legitimacy and argues that deliberative equality is an irrelevant and dangerous quality
indicator in the field of global finance. The chapter ends with policy recommendations and outlines
areas for further research.

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Chapter 2: Theoretical approaches to global financial regulation

Our understanding of global governance has benefited from the work of scholars in fields as
diverse as economics, sociology, political science, and law. As is often the case in multi-disciplinary
research areas however, channels of interaction across disciplinary boundaries are not as open as they
should be. Academic practice and habit sometimes prevents scholars to look outside their community
for inspiration and challenges to their theories and concepts. This chapter presents an attempt at
breaking down these barriers and overcoming the current fragmentation of theoretical work on global
governance. In order to make sense of the empirical pattern of uneven progress that is manifest in G20-
led global regulatory reform, it is necessary to review a wide spectrum of theoretical approaches to this
issue area and compare them in terms of their inferential leverage.
This chapter starts with a discussion of the history and fundamental concepts of global
governance. It then narrows the analytical focus to global economic and financial governance. In order
to attain a solid understanding of the global financial reform process, salient theories of global financial
governance are tested against each other and against the empirical data. The chapter draws on work
from various fields of the social sciences to single out eight such theories. The theoretical foundations of
each of these eight approaches are presented. In some cases, challenges or extensions to the theory are
proposed. Subsequently, this chapter specifies the expectations and respective hypotheses that follow
from each approach regarding the progress of global financial regulatory reform.
Global Governance
Global governance has had a peculiar trajectory in modern history, with drastically varying
degrees of scope and institutionalization. The following paragraphs present a brief overview over
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selected theoretical approaches to global governance and identify gaps that this dissertation seeks to
address.
Abbott and Snidal (2001, p. 346) define global governance as “[…] the formal and informal
bundles of rules, roles and relationships that define and regulate the social practices of state and
nonstate actors in international affairs.” This is a very wide definition that attempts to encompass the
entire spectrum of cross-border institutions. Indeed, governance arrangements vary in scope (regional,
global), institutional form, and stakeholders (public, private) according to the nature of the issue area to
be governed. A first useful step is thus to narrow the area of interest to global economic governance.
Humans have engaged in cross-border economic exchange for millennia, but for almost the
entirety of this time period the global governance institutions that guided this exchange were minimal.
No World Trade Organization was necessary to ensure the functioning of the Silk Road, for example,
instead the rules of the market coordinated human behavior. Even today, although it is embedded in a
social, legal, and political environment, the market is the default institution of global economic
interaction.
The need for global governance arises from the externalities of human interaction across
national borders that are not internalized by market forces alone. There is a wide variety of externalities
that call for corresponding global governance arrangements.
The first organizations designed to handle global governance tasks have been created during the
wave of globalization that preceded the current one. Cross-border flows of capital, goods, and labor
peaked in the decades before World War I, and intergovernmental organizations such as the
International Telegraph Union (1865) and the European Rail Union (1890) were established to regulate
the expanding cross-national trade, communication, and transportation infrastructure. In this situation,
regulators faced network externalities: the biggest obstacle to exchange was the lack of standardization.
Once all economic actors would adhere to a single standard, transaction costs would be greatly reduced,
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and the resulting efficiency gains would enhance human welfare. Therefore, the nature of strategic
interaction was that of a coordination game (Abbott & Snidal, 2001). Early functionalists (Mitrany, 1944)
interpreted this phenomenon as a sign that increasing economic interdependence generates a demand
for global governance arrangements that will ultimately facilitate the convergence of state preferences
(Matthew & Zacher, 1995; Murphy, 1994; Rosamond, 2000). However, functionalist accounts of global
governance have been criticized for relying on a false dichotomy between technocratic administration
and power politics. Seemingly neutral standard-setting and administrative tasks have significant
distributional consequences. As a consequence, actors bargain hard for the choice of one among a
variety of possible governance structures. The functionalist approach is ill equipped to fully incorporate
the politics underlying this process (Kahler & Lake, 2003).
The interwar years saw a sharp reversal of both economic interdependence and relevance of
global governance arrangements. Interestingly, it was at a historic low point of global integration at the
end of World War II that most institutions of global economic governance of relevance today were
established. The temporal evolution of global governance institutions thus attenuates the causal link
functionalists make between economic interdependence and institutional development (Kahler & Lake,
2009).
Global economic integration increased dramatically from the 1970s on, but this new wave of
globalization has not produced a matching network of global governance institutions. This can be seen
as an indicator that network externalities and coordination games are not the predominant issues of
global economic governance. In a world where no particular regulatory standard is objectively welfare-
enhancing and where regulatory cooperation has distributive consequences, theories that highlight the
political dimension of global governance promise to entail high explanatory power. Kahler and Lake
(2003) emphasize the intrinsic link between form and substance of global governance structures: “Since
institutions shape the politics of choice and the outcomes observed, concerned parties will attempt to
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align governance structures with their interests. That is, the politics of designing, building, and
overturning institutions of governance at all levels is really about policy choices. Thus, debates about
supranationalism, decentralization, the respective roles of public and private sectors, and accountability
are often struggles over institutions that will produce results favoring some groups or interests at the
expense of others. Contests over governance are contests over policy.” (p. 20).
Competing Approaches to Global Financial Governance
The relationship between global governance arrangements and policy outcomes has attracted
much scholarly attention over the last decades. Economists, political scientists and legal scholars have
developed a variety of theoretical approaches to a field that is intrinsically interdisciplinary. State of the
art theories also vary in their scope of application: some seek to understand global governance in
general, others focus on global economic or financial governance. The following paragraphs discuss
eight relevant theoretical approaches and extract their predictions and hypotheses regarding global
financial regulatory reform.
The first two theoretical approaches presented here carry intellectual heritage from
Kindleberger’s (1973) hegemonic stability theory. They depart from the recognition that power is
unevenly distributed in the international system and that the great powers exert major influence over
governance arrangements and policy outcomes.
In a short but influential paper, Moises Naim (2009) proposes minilateralism as a solution to the
current problems of global governance, in the economic realm and beyond. He advocates for a strategy
to “bring to the table the smallest possible number of countries needed to have the largest possible
impact on solving a particular problem”. Successful negotiations, the author argues, can occur only in a
club-like environment where only a few of the most involved and powerful stakeholders are present.
Once an agreement is reached, however, it can be extended to all other countries that are willing to
subscribe to it.
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It is important to note that Naim’s minilateralism is not a new phenomenon but rather the
modus operandi of global governance in the realm of finance for decades. The establishment of the
Bretton Woods system in the aftermath of World War II has attracted a great deal of attention from
political scientists and economists (Eichengreen, 1998; Kindleberger, 1973; Polanyi, 1944). But when this
traditional IGO-centered system broke down in the 1970s, scholars started debating the conditions of
global financial governance and its further evolution (Ruggie, 1982; Strange, 1996). After the demise of
IMF-centered exchange rate coordination, macroeconomic policy coordination fell into the hands of the
G7 from 1973 onwards. Another area of global financial governance, prudential banking regulation has
never taken the route of a broad and inclusive institutional setting. Instead, the Basel Committee on
Banking Supervision (BCBS) was created by and for a long time restricted to financial regulators of only
10 countries (the so-called G10). In other words, for the last four decades, many governance bodies of
global finance were designed to maximize efficiency while paying little attention to representation.
In the wake of the global financial crisis, the members of this exclusive club of rich nations
decided to widen the institutions of global economic governance and bring major emerging economies
to the table. But the inclusion of new important stakeholders does not imply a departure from
minilateralism. This became clear when G20 members rejected a proposal by Secretary General Ban Ki-
Moon to convert a December 2008 UN Conference on Financing for Development into a summit to
address the financial crisis, and ignored a subsequent call by the Stiglitz Commission for the creation of a
Global Economic Coordination Council under UN auspices (Cooper, 2010; Wade, 2011; Kharas &
Lombardi, 2012; Knaack & Katada, 2013). Neither did the “marginal majority” of 150 states (Payne,
2010) participate in the negotiations regarding financial regulatory reform. For example, even though
over 120 jurisdictions claim to adhere to earlier Basel standards of prudential banking regulation for
example, only 27 member states were involved in the formulation of the new Basel III rules (K.
Alexander, Dhumale, & Eatwell, 2006; BCBS, 2011a).
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Hegemony à la Simmons
Even within these small, club-like governance bodies, power is unevenly distributed. In her
approach to the politics of financial harmonization, Simmons (2001) distinguishes between the
dominant center where market power is concentrated, such as the United States and Great Britain, and
the rest. Simmons (2001, p. 591) states: “The decisions of regulators in the dominant centers can
drastically change the choices available to other countries; they create a paradigmatic shift, and any
negotiations that follow are merely splitting hairs.”. Global governance arrangements in a given issue
area are a two-dimensional function of (1) market incentives for emulation and (2) externalities of non-
adherence to the center’s standards. If the externalities of non-adherence are low, multilateral
institutions play a marginal role, and market incentives decide whether harmonization occurs or not.
Conversely, in areas where negative externalities of non-adherence are high, the dominant centers use
multilateral institutional arrangements for a variety of tasks that range from information exchange and
technical assistance to outright political pressure for harmonization.
The global financial crisis represents a fortuitous occasion to revisit the assumptions and
conclusions of this theory. The crisis revealed the high degree of cross-border interconnectedness of the
contemporary financial system. No subsector of financial markets was exempt from negative cross-
border spillovers. It can thus be argued that Simmons’ second dimensions has contracted, turning all
sectors of financial activity into areas with significant negative cross-border externalities. This becomes
clear when looking at the two sectors where Simmons previously regarded non-adherence as innocuous
for financial stability in the dominant center: accounting standards and securities regulation.
Generally not considered one of the most thrilling areas of global finance, accounting standards
have gained unprecedented salience in the wake of the crisis. G20 leaders started paying attention to
the problems inherent in the inconsistencies between accounting standards applied in the United States
(GAAP) and elsewhere (IFRS) (J. Friedman, 2011; J. E. Stiglitz, 2010; Tirole, 2010). At the April 2009
27

summit in London, G20 leaders called on the two main accounting standard setting bodies to “make
significant progress towards a single set of high quality global accounting standards”, among other
initiatives to strengthen the financial system (G20, 2009a, p. 6). Since then, the Financial Stability Board
(FSB) has included accounting standards in every progress report to date (FSB, 2013c). Gadinis (2013, p.
171) notes with surprise: “That accounting inspires this level of detail in a report to government leaders
is, on its own, a fascinating development.”. Even though the convergence efforts in accounting have
been tepid and incomplete by the end-2013 deadline, the political salience of this issue area shows that
the dominant players in global financial governance are wary of the negative externalities that a lack of
cross-border harmonization would entail.
The emergence of political pressure for international regulatory coordination is even clearer in
securities markets. In 2001, Simmons stated that information sharing among securities regulators is
minimal due to concerns about confidentiality and the absence of systemic risk in this market. This was
particularly true for a subsector of the derivatives market that was not traded on exchanges but over the
counter (OTC). US Congress passed legislation in 2000 that explicitly exempted OTC derivatives from
regulation altogether (K. N. Johnson, 2011). Furthermore, there were few market incentives for
emulation of dominant regulatory standards, both in exchange-traded securities and derivatives
markets. The conditions of OTC derivatives contracts in particular are negotiated bilaterally and even
though the main industry association provides a common standard (ISDA Master Agreement), OTC
contracts display considerable heterogeneity not only across countries but also across counterparties.
However, awareness of negative externalities and subsequent political pressure for harmonization has
changed dramatically with the global financial crisis. Most financial experts had not anticipated the
degree of cross-border repercussions that interconnectedness in the derivatives market entailed. In fact,
in the run-up to the crisis, between 50% and 75% of OTC derivatives contracts of U.S. financial firms
involved counterparties in other countries. After the costly bailout of AIG, US policymakers made
28

derivatives regulation a cornerstone of domestic regulatory reform while simultaneously pushing this
issue area onto the G20 reform agenda (Greene & Potiha, 2012). The securities standard-setting body
IOSCO, previously described as a rather passive transnational government network, was put in charge of
coordinating derivatives reform across borders under the supervision of the FSB.
Figure 2.1: Changes in global financial governance

Source: Adapted from Simmons (2001)
In sum, it can be argued that the 2x2 taxonomy of Simmons’ theory of regulatory harmonization
collapsed into a 2x1 roster after the crisis because no area of financial regulation is considered to merely
entail negligible cross-border externalities any longer. This implies that independent of the degree of
market incentives for emulation, the dominant center will exert political pressure towards global
harmonization of regulatory standards and the elimination of free riding.
Hegemony à la Drezner
The idea that great powers remain the primary rule-makers of the global economy is further
developed by Daniel Drezner (2007). The author draws a useful distinction between benefits and
adjustment costs of policy coordination. Globalization has increased the rewards of international
coordination, but adjustment costs for affected domestic actors remain the same. For sizeable
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economies, the benefit of adjustment to another state’s standards are low in comparison to the
adjustment cost. This is because trans-border transactions represent a smaller share of the overall
economic activity. Market size matters because domestic actors voice their resistance if their perceived
adjustment costs supersede expected benefits, thus impeding policy coordination. In addition, big states
have the go-it-alone-power of large internal markets (Gruber, 2000). They can threaten to deny market
access and resort to economic coercion if other states refuse to adhere to domestic standards. This
conjecture has two implications. First, Drezner predicts that the equilibrium outcome is a convergence
to the standard prevalent in the largest country. Second, effective global governance is established only
if the great powers agree on the same standard.
To add further detail, Drezner introduces at a two-dimensional typology of global standards that
considers the degree of interest divergence among great powers on the one hand, and that between
great powers and other international actors on the other hand. The author contends that in the realm of
financial regulation, great powers exhibit a low degree of conflict whereas their interests significantly
diverge from that of the periphery.
Several questions remain unanswered in Simmons’ and Drezner’s accounts of global governance.
First, which are the great powers? Market size is what makes a power great in both authors’ accounts,
and the United States is the obvious player, but what about Europe, where political and market borders
don’t necessarily overlap? While Simmons (2001) regards the United Kingdom as a major player,
Drezner (2007) asserts only six years later that “the commonalities of policy content are powerful
enough to treat Europe as a single actor” (p. 38). This might be the case in the trade regime, but the
financial markets of the UK and continental Europe differ significantly in size, composition, and
embeddedness in their respective political environments. The literature on varieties of capitalism lays
the fault line between liberal and coordinated market economies in the Strait of Dover, and it is along
that line that many intra-EU struggles on financial regulation arguably develop (Gow, 2011; Hall &
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Soskice, 2001; Shah, 2012). Furthermore, it is unclear whether or not Japan and China qualify as great
powers in this context. Japan’s capital markets are predominantly domestic while China’s are only
starting to develop, but overall economic output and massive foreign exchange reserves give both
countries considerable weight in the global macroeconomy.
Second, financial markets operate in different ways than goods and commodity markets. In non-
financial sectors of the economy, adherence to higher regulatory standards puts the firm at a
disadvantage unless all competitors adhere to the same standards, thus introducing a strategic situation
akin to a Prisoners’ Dilemma. Financial markets in contrast are marked by information asymmetries
between parties to a transaction and therefore the price of capital is always risk-adjusted. As a
consequence, adherence to higher regulatory standards, while increasing operational cost, also lowers
the cost of input (capital) for financial intermediaries. New entrants or firms without a track record that
would inspire investor confidence, such as many banks in developing countries for example, have a
strong incentive to adhere to global prudential standards in order to gain cheaper access to capital.
Furthermore, the net effect of higher standards in finance varies between different market sectors and
types of firms.
Third, the authors are not specific enough about who ultimately bears the cost of adjustment to
global standards. Regulation entails both adjustment costs in business practice and the cost of
supervision. In self-regulatory regimes, the private sector typically shoulders both. If supervision is in the
hands of public authorities, however, the state alone faces supervisory costs. The cost of supervision for
states was small in the last 20 years because supervisory responsibility was largely in the hands of the
private sector itself (Helleiner & Pagliari, 2010b). Adjustment costs for firms on the other hand were
relatively small because adherence to the new standards did not entail a significant departure from
status quo business models. The wave of deregulation and promulgation of self-regulatory standards
thus appeared to include all stakeholders in a win-win situation: the state could ensure systemic stability
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while delegating a large portion of the regulatory cost to a private sector that was willing to supervise
itself according to prudential standards that did not impose obstacles to its business models.
The fallacy of this win-win situation became painfully clear during the global financial crisis. In a
drastic departure from the previous model, financial reform today implies both a return of supervisory
authority to the state and tougher regulation (Helleiner & Pagliari, 2010a). In principle, this entails high
adjustment costs for both the public and private sector. The lack of theoretical precision outlined above
notwithstanding, great power theories of global financial governance allow scholars to formulate
refutable hypotheses regarding post-crisis governance arrangements and policy outcomes.
In the wake of the string of financial crises of the late 1990s that shook emerging markets in Asia
and South America, regulators in North America and Europe recognized that promoting a more rigorous
set of prudential standards promised to reduce the negative spillovers of financial crises. Drezner (2007)
states: “For developed countries, the benefits of global financial regulatory coordination at stringent
levels of regulation were significant, while the adjustment costs were relatively minimal.” (p. 123). In
developing countries in contrast, adherence to stricter regulatory standards would require both a
significant increase in resources dedicated to financial regulatory authorities and in compliance costs for
the private sector, whereas the benefits of these changes would be much less tangible. Given this array
of interests and power, the dominant players are likely to establish what Drezner calls “club standards”,
standards that are formulated by a small group of stakeholders but enforced through an international
organization that can monitor the compliance of members and outsiders. Indeed, in the early 2000s the
dominant powers devised the Financial Stability Forum, a club-like governance body that originally was
restricted to only the G7, Hong Kong, Australia, and the Netherlands to develop and promote what
became known as the 12 Key Standards of financial regulation (Griffith-Jones, Helleiner, & Woods, 2010;
Blustein, 2012).
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The 2007-9 financial crisis has only reinforced this alignment of costs and benefits. Developed
countries, especially the United States and Europe, were hardest hit by the crisis and were forced to
massively increase the burden on their public finances in order to bail out financial firms both at home
and abroad. Developing countries on the other hand survived the crisis relatively unscathed.
Consequently, regulatory reform in the wake of the crisis is driven by the dominant powers who are
willing to incur the costs of a regulatory reform that is designed to protect themselves from another
financial breakdown. Jörgen Holmquist, Director General of at the European Commission put it in clear
words at a Washington conference in April 2009: “From a regulatory point of view, the G20 roadmap is
mainly an EU-US intellectual product. When the process started last November, it came as a comfort to
us to see how much we had a common view both on the diagnosis of the causes of the crisis and on
what is needed to tackle them.” (Holmquist, 2009, p. 11). Developing countries on the other hand are
voicing concerns not only about the burden of higher supervisory requirements but also the negative
impact that regulatory reform would have on their access to capital abroad (FSB, 2013b). Again, financial
prudential rules are emerging as club standards in that they are formulated by a slightly larger but still
small group (the G20) and enforced through an equally exclusive governance body, the Financial
Stability Board (FSB)(Pauly, 2010).
In sum, both Simmons’ and Drezner’s approaches predict that the global financial crisis will lead
to the emergence of a harmonized set financial regulatory standards. The standards are expected to be
formulated in a minilateral club such as the G20 and the FSB. Moreover, where market incentives for
emulation prove insufficient, the dominant powers have a strong incentive to exert political pressure
towards global harmonization, making sure that all relevant jurisdictions adhere to the dominant
standard and that none resorts to free-riding.
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Epistemic communities
An alternative approach to global financial governance is centered on the concept of epistemic
communities. In a seminal article over a quarter-century ago, Haas (1989) describes the emergence of
an actor with increasing influence in the international system: epistemic communities. The author
defines them as transnational networks of experts that share a set of normative and principled and
causal beliefs as a rationale for their actions. These communities are of increasing importance in issue
areas characterized by uncertainty, where policymakers rely on experts as knowledge generators and
information providers. The case for epistemic communities is particularly strong in a highly technical and
uncertain issue area such as global finance.
The epistemic community approach to global financial governance challenges hegemony
theories in that it attenuates the causal connection between market power and influence over policy
outcomes. The following two conjectures drive this approach: First, epistemic communities operate as
transnational networks. The establishment of transnational ties on the basis of shared causal beliefs
may weaken the allegiance of epistemic community members to any particular nation-state. Second,
these transnational networks of experts have increasing influence over the policy-making process.
Especially in issue areas of risk and uncertainty such as global finance, it is hard for policymakers to gage
which option in a given spectrum of policies aligns more with the “national interest”.
Kapstein (1989) is among the first scholars to apply the epistemic community approach to global
financial regulation. He traces the development of the original Basel Accord of 1988 and shows that the
success of this agreement is not only a consequence of leadership by the US and Great Britain. Rather,
the Basel Accord was made possible because banking regulators reached an intellectual consensus
regarding financial risk and the optimal measures to address it. It is sensible to extend Kapstein’s
approach to all areas of financial governance by focusing on the work of epistemic communities in
developing consensual knowledge about how to regulate a given market sector.
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The epistemic community approach to financial regulatory reform further benefits from
scholarly work done in the field of historical institutionalism. It posits that institutional interests are
often analytically prior to the material interests of domestic actors. The embeddedness of actors in
longer-standing institutional structures influences both their preferences and power at the national and
international bargaining table. Consequently, historical institutionalists focus on sequencing and the
constitutive nature of institutional contexts. One particular mechanisms of this institutional evolution is
policy feedback: Institutional reform at a given moment has a propensity to create client groups that
then have a strong incentive to maintain their privileged position. Thus preference formation and
institutional development are deeply intertwined processes. Policy feedback mechanisms diverge not
only from rationalist but also constructivist assumptions because preference formation is based neither
primarily on material interests nor ideas, but rather on previously existing institutional structures (Farrell
& Newman, 2010). For example, manufacturing firms in import-substitution, export-promotion, and
laissez-faire institutional contexts might develop very different positions on the spectrum of possible
preferences. In the realm of finance and accounting, Büthe and Mattli (2011) show how the historically
grown domestic institutional environment influences the ability of private actors to influence global
regulatory institutions.
Historical institutionalists regard relative sequencing as another important mechanism. The
timing of domestic and transnational institutional development has a decisive influence over regulatory
outcomes at the global stage. While the original theory focuses on relative differences in regulatory
capacity among countries, this dissertation employs the same concept to different market sectors. The
development of consensual knowledge in epistemic communities takes time, and regulators have
started generating knowledge and building regulatory capacity in some market sectors much earlier
than others. In line with this theory we can thus expect global financial regulatory reform to be
successful in areas where financial experts have had enough time to reach a consensus on the optimal
35

way of regulating a financial market sector. Conversely, regulatory reform can be expected to lag behind
in new areas where no such consensus is found or where it is still being developed.
Redistributive Concerns
A fourth approach to global financial regulation highlights the uneven distribution of costs and
gains from global standards. Oatley and Nabors (1998) challenge the idea that global agreement is built
on consensus-building in epistemic communities and the realization of joint gains. They squarely take on
Kapstein’s account of the Basel Accord and show that rather than consensual knowledge, the global
agreement was driven by domestic tension in the United States. The authors start with the recognition
that the benefit of financial regulation is relative systemic stability. In the wake of the Latin American
debt crisis, many American banks faced serious liquidity and solvency problems that threatened to have
systemic repercussions. Investors and depositors thus called for a more stringent regulatory framework.
However, any regulatory approach entails costs for the private sector, and any regulation that only
applies to domestic corporations affects their competitiveness in the international marketplace. By the
1980s financial markets had reached a degree of cross-border interconnectedness that made
international competitiveness a major concern for the US financial sector. The only way to cater to both
constituents was to internationalize financial regulation.
The difficult trade-off between stability and competitiveness remains the centerpiece of further
theorizing on the issue of global financial regulation (D. A. Singer, 2004, 2007). But Oatley and Nabors
(1998) go one step further. According to the authors, the purpose of international harmonization is not
merely to impose the same regulatory costs on all corporations around the world, ensuring the oft-cited
“level playing field”, but to transfer resources away from foreign firms to compensate the domestic ones.
At the time Basel I was implemented, Japanese and French banks had much lower capital
buffers than their American counterparts. Foreign firms used this advantage to gain market share in the
major financial centers. Under these circumstances, Oatley and Nabors explain, the effect of Basel I was
36

not only to erode the advantage of foreign competitors but to put American banks at an advantage
because they had to raise less capital in order to comply with the new prudential standards. The authors
contend that this kind of transfer and redistribution in favor of the domestic sector is the rationale
behind global financial regulation. But why would the government of any other country voluntarily sign
an agreement that erodes the competitiveness of its financial sector or even puts it at a disadvantage?
Oatley and Nabors argue that the United States and Great Britain relied on combined market power to
coerce other nations. A year before Basel I was signed, the two countries reached an agreement to raise
capital requirements for all financial institutions that want to operate under its jurisdiction. Faced with
the dilemma between exclusion from the major financial centers and succumbing to the conditions of
the bilateral treaty, the government of Japan and other reluctant countries had no better option than to
engage in negotiations for a global agreement.
In a recent paper, Oatley and Winecoff (2011) argue that Basel III is essentially another instance
of the same phenomenon. In the wake of the global financial crisis, US authorities again had to find a
way to balance public demands for stricter regulation and private sector concerns about international
competitiveness. And like in the 1980s, American banks were at an advantage because the gap between
average capital buffers and the new minimum requirements was smaller than for foreign competitors.
This argument will be subjected to further scrutiny in the context of the evolution of Basel agreements
in chapter four.
Even though redistributive cooperation theory was developed to explain prudential banking
regulation, its explanatory scope can be extended to all sectors of global financial regulation.
Furthermore it is possible to extract predictions regarding the progress of global financial regulatory
reform. Because redistributive cooperation theory highlights the importance of adjustment costs we can
expect global cooperation to be easier where adjustment costs are negligible, diffuse, or evenly
distributed across jurisdictions. In contrast, in areas where concerns over adjustment costs are so strong
37

that the great powers have no option other than to resort to coercion, global cooperation and
regulatory reform progress can be expected to be insufficient.
Regulatory Capture
The fifth approach to global financial regulation considered in this dissertation concentrates on
the power of special interest groups. The theory of regulatory capture has a long history and a variety of
specifications that will be discussed in detail in this section.
Over the last century or so, scholarship in political economy has found two ways to
conceptualize regulation. The first approach regards regulation as an intervention in the name of the
public interest to redeem market failure in a certain area. Market failures are the product of asymmetric
information between parties to transactions, limited ability of agents to make binding commitments,
and other forms of incomplete contracts (Akerlof, 1970; Pigou, 1920). Another major class of market
failures arises from externalities, that is consequences of an economic transaction that are not fully
internalized by the transaction parties. Joseph Stiglitz, an economist who has made major contributions
to the study of market failures over the past decades, states: “In short, regulation is necessary because
social and private costs and benefits, and hence incentives, are misaligned.” (J. Stiglitz, 2009, p. 13). A
special kind of market failures is caused by systemic externalities, that is failures that arise from the
correlated behavior of a large number of institutions, none of which is systemically significant in itself. In
the global financial crisis, systemic externalities played a significant role, sparking a vigorous debate
about the nature of systemic risk in financial markets and how to address it with macroprudential
regulation (Acharya, Cooley, Richardson, & Walter, 2011; Turner, 2012).
The alternative approach posits that rather than addressing market failures, the purpose of
regulation is the redistribution of resources to the benefit of a certain group. This line of thinking
associates regulation with regulatory capture. Mattli and Woods (2009, p. 12) define it as the “[…]
control of the regulatory process by those whom it is supposed to regulate or by a narrow subset of
38

those affected by regulation, with the consequence that regulatory outcomes favor the narrow ‘few’ at
the expense of society as a whole.”
The theory of regulatory capture revolves around the relationship between three stakeholders:
the principal, usually a legislative body, the agent i.e. the regulatory agency, and those affected by the
regulation. The pioneering work of Stigler (1971) focuses on the relationship between the first and the
last. Stigler recognizes that the transaction cost of channeling and aggregating information from the
public to decision makers in the political arena is high. This is because the public must express its
preferences in simultaneous fashion in a one-point-in-time decision, that is elections. This mechanism
contrasts with “voting” procedures in the marketplace, where customers develop and express their
preferences over time, giving market participants the chance to react continuously to changes. In
addition, market decisions only involve those individuals that are immediately concerned with a certain
issue (product) whereas the expression of preferences in the political system involves many voters who
are unconcerned and uninformed about a given policy area. Due to the resulting scarcity and lack of
precision in the flow of information from the public, politicians enjoy a great deal of discretion in the
policy-making process (Stigler, 1971).
In order to remain in office, politicians need financial resources (for electoral campaigns) and
votes. Special interest groups are in a privileged position because they are able to provide either, or
both, in exchange for policies that favor them, usually to the detriment of the rest of society. For
example, trade unions can influence their members to favor one candidate over another, and industry
groups can make substantial campaign contributions. In principle, the rest of society could neutralize
this mechanism by making a credible commitment to an equivalent amount of votes or capital. However,
the rest of society is facing diseconomies of scale. First, the incentives for free riding increase with group
size, generating the well-known collective action problem. Second, the bigger the group that seeks
wealth transfer via regulation is, the more concentrated is the base of the opposition, and high expected
39

per-capita losses are an incentive for resistance. Conversely, small groups can mobilize resources
without much resistance because benefits are concentrated and costs dispersed across the rest of
society. Because politicians are not able to win or stay in power merely with the support of the sum of
opponents to special interest policies, they are prone to regulatory capture (Olson, 1968; Peltzman,
1976; Stigler, 1971).
In the literature described above, the process of capture involves only the legislative body.
Regulatory agencies are understood as merely following a certain policy or are not contemplated at all.
An alternative approach employs principal-agent theory to highlights the slack between the legislative
principal and the regulatory body. The legislature is modeled as a welfare-maximizing institution that
operates in the benefit of the public. It puts an agency in charge of regulating a sector of the economy
but has limited control over its operations. The agency in turn has sufficient resources (time and
expertise) to obtain information about the sector it regulates. Given this information asymmetry, the
agency may have an incentive to collude with the regulated sector and withhold information from the
scrutiny of the legislature and the public at large. Rent-seeking behavior occurs when the payments
from the regulated sector supersede the rewards by the legislature for regulatory diligence (Laffont &
Tirole, 1991; Estache & Wren-Lewis, 2009).
In one of the oldest empirical studies on regulatory capture, Huntington (1952) reveals how the
US regulator for interstate transportation extends favors to railroad companies to the detriment of
motor carriers and the users of railroad services. One of the major redistributive effects of regulation is
that it eases competitive pressures for established firms by raising the entry cost into a certain sector of
the economy. In an empirical study that spans 85 countries, Djankov et al. (2002) show that stricter
regulation for the operation of a business is not associated with higher quality products, better pollution
records or health outcomes, but with higher levels of corruption.
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Both of the above approaches to regulatory capture have in common that special interest
groups channel resources to public institutions in return for favorable treatment or policies. That is, they
buy access to politicians in order to communicate their preferences or they buy influence in the policy-
making or regulatory process. In addition, scholars have identified a third mechanism of regulatory
capture that relies on costly signaling (Grossman & Helpman, 2001, 1994).
According to Gordon and Hafer (2005), rather than trying to influence policy directly, special
interest groups spend money on lobbyists and campaign contributions in order to signal to public
authorities that they are willing to fight agency decisions that are not in their favor. This signal of
“flexing muscle”, the theory goes, prompts regulatory agencies to update the cost benefit analysis of
their actions and to avoid confrontation with the special interest group. In support of this theory,
Gordon and Hafer find that regulators in the United States are less stringent in their inspection of those
nuclear power plants whose operators make major political expenditures.
From Stigler’s original article until today, the public choice approach to regulation has
illuminated many relevant facets of capture. This line of scholarship has used rigorous game theoretical
models to bolster the logical consistency of capture theory, and in several instances it has provided
empirical support for its claims and hypotheses (Krause & Douglas, 2005). What limits the usefulness of
this line of thinking, however, is that it is too narrow, in three senses of the word.
First, formal modeling of regulation tends to focus on one specific type of regulation and
capture. For example, Laffont and Tirole’s model captures essential features of the regulation of natural
monopolies and government procurement (Bernstein, 1977). Carpenter (2010; D. Carpenter & Ting,
2007) models approval regulation as prevalent in the area of public health and safety. Stigler conceived
of capture as designed to raise entry costs for potential competitors. While all of the above-mentioned
approaches map onto a certain aspect of regulation, they are too narrow to provide a meaningful model
of the relevant mechanisms in the complex field of financial regulation.
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Second, public choice models tend to emphasize financial expenditure as a means of capture.
While lobbying expenses and campaign contributions are a major instrument of special interest politics,
and certainly the most easily measurable, at least in the United States, there is no evidence that it is the
most effective or even the most prevalent channel for regulatory capture. By narrowly focusing on
political expenditure, public choice models tend to ignore the manifold mechanisms of capture that are
described below.
Third, state-of-the-art game-theoretical models of regulatory capture have limited themselves
to the realm of domestic politics. They rely on assumptions that might fit the political structure of the
United States and maybe similar developed democracies. But they are too narrow to meaningfully map
the wide variety of domestic institutional arrangements and actors in the major economies around the
world, let alone their interactions across borders.
In order to make sense of the current process of financial regulation as it unfolds in the
domestic, international, and transnational realm in parallel fashion, it is necessary to transcend the
limitations of the public choice approach to regulation. Nevertheless, the mechanisms of capture that
have been identified by this approach should inform theory building in scholarship on the political
economy of global regulation. The following section presents the state of the art of this field with an
emphasis on financial regulation.
Capture can manifest itself in all stages of the regulatory process, from agenda-setting,
negotiation, implementation to monitoring and enforcement (Abbott & Snidal, 2009). The result of
capture in the first two stages is the absence of regulation in an issue area where it would have imposed
costs on special interest groups. The counterfactual is of course hard to ascertain, especially at the
agenda-setting stage. At the negotiation stage however, regulatory proposals that are discarded at some
point and under certain political circumstances can be subjected to the test of regulatory capture. In the
implementation, monitoring, and enforcement stages, the gap between de jure regulatory standards
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and de facto situation is more amenable to scrutiny. Capture at the implementation stage can result in
rules and standards that are either inadequate to safeguard societal preferences or that are not
enforceable. Finally, special interest groups can be the reason why compliance with regulatory
standards is not monitored or enforced. In the area of global financial standards for example, domestic
interest groups that lack the power to exert influence at the international negotiation stage can
nevertheless resist subsequent domestic implementation, monitoring and enforcement. The result is
either insufficient compliance or mock compliance (Mosley, 2010; Walter, 2008).
The mechanisms of regulatory capture are as variegated as its results. As mentioned above,
although political campaign contributions and lobbying expenses are the channels that have received
most attention by scholars, there is a wealth of instruments by which special interest groups seek to
influence regulation. A prevalent one among these instruments is revolving doors.
The flow of people between the private and public sector contributes to a skewed incentive
structure for regulators. This is both because public officials are recruited after internalizing
“professional ecologies” during extended careers in the private sector, and because lucrative positions
may await them after they step down from their public duties. Furthermore, industry associations have
an incentive to recruit ex-regulators as lobbyists because they can use those personal networks forged
during their tenure as public officials in order to influence policymakers (Baker, 2010).
While standard forms of political expenditure use financial capital, the revolving doors
instrument relies on human capital. Both are relatively abundant in the industries that are famous for
their lobbying, for example tobacco, the pharmaceutical and the financial services industry. But only the
latter can count on a third source of capital that most other sectors of the economy are lacking, that is
cultural capital.
Johnson and Kwak (2010, p. 93) note: “Capture does not imply that regulators are corrupt, or
that their actions are motivated by their personal interests. By contrast, regulatory capture is most
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effective when regulators share the worldview and the preferences of the industry they supervise.” The
phenomenon that all major stakeholders prior to the global financial crisis shared the idea that a large,
sophisticated, and only lightly regulated financial sector is good for the overall economy is what the
authors identify as cultural capital. Financial regulators were subject to intellectual capture. This is
because regulators and financial executives often undergo the same formal training and participate in a
tightly knit community that cultivates a relatively narrow set of beliefs and assumptions at the expense
of a wider intellectual spectrum (Baker, 2010).
It is important to note that each of the above mechanisms of capture operates in different areas.
For example, political expenditures are usually restrained to the domestic realm. Officials in
international organizations and government networks are not concerned with elections. There are no
campaigns that any special interest group could influence with financial contributions, and cross-border
regulatory institutions usually do not have to bargain with legislatures for budgetary health and survival.
In contrast, capture on the basis of human and cultural capital is a mechanism that operates
worldwide in principle. No matter whether they work in domestic agencies, international organizations,
or government networks, regulators are facing an incentive structure that is skewed by revolving doors.
The same holds true for intellectual capture. If the selection mechanisms of formal education and a
tightly knit community narrow the spectrum of opinions regarding regulation at the domestic level, it is
hard to imagine that they are not at work in the elite circles of global financial regulation. If and under
what conditions however these kinds of regulatory capture take place is an empirical question.
In an encompassing approach to regulation and capture at the global level, Mattli and Woods
(2009) distinguish between the institutional supply and societal demand side for regulation. According
to their framework, common interest regulation is only achieved when institutions with multiple access
points and transparent procedures combine with broad societal demand. Conversely, narrow demand
for regulation invariably leads to capture, as does limited institutional supply.
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On the supply side, Mattli and Woods follow a proceduralist approach that assesses institutional
quality by the standards of due process, not substantive or normative considerations. The sophisticated
system of multiple access points, checks and balances, and review procedures inherent in the
institutional design of democracies safeguards the principles of transparency and participation in the
domestic realm. Institutional supply even in advanced democracies is suboptimal as the literature on
domestic regulatory capture shows. Moreover, the problems of limited transparency, participation, and
review are anything but solved at the global level. Kahler and Lake (2009) assert: ”Secure, concentrated
interests – those that enjoy regulatory capture at the national level – are most likely to prefer that
regulation remain national or that informal, networked governance emerge at the international level.”
(p. 259).
The deficiencies of institutional supply in government networks are twofold. First, the process of
formulation and negotiation of regulatory arrangements takes place without input from national
legislative bodies. Second, and this is what distinguishes them from traditional IGOs, government
networks circumvent domestic legislative veto points because the standards they promote do not
require ratification to come into effect. Mattli and Woods (2009) summarize these institutional supply
side issues in the following words: ”The problem posed by closed processes for rule-making,
implementation, and enforcement is compounded at the global level by the lack of an overarching
sovereign but constitutionally constrained authority that oversees regulators on behalf of the people.”
(p.20).
The question of who “the people” are and how their preferences are represented highlights the
problems on the demand side of global regulation. Mattli and Woods (2009) assert: “Global regulation is
at great risk of capture. In part this risk is due to institutional constraints – the lack of transparency, due
process, and mechanisms of accountability at the global level. Equally important, however, the risk of
capture is due to weakness and unevenness of demand for robust regulation at the global level, largely
45

because the requisite expertise and financial as well as organizational capacity to participate
meaningfully in global regulation are not evenly distributed across affected countries or transnational
non-state actors.” (p. 43).
Demand for robust regulation is not confined to civil society, and it is not necessarily linked to
the distribution of costs and benefits, as the following theories of regulatory erosion show. Fernandez
and Rodrik (1991) assert that uncertainty about the distributional effects alone can be sufficient to
reduce demand for reform. In many areas the beneficiaries and losers of a policy change cannot be
identified beforehand. In a context of risk aversion, uncertainty can lead to status quo bias.
Aizenman (2009) builds on this model in his work on the “paradox of regulation”. He argues that
the purpose of regulation is to reduce or eliminate the likelihood of breakdowns and crises in a given
issue area. However, the event of no-crisis is imperceptible and thus cannot be credited to a certain
regulatory arrangement or policymaker. Conversely, the costs of regulation are both transparent and
attributable. This information asymmetry leads to a gradual erosion of regulatory intensity over time. As
the public updates its knowledge of the probability of crisis in iterative fashion, the counterfactual of
“crisis prevented” becomes increasingly intangible. Thus, the paradox is that the demand for regulation
decreases the more successful it is at preventing a crisis.
Financial prudential regulation might be a great example for this process. Aizenman (2012)
asserts that the absence of a major financial crisis during the “Great Moderation” phase from 1985 from
2005 reduced the expected benefit of stringent regulation in the eyes of the public, thus opening the
door to a gradual process of deregulation.
Any systemic crisis is an instance of an event whose probability distribution is unknown, and as
such it lies in the realm of Knightian uncertainty. This does not change even after a crisis occurs because
the event happens with too low frequency over time. Thus, the cost of under-regulation cannot be
calculated. At the same time, the cost of over-regulation also escapes any meaningful way of
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measurement. Under these circumstances, Cooley and Walter (2011) assert: “So optimum regulation is
the art of balancing the immeasurable against the unknowable.” (p. 35).
Aizenman’s theory of regulatory erosion in times of no-crisis represents a promising starting
point for empirical testing. Further research should illuminate whether this mechanism can be found in
other issue areas with similar characteristics of uncertainty, for example antiterrorism. Also, a study on
attitudes regarding environmental standards to curb global warming after the occurrence of
meteorological disasters could test whether support for tighter regulation increases in the aftermath of
a crisis.
A crisis can be understood as a demonstration effect that turns narrow societal interest in
regulation into broad one. In cases of extraordinary regulatory failure, such as the global financial crisis,
large sectors of society become aware of the social cost of the regulatory status quo. Political
entrepreneurs transform the emerging demand for change into pressure on legislatures and regulatory
authorities. According to some scholars, the demonstration effect may trigger over-regulation,
especially in areas of uncertainty (Breyer, 1993; Aizenman, 2012). However, there is no necessary
connection between extraordinary failure and tighter regulation. This is because the regulatory process
is lengthy, and special interest groups can regain the upper hand once public attention has faded. Only
entrepreneurs that are successful at creating an enduring pro-change alliance that lasts through all
stages of the reform process can push for common interest regulation as a result.
While there is a clear connection between weakness of demand and regulatory capture by
special interests, unevenness of demand deserves further scrutiny. Demonstration effects such as major
accidents or crises happen within certain temporal and geographic limits. Even a disaster like the global
financial crisis had only limited repercussions for the financial markets of emerging countries and some
Western states such as Canada and Australia. It can be argued that short of global warming, almost
every crisis is going to generate uneven public demand for regulatory change. However, great power
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theories of global governance show that the power to drive regulatory reform is distributed just as
unevenly. Therefore, when a demonstration effect occurs in the dominant center, regulatory reform can
spread even to jurisdictions that did not incur the costs of regulatory failure. Conversely, a crisis in the
periphery is unlikely to trigger global reform even if the center features the same or similar regulatory
deficiencies. Had the breakdown of the securitization chain only occurred in Iceland, for example, the G-
20 driven financial reform program might have never materialized. Therefore, the connection between
unevenness of demand and common interest regulation on a global scale is ambiguous.
Scholarship on transnational mechanisms of influence is in its early stages of development. In a
brilliant case study, Sell & Prakash (2004) trace how transnational pharmaceutical industry associations
and social movement organizations influenced WTO negotiations regarding intellectual property rights
protection. In the financial realm, Kevin Young (2012) has presented valuable research on regulatory
capture in government networks. The author criticizes mainstream IPE literature for conceiving of
capture as a consistent and systematic process that always leads to the weakening of regulatory
standards. He argues that “it is spurious to simply assume that policy changes which benefit a group are
made at the behest of that group.” (p. 7). This observation is supported by research on approval
regulation (D. Carpenter, 2004; D. Carpenter et al., 2010). In subsequent work, Carpenter stipulates
three evidential standards that must be met to assert capture. An empirical study must provide a
falsifiable model of the public interest in a given issue area and show a policy shift away from the public
interest and towards the interest of the industry. Only if these two conditions are met can evidence of
action and intent by the industry linked to regulatory capture (D. Carpenter, 2013). Young (2012)
acknowledges that lobby groups seek privileged positions to signal their preferences early in the
regulatory process, and that their ability to provide detailed technical information and arguments gives
them a strategic advantage. However, he asserts that there is no stringent causal connection between
access to regulators and influence.
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Pagliari and Young (2012) take this idea a step further by proposing a theory of leveraged
interests. According to this theory, the degree to which interest groups are able to form coalitions with
other sectors determines their chances to influence the policymaking process. This is because in
comparison to a single-sector group, coalitions have more and complimentary resources, a greater
variety of access to policymakers, and more credibility. In contrast, opposition from other players in the
private sector can annihilate the lobbying power of a special interest group. In its current stage of
development, leveraged interest theory has an exclusive analytical focus on the private sector. Future
research should investigate the role civil society actors play and thus connect the idea of leveraged
interests to Mattli and Woods’ (2009) broader picture of societal demand and institutional supply for
common interest regulation.
When looking at global financial reform from a regulatory capture perspective, timing
differences can be considered important. This is because societal demand for robust regulation erodes
over time, and because the benefits of avoiding another crisis become more elusive. While this
hypothesis merits attention, it cannot be tested with the synchronous sample of cases used in this
dissertation. The research design of this dissertation is also incapable of identifying capture at the
agenda-setting stage because it takes publicly pronounced reform commitments as the benchmark. It is
however congruent with the following hypothesis: We can expect regulatory capture to operate in a
reform area that fall short of G20 commitments if the financial services industry has communicated its
opposition and deployed its resources to change regulation in that area. It is important to keep in mind,
in the light of Young’s and Carpenter’s concern about the faulty identification of regulatory capture,
industry intent and action is a necessary but not a sufficient condition. Thus, public opposition by the
finance lobby can lead us to expect regulatory capture but it is no proof of its existence.
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Cooperative Decentralization
The sixth approach of relevance for this dissertation seeks to explain a change in trajectory in
global financial governance. Prior to the crisis, authority in the parochial field of financial regulation
rested with technocrats who were relatively isolated from domestic political pressures. This changed
dramatically with the crisis when financial regulatory topics became a main arena of political contention.
Social movement organizations such as Occupy took to the streets and a wide spectrum of citizens
expressed their outrage over the ways reckless, overpaid bankers ruined their lifetime savings and
employment opportunities (FCIC, 2011). The politicization of financial regulation put politicians under
pressure to act fast and show protagonism in reigning in the excesses of the financial sector. Helleiner
and Pagliari (2011) describe this shift as follows: “Faced with newly engaged political leaders and
resurgent domestic political pressures, transnational networks of financial officials were increasingly
forced to react rather than to lead the international regulatory reform process.” (p. 182).
The politicization of financial regulatory issues and the resurgence of politicians thus leads to a
patchwork of regulatory solutions that address primarily domestic concerns to the detriment of
transnational networks of financial governance. The operation of these networks is further undermined
because the crisis revealed widespread regulatory failure, eroding mutual trust among regulators. This
does not mean that the post-crisis financial system returns to the state of fragmentation along
jurisdictional lines that was prevalent before the latest wave of globalization. Helleiner (2014b) clarifies
the cooperative decentralization hypothesis by outlining several possible scenarios for the post-crisis
financial regulatory landscape. One such scenario features the strengthening of multilateral financial
governance institutions such as the G20, the FSB, and the IMF, driven by strong cooperative behavior
among the major powers. An alternative scenario foresees increasing fragmentation along jurisdictional
lines where regulatory initiatives and financial crisis management are undertaken unilaterally, bilaterally
50

or regionally in the case of the European Union. Cooperative decentralization can be understood as a
hybrid between these two scenarios.
Therefore, the cooperative decentralization approach predicts that government networks such
as the FSB take backstage to domestic regulatory initiatives. Those issues on the G20 agenda that
experience a greater degree of politicization can be expected to be more prone to unilateral initiatives.
Conversely, government networks may have more space and time to develop a transnational consensus
and ensure consistent implementation in policy areas where political leaders are under less pressure to
“fix the problem” before the next election.
Sector differences
Whereas previous reform programs such as Basel focused on one specific financial sector, the G-
20 driven post-crisis reform targets a large part of global financial markets. Domestic regulatory
agencies and global standard-setting bodies tend to be delimited by market sector, and banking
supervisors, central bankers, and financial market supervisors espouse different regulatory philosophies
(Helleiner & Pagliari, 2011). Furthermore, competitive pressures and the nature of externalities vary
across financial sector. Coffee (2014) notes that banking regulators have extensive supervisory control
because banks need to obtain a charter from the regulator in order to operate in a given jurisdiction. In
contrast, no charter is necessary for a firm to use financial market infrastructures such as OTC
derivatives markets. The situation is different again for insurance providers.
In line with the tenets of the sectoral approach we can thus expect global financial reform
progress to vary with the sector to be regulated. In particular, reform progress can be expected in areas
where regulated firms are few, market participants can be controlled with entry permits such as
charters, and regulation has a longer historical trajectory such as banking. In contrast, those items on
the reform agenda that cover financial market infrastructure and the insurance sector are expected to
encounter delays in standard setting and policy implementation.
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Government networks
The eighth and final approach to global financial governance concentrates on the tension
between government networks and the nation-state. It builds on a large theoretical body of networked
governance that has been developed by sociologists, economists, and legal scholars.
Network theories of global governance reject the idea that monolithic nation-states are the
primary actors on the global stage. The transformation of the dominant form of human organization
from vertically structured hierarchies to transnational networks that characterizes the rise of the
network society (Castells, 2000, 2004) includes global governance arrangements. Non-state actors from
business or civil society organize across borders to take on economic governance functions in ways that
create a new world of transnational neopluralism (Cerny, 2010). However, this interaction between non-
state actors and traditional state-led governance has posed problems both for theorists and policy-
makers.
In an attempt to theorize public-private tensions in global economic governance, Abbott and
Snidal (2009) identify four competencies that are essential for regulatory institutions. The first two are
independence from special interests and representativeness of all constituents and their preferences.
IGOs may be able to ensure independence and representativeness to a certain extent, but they are
lacking other essential competencies. In order to operate effectively, institutions need expertise and
operational capacity to implement global rules. These competencies tend to rest in the hands of private
actors, who in turn are incapable of guaranteeing independence and representativeness. Purely private
regulatory efforts have frequently led to standards wars, wasteful duplication of standards, and
exclusion of non-industry interests (Mattli, 2003). In sum, no single type of actor possesses all
competencies necessary to successfully deal with global economic governance issues (Abbott & Snidal,
2009).
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One way to combine the strengths of different actors and ameliorate both state failure and
market failure is orchestration (Abbott & Snidal, 2010). This concept refers to an alliance of NGOs and
private actors under the lead of an IGO. During Kofi Annan’s tenure as Secretary General, the United
Nations has pursued a similar strategy. UN agencies and other IGOs convened government officials,
business associations and NGO representatives to work on joint solutions in a variety of issue areas. But
these so-called tripartite global policy networks have received criticism from across the political
spectrum. Some critics argue that bringing selected representatives of the social and the private sector
together under the purview of governmental authority represents a replay of corporatism at a global
level. Just like their national counterparts, these global tripartite networks are not representative of the
larger polity. Others argue that non-governmental actors are either driven by profits (business) or
passion (NGOs). Tripartite networks that put these stakeholders alongside democratically elected
governments thus blur the distinction between public legitimacy and private power.
At a national level, governments perform the essential function of aggregating the preferences
of the whole spectrum of interest groups into a coherent set of rules and policies, at least in principle (H.
Milner, 1992). The increasingly transnational nature of economic transactions would require this
function to be performed at the global level. Yet world government is neither desirable nor feasible. At
the same time, a decentralized patchwork of private and public actors cannot fulfill governance
functions with the same degree of legitimacy as a government. This situation is what Slaughter (2004)
calls the governance trilemma. The author defines this trilemma as “[…] the need to exercise authority
at the global level without centralized power but with government officials feeling a responsibility to
multiple constituencies rather than to private pressure groups” (p. 257).
In the eyes of Slaughter and others, government networks have emerged as the best solution to
the governance trilemma. Unlike hierarchies, authority is shared, but government networks often lack
the formal delegation inherent in supranational arrangements. Slaughter (2004) notes that such
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networks defy traditional academic categories: “As a number of scholars point out, these ‘organizations’
do not fit the model of an organization held either by international lawyers or political scientists: they
are not composed of states and constituted by treaty; they do not have legal standing; they have no
headquarters.” (p. 43). Instead, government networks are characterized by enduring and repeated
interactions among government officials in a given special policy area. The pioneering work of Keohane
and Nye (1977) depicted transgovernmental relations as an essential addendum to further the power of
inter-governmental organizations. Today’s government networks however exist both under the
umbrella of and completely independent of IGOs.
While these networks carry the legitimacy of national governments, decision-making procedures
are much more informal than in traditional inter-governmental settings. Soft power mechanisms such as
persuasion, socialization, and information-based peer pressure are commonplace in government
networks (Slaughter, 2004).
A look at the legal instruments of government networks helps illuminate their prevalent modus
operandi. Classic inter-governmental organizations are firmly embedded in international law: they are
established by virtue of an international treaty that enters into effect once a pre-determined number of
signatory states ratify the treaty. The IGO then provides the institutional environment in which
representatives of member states engage in often onerous and protracted negotiations for rules that
again become legally binding after ratification by a certain number of member states (Sands & Klein,
2001; Shaw, 2008).
In contrast, government networks rely on three main instruments: promotion of standards and
best practices, regulatory reports, and information sharing and enforcement cooperation. Rather than
treaties, agreements take the form of a Memorandum of Understanding (MoU). These documents are
not legally binding and do not require ratification (Brummer, 2010). Because of its peculiar modus
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operandi Slaughter (2004, p. 33) characterizes government networks as the “political equivalent of the
informal economy, alongside formal international institutions”.
The advantages of this kind of cooperation are obvious. Government networks address the
demand for intergovernmental cooperation but significantly reduce sovereignty costs: retaliation issues
are less salient, and there is little delegation of authority to agencies, as chapter 7 will discuss in greater
detail. Furthermore, the relative absence of ratification procedures deprives domestic players of veto
power, and unexpected coalitions between domestic interest groups and supranational authorities can
be ruled out. In addition, negotiation costs are low, too, because the drafting stage is less time-
consuming and agreements can be rather easily amended or changed. As Slaughter (2004, p. 49) puts it,
“Widespread use of Memoranda of Understanding (MOUs) and even less formal initiatives has sped the
growth of transgovernmental interaction exponentially, in contrast to the lethargic pace at which
traditional treaty negotiations proceed.” This quality of government networks is especially valuable
when establishing an international regulatory framework for a sector marked by complexity and
uncertainty, and with a fast rate of technological change and innovation, such as finance (Brummer,
2010).
However this array of instruments, often dubbed “soft law”, raises certain questions. What if
market forces do not favor compliance with global standards? Given the apparently low cost of
defection, how can opportunism be discouraged? What prevents stakeholders from choosing alternative
regulatory approaches, cherry-picking certain aspects of agreements, or under-enforcing rules?
Kal Raustiala (2005) addresses these questions by differentiating between form, substance, and
structure of institutional design. According to the author, “there is no such thing as ‘soft law’.” (p. 586).
States may choose a legally binding or not binding form, and domestic actors and governments
themselves have traditionally pushed for the former. However, the legality of commitments is a neither
necessary nor sufficient for their effectiveness. Often states decide to formulate legally binding but
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shallow agreements with large “compliance cushions”. While they can thus ensure compliance,
safeguard their reputation, and please domestic interest groups, state behavior is unlikely to change.
The structure of international agreements refers to the rules and procedures to monitor the
performance of parties, deter and punish non-compliance. Legally binding agreements with weak
structure are of questionable effectiveness for example. In contrast, many of the informal agreements in
government networks count on a strong monitoring and enforcement structure. Regular peer reviews,
sanctions or even conditional membership provide a strong incentive system for state compliance. Thus
state behavior can depart from the status quo because of substantive agreements of weak legal form
but strong review structure (Raustiala, 2005).
The network approach to global financial governance leads to novel hypotheses regarding global
financial reform. The combination of weak legal form and strong review structure of agreements forged
in government networks is expected to facilitate global consensus-building on post-crisis standards and
their coherent implementation. Thus, wherever government networks play a central role in the policy
process we can expect global reform to be successful. Conversely, regulatory reform is expected to be
slow or patchy in areas where government networks are either non-existent or where nation-states
decline to transfer rule-making authority to them.
These eight competing approaches to global financial governance will be subjected to empirical
testing in the three major areas of global financial regulatory reform: banking regulation, OTC
derivatives markets, and ending TBTF. Chapter four to six will trace the regulatory reform process at the
G20 and the FSB and compare the explanatory power of each approach in the respective issue area. The
following chapter will discuss methodological considerations and clarify the terms of the empirical study.

56

Chapter 3: Methods

This chapter develops the methodological foundations of this dissertation. It starts by
highlighting the unique nature of global financial regulatory reform. The chapter then discusses the
strength of qualitative research methods in such fields of inquiry. A subsequent section focuses on the
epistemological differences between causal effects and causal mechanisms. It presents a variety of
small-n approaches and introduces systematic process analysis as the central research method in this
dissertation. The chapter continues by examining recent challenges that conventional large-n statistical
analysis faces on epistemological and ontological grounds. In line with these critiques, the chapter re-
evaluates the merit of qualitative research geared toward the understanding of causal mechanisms
rather than causal effects. Afterwards, case selection techniques are discussed. The results of process
tracing in this work are triangulated with findings from a probit regression analysis. Finally, the chapter
presents information on the sources that inform this systematic process analysis and ethical
considerations that guided the interview process.
Like many other objects of study in the field of International Relations, the G20-led reform of
global financial regulation in the wake of the biggest crisis since the Great Depression is a rare, unusual
event that defies generalization. Its unique nature however does not prevent scholars from engaging in
research that is methodologically sound and compliant with rigorous standards of scientific inquiry.
Post-crisis global financial regulatory reform does not represent a class of events, but much like
China’s post-Mao economic liberalization or post-Soviet economic restructuring in Eastern Europe,
inferences from this unique event can be drawn that illuminate the intricate interaction between
economic and political processes, furthering our understanding of seemingly unrelated events and
larger tendencies of international political economy (Gerring, 2004).
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Qualitative research designs are an attractive option for researchers that focus on such
multifaceted events and the intricacies of their evolution over time. Bennett and Elman (2007) assert:
“The prominence of qualitative methods in IR thus reflects these methods’ advantages in studying
complex and relatively unstructured and infrequent phenomena that lie at the heart of the subfield.” (p.
171). At the same time, qualitative methods have evolved as researchers seek to make qualitative
approaches more rigorous and open to public scrutiny.
Global financial regulatory reform neatly fits Bennett and Elman’s characterization of a complex,
relatively unstructured and infrequent phenomenon. This dissertation seeks to understand the reform
process by analyzing both actor-level and institutional variables. The eight approaches to global financial
governance outlined in chapter two each rely on unique combinations of these variables. Furthermore,
actors and institutional structure are not modeled as independent but rather in an interactive process
that unfolds over time. Because understanding the political economy of this reform process requires
special attention to temporal development, sequencing, and complex interaction effects between
institutional and actor-level variables, process tracing stands out as the most adequate method of
inquiry.
At the core of process tracing lies a fundamental ontological difference between causal effects
and causal mechanisms. Conventional statistical methods seek to maximize parsimony by identifying
linear or curvilinear relations between certain causal variables and the outcome. Causal mechanisms in
contrast highlight the complexities of the causal process. More than merely a sequence of intervening
variables, causal mechanisms such as learning, competition, institutional conversion, and path
dependency capture complex interaction effects that defy conventional techniques of causal inference.
Process tracing enables the researcher to identify the operation of such causal mechanisms.
Furthermore, because causal mechanisms are portable concepts in principle, scholars contribute to
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theory development in the larger sense by discovering mechanisms that might elucidate seemingly
unrelated social phenomena (Falleti, 2006).
Process tracing is part of a family of small-n methods. Hall (2006) distinguishes between three
main approaches. First, a historically specific approach seeks to find the full set of causal factors that led
to an event. This approach also incorporates context factors that are not directly causally related. A
second approach seeks to provide a multivariate explanation of a phenomenon. It aims to identify a
small set of relevant causal factors for a given class of events and measure their relative effect size. This
approach can most easily be combined with statistical methods of inquiry. The final approach is what
Hall (2006) calls a theory-oriented explanation. This approach places more emphasis on extrapolating
hypothetical causal chains from state-of-the-art theories in the field and testing them on available data.
It is as part of this latter approach that Hall introduces what he calls “systematic process
analysis”. His method consists of a sequence of four steps. The inquiry begins with theory formation.
The researcher selects rivaling theories that could explain the outcome of the event under study. As a
second step, the scholar derives predictions from the theoretical frameworks that should be as “brittle”
as possible, that is distinguishable from the predictions of other theories and falsifiable by the data
available. The third step involves empirical observation with a special emphasis on the process that
leads to the outcome. Different theories usually rely on different micro-foundations to explain the
connection between a set of causal factors and the outcome, and the researcher should verify whether
the empirical chain of events is compatible with these foundations. Thus, even when rival theories
predict the same outcome, a systematic process analysis is able to validate and falsify the claims they
make regarding which process leads to this outcome. As a final step, the researcher assesses the
plausibility of the theory and the validity of the observations made. A systematic process analysis along
these lines represents the methodological core of this dissertation.
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Table 3.1 Systematic Process Analysis
1. Theory Formation specify rivaling theories that could explain the outcome
2. Predictions derive predictions from theories that are as “brittle” as
possible
3. Observations focus not on correlation but process that leads to the
outcome
4. Conclusions judgments about the plausibility of theory and validity
of observations
Source: Hall (2006)
Not only is the object under study a rare, unusual event, but it also involves a very reduced
number of actors. Global financial reform is driven by the G20, a group that unites the national
governments of 19 nation states and the European Union. The reforms are coordinated by the Financial
Stability Board that has a slightly larger membership than the G20. Five jurisdictions, namely Singapore,
Spain, Switzerland, Hong Kong and the Netherlands have representation in the FSB but not directly in
the G20, bringing the total number of FSB membership to 24. However, much of the financial regulatory
reform agenda in Europe is driven by the European Commission, and the legal characteristics of the
financial regulatory reform package severely curtail the discretion of EU member states in its
implementation. Consequently, the European Union is regarded as a single jurisdiction by many scholars
of financial regulation and the FSB itself. Under such circumstances, some scholars recommend the
disaggregation of actors into sub-national units (King, Keohane, & Verba, 1994; Snyder, 2001). However,
in the field of financial regulation, sub-national entities tend to be irrelevant, with very few exceptions
(Canada for example is the only country that has sub-national securities regulators).
The reduced number of stakeholders involved in global financial regulatory reform limits the
range of applicable research designs. In particular, the asymptotic assumptions underlying most of
statistical analysis do not hold for a small-n sample. In this situation, scholars traditionally resorted to
the “comparative method” (Lijphart, 1971), identifying a certain set of causal variables and assessing
their connection to the outcome over a number of observations.
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This approach has multiple shortcomings. First, the number of causal variables is likely to be
circumscribed because a small-n study has limited degrees of freedom. This often leads scholars to opt
in favor or against including certain causal variables based on plausibility considerations that are often
insufficiently reproducible and open to public scrutiny. Second, the comparative method relies on
correlations between causal variables and the outcome without providing much leverage to make causal
inferences. It is thus not surprising that this method has been regarded as an inferior variant of large-n
regression analysis (Hall, 2006).
From a methodological standpoint, both the comparative method and large-n regression
analysis have faced criticism on epistemological and ontological grounds in recent years. First, scholars
such as Rubin and Campbell point out that conventional field studies using regression analysis are ill-
designed to establish a counterfactual that forms the epistemological basis for any causal inference
(Rubin, 2008; Shadish, Cook, & Campbell, 2002). As such, regression analysis merely provides
information about correlational attributes between variables. Only experimental designs that randomly
assign cases to a treatment and control group can provide the inferential leverage to assess causal
relationships between variables (Campbell, Stanley, & Gage, 1963; Trochim & Donnelly, 2006).
For researchers that study aggregate social phenomena, this assertion poses a fundamental
challenge. Because hardly anything in international political economy is randomly assigned, the scope
for natural (quasi-)experiments is severely limited. Moreover, as the gold standard for causal inference,
experimental designs typically rely on random assignment of a number of individuals to treatment and
control groups. Researchers seeking to apply this design to the level of aggregation that is of interest for
international political economy are faced with formidable obstacles. Gerring and McDermott (2007)
assert: “Regrettably, experimentation on large organizations or entire societies is often impossible—by
reason of cost, lack of consent by relevant authorities, or ethical concerns. Experimentation directed at
elite actors is equally difficult. Elites are busy, well remunerated (and hence generally unresponsive to
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material incentives), and loathe to speak freely, for obvious reasons.” (p. 693). Some scholars intend to
circumvent these obstacles by conducting experiments with college students and scaling up their
inferences to the national or international level. However, the aggregation problem inherent in such
research designs severely undermines their external validity.
The second challenge to regression analysis derives from the ontological nature of the objects
under study. At its core, scientific research aims to reduce the complexities of the natural world and
extract parsimonious causal relationships (M. Friedman, 1953). Yet most relevant phenomena in
international relations involve interaction effects among many structural and agent-based variables,
path dependencies, and strategic interaction among large numbers of actors. Research designs that seek
to extract simple cause-effect relationships between variables often fail to account for the nonlinear
properties and overall complexity of phenomena in this field of inquiry (Bennett & Elman, 2006).
The sub-discipline of development economics provides a good example to illustrate this
argument. The first generation of growth theories were designed to explain the long-term trajectory of
economic output with mathematical precision based on solely the production function and relative
capital endowment of a given country (Solow, 1956). While this generation of theories had considerable
predictive power and reasonably matched the evolution of OECD countries, it failed to explain the
growth trajectories of developing countries. Subsequent attempts to enrich the original model with
additional variables also failed to provide sufficient explanatory power (Baumol, 1986; Mankiw, Romer,
& Weil, 1990). However, a new approach in developing economics incorporates a wide spectrum of
economic and political variables and seeks to model their complex interaction over time. Relying on a
combination of detailed historiographic analysis and instruments of game theory, this approach
foregoes the parsimony of a law-like equation but it provides researchers with vast inferential leverage
to explain a universe of growth trajectories in the developing world (Acemoglu, Johnson, & Robinson,
2000; Acemoglu & Robinson, 2012).
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Other disciplines in the social sciences have evolved along similar paths. The recognition of
multidimensional complexity in the ontology of large-scale social phenomena has compounded the
epistemological challenges to conventional research methods. Hall (2006) summarizes this evolution: “In
short, despite the continuing popularity of regression analysis, recent theoretical developments in social
science tend to specify a world whose causal structure is too complex to be tested effectively by
conventional statistical methods.” (p. 26).
Advances in game theory have enabled researchers to specify complex interaction effects
between variables and subject them to public and empirical scrutiny. In particular, the rationalist
paradigm in international relations relies largely on game theoretic reasoning (Fearon, 1995; Fearon &
Laitin, 2003). However, a game-theoretic approach becomes unwieldy the more relevant variables are
added to the model. For example, Daniel Drezner provides formal proofs for the individual elements
that provide the foundation for his theory of regulatory outcomes. Nevertheless, his overall argument is
not amenable to game theoretic modeling because it involves too wide a variety of relevant actors.
Drezner (2007) admits: “Throwing all of these actors into the game-theoretic grinder increases the
complexity of a formal model to the point where the computational costs outweigh the explanatory
benefits.” (p. 25).
The quality of any systematic process analysis relies on thoughtful case selection. Experimental
methods place special emphasis on random selection of a sample from a large population. Because
much of IR is concerned with rare but momentous events that may not belong to a larger class of
phenomena, large-n sampling rules are of limited relevance for this kind of research. The underlying
quality standard that applies to both quantitative and qualitative methods is conditional independence.
That is, case selection must not be based on the dependent variable(s). Moreover, the dependent
variable(s) should not have a reverse causal relationship to the explanatory ones. Because random
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selection is not a feasible option to satisfy the conditional independence requirement in small-n
research, intentional case selection is necessary (King et al., 1994).
Qualitative researchers have developed a series of case selection mechanisms in recent decades.
Prominent studies have used least likely case, most and least similar case, and deviant case selection
techniques. The most similar case technique uses a selection of cases that differ in the dependent
variable but in as few explanatory variables as possible. Because this design is prone to omitted variable
bias, researchers have to pay special attention to the remaining differences between the cases under
study. Furthermore, alternative explanations for the difference in the dependent variable must be taken
into account (Bennett & Elman, 2007). As mentioned above, the comparison between different
theoretically grounded hypotheses is an essential element of systematic process analysis.
This dissertation is concerned with the global financial regulatory reform process. It seeks to
explain the differences in the gap between the commitments made by G20 leaders in the wake of the
2007-9 crisis and the current state of their implementation. The scope and membership of post-crisis
financial regulatory reform has no precedents in post-war history, and the global financial crisis itself can
be compared in severity only to the Great Depression of the 1930s. It is thus hard to argue that post-
crisis financial reform is representative of a greater class of events. This dissertation contributes to
existing scholarship on the global governance of finance and the operation of government networks,
developing insights and predictions that are relevant for a wider universe of issues in global networked
governance. Nevertheless, it provides research on a unique process of post-crisis reform that as such
represents the population of all relevant cases.
Unlike other small-n studies in IR, the units of observation in this study are not countries but
items on the reform agenda. Specifically, this study compares reform progress in three issue areas, that
is prudential banking regulation, OTC derivatives regulation, and structural reform (ending too-big-to-
fail). This dissertation thus employs a most similar case selection mechanism. Most explanatory
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variables of relevance for these three agenda items are constant. The G20 reform agenda has been
formulated by the same group of nation-states and made public at leaders’ summits in 2009. In the 5-
year period of observation, some governments have changed, but both G20 membership and the
declared G20 support for the financial regulatory reform agenda have remained constant. Furthermore,
the G20 have given the FSB responsibility for coordinating the implementation of all financial regulatory
reform commitments. Thus, the relevant actors and institutions remain the same across cases and over
time to a large extent.
New developments in research design attempt to combine the power of case studies and
statistical analysis. They develop from the recognition that case studies rely on longitudinal or spatial
comparison, or on a comparison with a counter-factual as a quasi-control group. Gerring and
McDermott (2007) assert: “All case study research is, in this sense, quasi-experimental.” (p. 689). In
some cases, a quasi-control group can be generated using statistical computation. Abadie, Diamond, and
Hainmueller (2010) provide an example of this method by comparing the effects of a policy in California
with a synthetic control case. By synthesizing a state that matches California in relevant dimensions
from the pool of states in the United States, this approach can circumvent problems inherent in the
choice of natural comparison units. For the purpose of this dissertation however this approach is not
applicable. The cases under study here are issue areas, not geographically delimited areas. In addition,
there is no pool of plausible elements from which to synthesize a counter-factual reform process.
Nevertheless this dissertation seeks to triangulate quantitative and qualitative methods where
possible. In particular, chapter 4 on prudential banking regulation presents the results of a regression
analysis. A probit regression is used to provide insight into the predictors of over-compliance with Basel
III. This quantitative approach to the political economy of Basel implementation serves to elucidate
several competing explanations and their shortcomings in explaining the outcome of global financial
65

regulatory reform. Thus, the triangulation of findings using a multi-methods approach strengthens the
robustness of the empirical test that the hypothesis is subject to (Gerring, 2007, 2011; Hempel, 1998).
This dissertation takes inspiration from a recent study on the political economy of financial
regulation. Posner (2009) traces changes in transatlantic regulatory relations over a 20-year period
leading up to the global financial crisis. The author argues that the shift from the dominance of US
preferences to mutual accommodation is the result of centralization in European rulemaking that
changed transatlantic bargaining dynamics. Posner presents five competing explanations from state of
the art theory and derives specific predictions for each of them. He then proceeds to trace the evolution
of six regulatory disputes between the United States and the European Union, using a combination of
sources that range from private and public regulatory documents and interviews to the financial press.
The study relies extensively on dynamic comparison, that is the analysis of temporal variation in the
empirical process to draw causal inferences. In order to check whether his causal variable, centralization
in EU rulemaking, precedes the change in regulatory bargaining Posner conducts a congruence analysis
for all six regulatory disputes. Finally, the author revisits competing explanations and finds that some of
the predictions derived are at odds with the empirical observations. He is able to even dismiss those
competing explanations that correctly predict the outcome by showing their incompatibility with the
causal mechanism that leads to the outcome. In sum, by relying on intensive testing Posner presents a
systematic process analysis that subjects itself to rigorous methodological standards and openness to
public scrutiny.
The systematic process analysis of this dissertation relies on a variety of sources. Archival
research provides the foundation of this research. The global financial reform leaves a paper trail that
ranges from G20 summit declarations and FSB reports to public hearings, legal text, and letters and
statements issued by individual regulators. Additional information is provided by the financial press.
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The second major source of information comes from interviews with involved stakeholders.
Conducting face-to-face interviews with a variety of people involved in financial regulatory reform
complements and strengthens the insights gathered from archival research. It enables the researcher to
gain access to the experiences and motivations of stakeholders that are unavailable on public record.
Moreover, the interviewer has the possibility to understand the opinions and thought processes of
relevant actors which enables him to clarify the micro-foundations of events and patters at the macro
level (Lynch, 2013; Mosley, 2013).
In practice, archival research and interviews build on each other in iterative fashion. The
preparation phase for each interview included concentrated research for documents issued by the
organization that the interviewee represented, and relevant counterparties. The results of this archival
work then informed the interview questions. In turn, interviewees often made references to relevant
documents, thus informing a follow-up archival research phase (Gallagher, 2013; C. Martin, 2013).
The interview partners were selected using a snowball sampling method. Financial regulators in
general and central bankers in particular tend to be busy people who are not very responsive to cold
calls. I therefore relied heavily on recommendations by previous interview partners. In a sense, an
interview with a regulator helped me gain an understanding of his or her perspective on regulatory
reform, while the interviewee could assess my level of understanding and preparation in order to judge
whether recommending another regulator for the next interview would imply wasting that colleague’s
time. Fortunately almost all regulators interviewed referred me to new interview partners. By
snowballing my way through the financial regulatory community, I was able to include a large number of
officials that are directly involved in the reform process at the G20 and the FSB.
Three other groups of relevant stakeholders were included in this research. The first is
comprised of civil society organizations that represent consumers, workers, and taxpayers in financial
regulatory reform. Second, I interviewed representatives from financial sector lobby organizations. Third,
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academics who work on financial regulatory issues are among my interviewees. These three groups
represent the full spectrum of stakeholders that seek to shape global financial reform together with
government officials.
In order to capture a greater variety of perspectives and enhance external validity, my
interviews covered individuals on a wide political spectrum and geographical range. Over a 2-year period
from 2012 to 2014, I was able to conduct 57 interviews with stakeholders in China, Hong Kong, the
United States, Argentina, Brazil, Belgium, France, the United Kingdom and Switzerland. Interview
partners represented national governments, central banks, and international organizations, as well as
national, regional, and international NGOs and lobby firms.
In order to protect their interests, of interview partners had to give informed consent to be
interviewed, and again for the recording of the interviews. Interviewees were assured that any
reference to the information revealed in the interview will be made by function and country (i.e.
Brazilian regulator), never by name. One regulator asked for the interview not to be recorded, two
others requested a preview of my work before publication, and one requested that no reference be
made to the interview itself. I am complying with all requests made. In addition, I am sending drafts of
my work to selected interview partners in order to involve them in the interpretation of findings.
The following chapters will make references to interviews and public documents following the
rules outlined here. Their primary function is to support the systematic process analysis of global
financial regulatory reform in this dissertation.

68

Chapter 4: Basel III

Banks were at the center of the financial turmoil that shook much of the world in 2007-9. The
series of bank failures and take-overs leading up to the fateful collapse of Lehman Brothers in
September 2008 highlighted the shortcomings of existing regulation, especially in the world’s dominant
financial centers. In recognition of this regulatory shortfall, G20 leaders pronounced their will to
overhaul prudential banking standards at the Pittsburgh Summit in September 2009:
„We commit to developing by end-2010 internationally agreed rules to improve both the
quantity and quality of bank capital and to discourage excessive leverage. These rules
will be phased in as financial conditions improve and economic recovery is assured, with
the aim of implementation by end-2012.“ (G20, 2009c, para. 13, Annex 1).
G20 leaders committed to the intended implementation deadline again during the subsequent
Toronto Summit and meetings of G20 Finance Ministers and Central Bank Governors. The Basel
Committee on Banking Supervision (BCBS) agreed on a new set of rules to improve capital buffers and
ensure adequate leverage and liquidity for banks in September 2010 (Schneider, 2010a), ahead of the
stipulated deadline. The final agreement, Basel III, was published in December of 2010. At the same time,
the phase-in of the new requirements was extended much beyond the two-year period foreseen in
Pittsburgh. At the Seoul Summit in November 2010, G20 leaders stated: “The new framework will be
translated into our national laws and regulations, and will be implemented starting on January 1, 2013
and fully phased in by January 1, 2019.” (G20, 2010b, para. 29).
A closer look at the details of the phase-in agreement reveals that the implementation period
actually stretches beyond 2019. The new global rules entail a stricter definition of capital and risk-
weighted assets that are used to calculate capital, leverage, and liquidity ratios, as explained in further
detail below. A report on Basel III implementation states that “capital instruments that no longer qualify
for non-common equity Tier 1 capital or Tier 2 capital will be phased out over 10 years beginning 1
January 2013.” (FSB, 2010b, p. 4). In other words, while the original aim was to complete prudential
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banking reform by 2012, banks have until 2023 to fully implement the rules that are designed to
enhance their resilience vis-à-vis future economic shocks.
Nevertheless, in comparison with all other items on the financial reform agenda, Basel III can be
considered an outstanding success. The government network in charge (BCBS) managed to incorporate
new elements into the global regulatory standards that would be considered revolutionary from a pre-
crisis perspective. It attained consensus on prudential standards and consistency in its implementation
in spite of a concurrent drastic increase in number and heterogeneity of its membership, incorporating
all remaining G20 members in 2009. Furthermore, Basel III is currently being implemented by a large
number of countries that are not Basel members, and several important jurisdictions have decided to
issue rules that exceed the new global standard. This chapter seeks to provide insight into this success
story of global regulatory reform by analyzing the political economy of Basel III.
The chapter is organized as follows. The first section briefly presents the evolution of Basel III
implementation and shows how banks have adjusted to the new standard much ahead of the 2019
deadline. The main part of the chapter analyzes this reform progress from the perspectives of the eight
approaches to global financial governance outlined in chapter 2. It discusses theory developments that
are specific to Basel agreements and tests the hypotheses of each approach using available empirical
data. Reform progress in prudential banking regulation is congruent with the expectations of four out of
the eight approaches. The third and final section focuses more specifically on differences in regulatory
preferences among Basel member jurisdictions and employs quantitative methods to identify predictors
of over-compliance with Basel III.
Prudential banking regulation is the most successful item on the G20 post-crisis financial reform
agenda. Following the call to overhaul banking standards at the Pittsburgh Summit, regulators at the
Basel Committee started developing a new global standard, reaching a general agreement within less
than a year. The new Basel standards were first published in September 2010 and slightly revised at the
70

end of the year. Implementation of the new capital rules proceeded fast in some but not all member
countries. By the end-2012 deadline, 11 out of 27 Basel member jurisdictions had final Basel III rules in
force. Implementation lagged behind in the 9 member jurisdictions that are part of the European Union
and the United States, among others. In other words, many emerging economies did not wait for the
great powers to implement Basel III first, a result that contrasts starkly with reform progress in OTC
derivatives regulation as chapter five will show. In 2013 all remaining jurisdictions finalized the rule-
making progress and Basel III capital rules are effective in all 24 member jurisdictions since 2014 (BCBS,
2014e).
Basel III goes beyond capital standards, introducing new liquidity and leverage requirements.
The development of these new regulatory tools follows a different timeline and is thus not included in
the empirical analysis of this chapter. However, two new liquidity standards have been published in
January 2013 and 2014 and implementation in all Basel member jurisdictions is well underway (BCBS,
2014e; BIS, 2014a).
Figure 4.1 Basel III reform progress

Source: Carney (2014)
Even though Basel III will not be fully phased in until 2019, banks have adjusted their balance
sheets to meet the new requirements several years early (BCBS, 2013d). The Basel Committee uses
semi-annual data from a sample of over 200 banks in member jurisdiction to trace the evolution of their
capital buffers. In a series of reports, it shows that the gap between actual and required capital levels for
big banks in the sample decreased from €577bn in December 2009 to €15.1bn by end-2013. This
24
10 14
0% 20% 40% 60% 80% 100%
capital requirements
liquidity coverage ratio
effective implement no action
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compares to an after-tax profit of €419bn for the same group of banks in 2013.The latest monitoring
report published by the BCBS shows that over 90% of the sample already reached the final 7% core
capital (CET1) target at the beginning of 2014. Moreover, the big and small banks in the sample reached
average core capital ratios of 10.5% and 10.2%, respectively, substantially exceeding the minimum
requirements (BCBS, 2014b).
Figure 4.2 Basel III capital shortfall and average core capital ratios (CET1)

Sources: BCBS (2010c, 2012a, 2012b, 2013a, 2013b, 2014a, 2014b)
What explains reform success in this area of global financial regulation? This chapter analyzes
the Basel III reform process from the vantage point of eight approaches to global financial governance
and tests their respective predictions using available empirical data.
Regulatory Hegemony
The success of post-crisis reform in the field of prudential banking regulation is congruent with
several of the approaches to global financial governance presented in chapter 2. In line with Simmons’
0
2
4
6
8
10
12
0
100
200
300
400
500
600
700
Dec 2009 Jun 2011 Dec 2001 Jun 2012 Dec 2012 Jun 2013 Dec 2013
cap shortfall big banks (lhs, EUR bn) cap shortfall small banks
avg cap ratio big banks (rhs %) avg cap ratio small banks
7% Basel III threshold
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theory of regulatory hegemony, prudential banking regulation is an area where market incentives for
emulation operate. In a market characterized by fundamental information asymmetries, investors find it
difficult to assess the risk exposure of a bank. Meeting and even exceeding capital requirements as
mandated by the BCBS can serve as a signal of financial soundness to markets. Not all analysts agree on
this conjecture however. Hardy (2012) looks at the hasty pace at which US banks repaid government-
sponsored assistance under the TARP program. He argues that under-capitalization signals to the market
that a bank has little risk exposure and thus no need to build up capital buffers. The eagerness to pay
back TARP assistance however may reflect bank management’s intention to steer free of government
dependency as fast as possible in order to obtain a better negotiation position in post-crisis regulatory
debates. In line with the market incentives hypothesis, major banks have made clear attempts to reach
and exceed Basel III capital requirements much before the 2019 implementation deadline.
Hegemony theories of both the Simmons and the Drezner variety focus on the degree of
divergence in the interests between the great powers and the rest of the world. When the dominant
regulatory innovators are concerned that other countries will not adhere to their new global standards,
and that such non-adherence will entail negative externalities, they will work through club-like
international institutions to ensure consistent implementation and compliance. In line with this
prediction, the G20 authorized the Basel Committee to overhaul the prudential banking regulatory
system. BCBS membership was extended in 2009 to include all G20 members but it remains a club-like
governance body with only 27 member countries. Assessments of the degree of interest divergence
between the great powers and the rest vary. On the one hand, the FSB has published a series of reports
voicing concern that stricter capital requirements curb credit availability in emerging market economies
(FSB, 2012a, 2013b, 2014b). On the other hand, developing countries are not lagging behind in Basel III
implementation, and 89 countries that are not Basel members have declared their willingness to adhere
to the new standards (FSI, 2014). In sum, G20-mandated reform of prudential banking standards has
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evolved in ways that are congruent with the expectations of great power theories of global financial
governance.
Epistemic communities
Kapstein’s (1989) analysis of the 1988 Basel Accord provides the first theoretical explanation of
global financial regulatory cooperation that highlights the work of epistemic communities. The author
argues that Basel I is the product of the successful development of consensual knowledge regarding risk
in the banking system and Anglo-American leadership. It is the same community of financial economists
and banking regulators that developed the new Basel III standards. Because this transnational
community of experts had more than two decades to develop and refine its consensus regarding
stability in the international banking systems and the optimal regulatory tools to achieve it, the
epistemic community approach expects reform success in prudential banking regulation.
These expectations rely on the important assumption that consensual knowledge develops
gradually over time. Regulatory consensus is built on a large number of academic studies regarding
market operations, policy modeling, and impact assessments. In new areas of regulation global
cooperation is unlikely until a corresponding body of knowledge is developed to facilitate consensus in
the regulatory community. This approach thus produces a more specific hypothesis: regulatory reform is
successful where existing regulatory tools are further refined and reform progress lags behind where
new tools and measures have to be developed.
From the epistemic community perspective it is thus not surprising that the Basel Committee
rapidly reached consensus on higher capital requirements as a portion of a bank’s risk-weighted assets.
Changes in risk weights for certain asset classes can also be understood as the result of gradual change
and adaptation. However, this approach struggles to explain why reform was fast and successful even
though some regulatory changes from Basel II to Basel III approach the “revolutionary”. The new global
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standard does not only contain novel regulatory tools, it also engenders a fundamental shift from a
micro- to a macroprudential perspective on global banking as the following paragraphs will show.
Basel I and II approach the banking system from a microprudential perspective. Hanson et al.
(2011) explain the shortcomings of this approach in simple terms: “When a microprudentially oriented
regulator pushes a troubled bank to restore its capital ratio, the regulator does not care whether the
bank adjusts via the numerator or via the denominator—that is, by raising new capital or by shrinking
assets.” (p. 5). From a macroprudential perspective however, concurrent asset shrinkage of several
financial institutions may lead to a credit crunch as banks engage in early termination of loan contracts
and cease to offer new ones. Furthermore, fire sales of assets reinforce this credit crunch because other
financial intermediaries may prefer to spend available capital on purchasing these cheap but distressed
securities with high risk-adjusted rates of return rather than extending (less profitable) loans on their
own. This cycle of fire sales and liquidity shortages was the main reason why the fall of Lehman Brothers
in September 2008 had such wide repercussions (FCIC, 2011).
The global financial crisis thus taught regulators that resilience to shocks cannot be successfully
achieved for each bank in isolation, but rather at the systemic level. As a consequence, the Basel
Committee introduced several systemic safeguards. Four of these new measures deserve special
attention: Basel III includes a new capital conservation buffer and two new liquidity requirements. It also
strengthens capital requirements for counterparty credit exposures arising from derivatives, repo, and
securities financing transactions. In addition the new agreement enables supervisors to apply a
countercyclical buffer. The additional surcharge to large, interconnected global banks (so-called global
systemically important banks or G-SIB) is another regulatory innovation that will be discussed in chapter
6 (BCBS, 2011a).
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Figure 4.3 Basel III innovations

The capital conservation buffer allows banks to refrain from hasty asset sales under duress but
forces the institution to curb bonus and dividend payments in order to prevent further capital reduction.
The higher capital requirements for counterparty credit exposures in turn deals with a potential
downward spiral in capital markets that regulators call “wrong-way risk”. Since the amount of regulatory
capital that banks have to put aside depends on the credit rating of a counterparty, capital requirements
would increase in times of crisis when its credit quality deteriorates. Basel III therefore calculates capital
requirements for exposures to counterparties as if under duress (BCBS, 2009).
Two additional new instruments regulate bank liquidity. The crisis taught regulators that
financial shocks may expose even banks with adequate capital levels to severe liquidity risk. As a
consequence, the Basel Committee developed a short-term and a long-term liquidity requirement. The
liquidity coverage ratio requires banks to hold enough unencumbered high-quality liquid assets to face
liquidity needs in a 30-day stress scenario. This standard is supplemented by the new net stable funding
ratio, a longer-term requirement to ensure that banks have a maturity structure of assets and liabilities
risk-weighted assets
capital (equity)
= capital adequacy
ratio
capital conservation buffer
counter-cyclical buffer
G-SIB surcharge
stricter definition of capital
new risk weights for counterparty
credit exposures
leverage ratio
liquidity buffers:
liquidity coverage ratio
net stable funding ratio
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that makes them more resilient to liquidity shocks. The first standard has been published in January
2013 and is implemented starting January 2015 whereas the second standard is still under development
and will not go into effect until 2018 (BCBS, 2013c, 2014c). Because liquidity standards follow Basel III
capital requirements with lagged timeframes it is too early to assess reform progress. Thus they are not
covered in the empirical work of this dissertation. However, liquidity requirements are mentioned here
because they represent novel regulatory tools that challenge the view of Basel III as merely a result of
gradual regulatory development.
Basel Committee members had not developed anything like consensual knowledge regarding
liquidity requirements prior to the crisis, and experience with this kind of regulatory tool was confined
to one member jurisdiction, the United Kingdom. A UK regulator recalls the onerous process of
deliberation inside the epistemic community of banking regulators: “The experience I’ve had of fairly
simple, high-level liquidity rules and how when you try to apply them at the national level, every country
just has this exception that doesn’t quite fit the rule and wants special treatment and how much tension
there is between the ways different countries regulate their system and how they’re integrated into the
political system. You only have to look at the UK and France who are 20 miles from each other and then
our whole theology and fundamental approach to how we regulate our banks is so different. We come
into conflict on every single issue because we just have different views.” (UK Regulator 1, 2014)
The above measures increase the capacity of financial institutions to absorb external shocks
without producing knock-on systemic effects such as fire sales and credit freezes. But along with
measures that seek to improve the alignment of managerial incentives with those of depositors and
investors and new liquidity requirements, they merely address specific market imperfections (Rajan,
2006; Stanton, 2012). According to former FSA Chairman Adair Turner (2012), these measures represent
the perspective of a “micro-structuralist school” that assumes that global financial markets operate in an
efficient and stable manner when certain identifiable glitches in the system are repaired by regulatory
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action. In contrast, the “macro-Minsky” school proposes a more radical approach to financial regulation.
It assumes that financial markets are inherently prone to boom-bust cycles with negative spillovers for
the real economy.
The counter-cyclical buffer, a new addition to the Basel Agreement, reflects the concerns of the
latter school. The buffer is built on the insight that financial crises throughout the world in modern times
tend to be preceded by large credit expansion (Reinhart & Rogoff, 2009). Basel III provides the
regulators with the power to raise the capital requirement up to an additional 2.5% in order to curb
credit expansion by banks during a boom phase. Because credit cycles vary among countries, prudential
regulators in each jurisdiction have the authority to use the counter-cyclical buffer at discretion. It is
important to note that unlike other regulatory tools, this measure does not hinge on any specific market
imperfection but rather on the recognition that financial markets in general exhibit certain undesired
tendencies.
In sum, some elements of the Basel III package represent gradual developments from a
regulatory consensus that developed in the Basel Committee over the last two decades. Cooley and
Walter (2011) for example regard the new rules merely as a modification of pre-crisis laissez-faire
policies. Others contend that even the shift to a macroprudential perspective does not represent a
fundamental departure from the pro-market bias of financial regulation (Bair, 2012; Engelen et al., 2011).
In a similar vein, Helleiner (2014b) states: “The containment of systemic risk became the rallying call for
policymakers and regulators rather than values that might have led to stronger controls on markets,
such as distributive concerns relating to wealth and power of the financial sector vis-à-vis public
authorities and other societal interests.” (p. 128).
On the other hand, scholars argue that the innovative features of Basel III represent nothing
short of a Polanyian shift in thinking about financial regulation. Baker (2013a, 2013b) shows how until
2008, the global consensus among regulators was firmly based on the efficient market hypothesis. At
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the height of the global financial crisis however, the few economists and policymakers that espoused a
view of financial markets as prone to network externalities, pro-cyclicality, herding phenomena and
other market failures gained protagonism. They acted as norm entrepreneurs in promoting a macro-
Minskian diagnosis on the causes of the crisis and corresponding policy advice, changing the nature of
the debate on prudential regulation in a rather short 6-month period. Baker (2013a) asserts:
“Consequently, the macroprudential ideational shift had the characteristics of ‘an insider’s coup d’état,’
instigated by existing technocratic elites.” (p. 424). However, while the ideational change was
revolutionary, the process of devising and applying policy measures in line with a macroprudential
approach is inherently slow and incremental, subject to extensive experimentation phases and political
resistance by existing veto players.
With the benefit of hindsight, more scholars start to appreciate the discontinuities in financial
regulation that are incorporated in Basel III as an instance of policy layering (Mahoney & Thelen, 2010).
Tsingou (2010) for example explains the “milimetric” change in regulatory reform in the following words:
“The coherence has given way to a more adversarial debate but much of the agenda continues to be
formulated by the same policy community of experts and focuses on tweaking rather than reforming the
system.” (p. 22). Three years later, the author revisits regulatory reform and argues that incremental
changes do not preclude radical transformations. Moschella and Tsingou (2013b) reject the argument
that reform can only be the product of a large exogenous shock and argue that “in finance […] paradigm-
change is instead associated with incremental, endogenously driven dynamics.” (p. 4). In other words,
minor “tweaks” in a given regulatory repertoire might not only be no obstacle to radical reform, they
may indeed be the modus operandi of revolutionary change in the world of financial regulation.
By end-2014, both the gradualist and the “revolutionary” elements of the Basel III package
exhibit considerable reform progress. The evolution of post-crisis prudential banking reform thus lends
support to an approach that highlights the power of epistemic communities in global financial
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governance. At the same time it challenges the hypothesis that regulatory cooperation is unlikely in new
areas of regulation where consensual knowledge has not been developed yet. Therefore it is difficult to
explain Basel III reform success solely from the epistemic community perspective.
Redistributive Concerns
Oatley and Nabors (1998) challenge the idea that global financial regulation arises from the
successful operations of epistemic communities. They squarely take on Kapstein’s account of the Basel
Accord and show that rather than consensual knowledge, the global agreement was driven by domestic
tension in the United States. In the wake of the Latin American debt crisis, many American banks faced
serious liquidity and solvency problems that threatened to have systemic repercussions. Investors and
depositors thus called for a more stringent regulatory framework that safeguards the stability of the US
banking system. However, any regulatory approach entails costs for the private sector, and any
regulation that only applies to domestic corporations affects their competitiveness in the international
marketplace. By developing the Basel Accord and threatening to exclude foreign banks from doing
business in the financial centers unless they adhered to it, the Anglo-American coalition behind Basel I
was able to increase financial stability while shifting adjustment costs to competitors in foreign
jurisdictions.
The redistributive theory of global financial regulation is successful at highlighting the link
between certain constellations in the domestic political economy with outcomes in the international
realm. It combines the domestic political and interstate approach to regulation in rather parsimonious
ways that remain productive for hypothesis generation and testing. However, several shortcomings
merit attention. First, the theory described above assumes that once international standards are in place,
domestic tensions regarding financial regulation are resolved. In particular, the private sector in the
dominant center should be appeased by the net income transfer from foreign competitors that results
from global regulation. Yet the empirical evolution of regulatory politics calls this prediction into
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question. Second, the theory models a tightening of regulatory standards, while the reverse tendency is
not contemplated. This might be one of the reasons why this approach has been of little help in
explaining agreements that bring about a relaxation of regulatory standards. Third, banks are assumed
to employ lobby power only domestically in order to gain advantage vis-à-vis their foreign competitors.
However, financial institutions today cooperate across borders, dedicating considerable resources to
transnational lobby organizations.
The theory of redistributive cooperation is nevertheless very useful in that it highlights the
importance of difference in adjustment costs to new global standards. Furthermore, it portrays Basel
Committee members not as footloose members of a transnational community of experts but rather as
representatives of their respective countries (Thiemann, 2014). Much of the current IPE literature has
indeed examined Basel III as a process of negotiation among nation-states. A group of economists at the
Brookings Institution comments: “Negotiations came up against the familiar tension between the role of
banking supervisors as guardians of financial stability and their role as champions of domestic banking
sector interests. In the latter role, supervisors take on the role akin to trade negotiators, their objective
to secure the ‘best deal’ for domestic interests.” (Brunnermeier, De Gregorio, Eichengreen, & El-Erian,
2012, p. 24).
In their analysis, many scholars highlight the fact that the final agreement sets lower standards
for prudential banking regulation than the initial draft documents. In their assessment, Basel Committee
members started with high ambitions but managed to only find a low common denominator in the end.
Unlike Basel II, this result is attributed to individual jurisdictions, not transnational regulatory capture
(Hall & Soskice, 2001; Pagliari, 2013; Quaglia, 2012). According to journalistic and academic accounts, an
Anglo-American coalition pushed for tougher prudential standards against Continental European and, to
a lesser extent, Japanese resistance (Barker & Masters, 2012a; T. Braithwaite, 2010; Guerrera & Pimlott,
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2010; Lall, 2012). Admati and Hellwig (2013, p. 193) bluntly state: “The watering down of regulatory
reform was largely due to the efforts of France, Germany, and Japan.”
This alignment of jurisdictions is reminiscent of the negotiations that led to the first Basel
agreement in 1988. Oatley and Winecoff (2011) for example see a return of the dynamics of
redistributive cooperation (Oatley & Nabors, 1998). The comparison is problematic, however.
Without a doubt there are significant historical parallels to the first Basel Accord. The main
stakeholders of the new Basel Agreement, just like its predecessors, are the major advanced countries.
Even though China, India, and other emerging market economies have evolved into major powers in the
realm of trade, their protagonism in global finance has mostly focused on governance reform of the
international financial institutions (Wade, 2011). In contrast, emerging markets took the backstage in
the negotiations on financial regulatory reform, again (J. Hawkins & Turner, 2001; Mügge, 2014; Persaud,
2010; Reddy, 2012).
However, unlike in the 1980s, US banks have not lost market share to European or Asian
competitors in recent years (A. D. Singer, 2010). Even though foreign branches and foreign-owned
subsidiaries chartered in the United States increased their relative presence in the subprime bubble
years of 2004-7, they performed even worse than domestic competitors during the crisis. Consequently,
the market share of foreign banks in the US dropped since mid-2007, that is three years before the
finalization of Basel III (Goulding & Nolle, 2012).
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Figure 4.4 Share of foreign-related institutions in US banking market, percentage of total assets

Source: Federal Reserve of New York
In sum, Basel III can be understood to balance the competing interests of financial stability and
international competitiveness much like its predecessors. Adjustment costs to the new standard were
unevenly distributed across jurisdictions and regulators were aware of it. And while redistributive
concerns clearly played an important role in Basel III negotiations there is insufficient evidence that the
negotiation position of a jurisdiction is predicted by adjustment costs, as the quantitative study at the
end of this chapter shows. Furthermore, the push by Anglo-American regulators for stricter regulatory
standards cannot be linked to a loss of competitiveness by banks headquartered in the US and the UK.
Neither did these two jurisdictions threaten market exclusion in order to obtain adherence to Basel III.
In the absence of threats of market exclusion, significant differences in adjustment costs can be
expected to undermine global cooperation. But while Basel Committee members had access to
quantitative data on adjustment costs and were thus acutely aware of it, they still reached consensus on
a global standard in record time and proceeded with implementation in a timely manner. The
0
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8
10
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1980
1981
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1984
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1999
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2003
2005
2006
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2011
2013
Basel I Basel II Basel III
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redistributive concern approach to global financial governance thus fails to explain the success of this
item on the G20 reform agenda.
Regulatory Capture
The regulatory capture approach has an intellectual history in analyzing the work of the Basel
Committee. As this section will show, scholarly work on Basel II emphasized the mechanisms of capture
that resulted in the gradual weakening of regulatory standards. Basel III is portrayed by this camp as
another instance of capture because the new capital requirements are not stringent enough and
because they carry over important elements of the discredited old standard. Furthermore, the increased
complexity of the new Basel agreement is seen to reduce public scrutiny and open additional channels
of influence by special interest groups. This section reviews both of these arguments, taking into
account previous work on regulatory capture of Basel II.
Five years after the implementation of the original Basel Accord, the BCBS presented a proposal
for extending regulation to cover market risks. The banking industry, led by the Working Group on
Capital Adequacy of the Institute of International Finance (IIF) criticized the proposal from the beginning
and argued that the BCBS should provide incentives for firms to adopt more sophisticated risk
management systems. It promoted the use of banks’ internal risk models to compute risk weights and
corresponding capital adequacy levels (BCBS, 2004; Dewatripont, Rochet, & Tirole, 2010; Lall, 2012;
Underhill & Zhang, 2008).
In 1996, the Basel Committee agreed on an Amendment to the Capital Accord to Incorporate
Market Risks that lets banks choose between a standardized approach and an advanced approach that
relies on the internal risk model of the regulated institution (BCBS, 1996). This regulatory design became
a centerpiece of Basel II, and notably so, one that has carried on to Basel III (Hellwig, 2010). As Rochet
(2010) points out: “To an outside observer the succession of reforms that created Basel II out of Basel I
look rather like a series of pragmatic contingent adjustments in which the committee sought to protect
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itself as far as possible from criticisms originating in the banking industry, finally ending up allowing the
major international banks to determine for themselves the manner in which they would be supervised.”
(p. 81).
But the changes to the original Accord were not restricted to the risk weights of assets, that is
the denominator of the capital adequacy ratio. The numerator, that is the measure of capital that banks
have to provide to absorb losses on the asset side of the balance sheet, was watered down, too. The
original Basel Accord restricted Tier 1 capital to equity and retained earnings. As Herring (2011) states:
“However, over time, pressures from banks and creative investment bankers led to the acceptance of a
number of hybrid instruments that appeared to be sufficiently like equity to placate the regulators and
sufficiently like debt to convince the tax authorities that payments on such instruments could be
counted as interest payments and deducted in computing taxable income.” (footnote 4). Thus, banks
were able to reduce the common equity share of the capital requirement to a mere 2%. The drive
towards greater flexibility on both sides of the capital adequacy ratio was clearly in line with industry
preferences.
Table 4.1 Basel capital requirements
Requirements Basel I Basel II Basel III
minimum incl. capital conservation buffer
Common Equity Tier 1 2% 4.5% 7%
Tier 1 4% 4% 6% 8.5%
Total Capital 8% 8% 8% 10.5%
G-SIFI surcharge 0-2.5%
Countercyclical buffer 0-2.5%
Source: BCBS
Financial lobby organizations used a powerful combination of strategic information provision
and exit threats to push for relaxed banking standards. A British regulator argues that prudential
authorities actually aimed for tougher regulatory requirements even before the crisis, but their efforts
were thwarted: “It isn’t the case that before 2007 we just always believed that light touch regulations
it’s the right way to go. There’s a huge amount of political interference pushing the head, the top of FSA
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towards that. So there’s a lot of anecdotal evidence that whenever they tried to be strict on banks they
were called off by politicians. […]The line from them to politicians was “You don’t want to kill us. You
don’t want us to go elsewhere.” (UK Regulator 1, 2014).
Not everybody regards Basel II as an exemplary case of regulatory capture, however. Young
(2012) raises the bar of causal inference by stating that “[…]it is spurious to simply assume that policy
changes which benefit a group are made at the behest of that group.” (p. 7, see also Carpenter 2013).
He shows that regulators at the US Fed, the Bank of England, and the BCBS produced somewhat critical
reports on the validity of banks’ internal risk modeling systems, and that Basel II requirements are
systematically above those suggested by the IIF. That the financial industry did not get everything it
bargained for is barely a counterargument to regulatory capture, but Young’s point about inference
standards is well taken.
If regulators were not captured by private sector interests, what else could have motivated
them to water down prudential standards during the 1990s and early 2000s? An alternative explanation
can be found in Aizenman’s (2009) Paradox of Under-Regulation. The author’s theory is based on a
fundamental asymmetry of information: the benefits of a crisis avoided by strict prudential regulation
are unknown, whereas the costs of regulation are evident. The agents that set the optimal level of
regulation update their expectations of crisis probability repeatedly, applying Bayesian inference. Thus,
a prolonged period of success in avoiding a financial crisis actually generates complacency, eroding the
demand for prudential regulation. This is arguably what happened during the so-called Great
Moderation period of 1985-2005 (Engelen et al., 2011). Even though the late 1990s were shaken by a
series of financial crises, they occurred in the periphery of the global financial system, allowing Western
policymakers to attribute their occurrence to cronyism and sloppy implementation of the high-quality
prudential standards that supposedly kept financial markets in developed countries safe.
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In sum, in the transition from Basel I to Basel II, prudential standards were relaxed to a point
that they were unable to prevent the fall of an individual institution, let along the entire banking system.
Just before its collapse, British bank Northern Rock featured a capital ratio that over-complied with
Basel II standards by 146% (Rochet, 2010). While no study to date has been able to convincingly
establish a causal link to the deregulatory tendency that resulted in Basel II, the combination of constant
industry pressure for laxer regulation and growing complacency among the public and regulators in a
period of calm can be regarded as a plausible explanation.
Basel III has come under similar criticism by analysts who assert that the new standard
represents gradual change rather than a significant departure from Basel II. One of the reasons why
Basel III has been depicted as an instrument of minuscule rather than dramatic change is that scholars
perceived the new capital requirements as insufficiently high. This section traces the discussion on the
economics of capital requirements and the costs that banks must incur as they implement Basel III.
In one of the most critical assessments to date, Admati and Hellwig (2013) highlight three weak
points of Basel III. They decry the continued use of risk weights to assess capital adequacy and what they
perceive as an unnecessarily long phase-in period of the new regulation. Their main point of contention
however concerns the level of equity – capital in financial regulatory speak – that banks are required to
hold. Admati and Hellwig (2013) state: “There is no legitimate reason for the proposed Basel III
requirements to be so outrageously low. These requirements reflect the political impact that the banks
have had on the policy debate and the flawed and misleading claims that are made in discussions about
banking regulation – the bankers’ new clothes.” (p. 180).
The main claim that Admati and Hellwig set out to debunk is that equity financing is costly for
banks. The authors argue that the expected return on equity decreases as the equity ratio increases.
This is because downward risk is distributed among more shareholders, who consequently demand a
lower risk premium. At the same time, a bank with a higher share of equity financing is likely to make
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more prudent decisions because shareholders as a whole have more “skin in the game”, that is they are
more exposed to losses in the case of insolvency than bondholders and depositors (Admati, DeMarzo,
Hellwig, & Pfleiderer, 2011). Admati and Hellwig (2013, p. 191) conclude that “increasing equity
requirements from 3 percent to 25 percent of banks’ total assets would involve only a reshuffling of
financial claims in the economy to create a better and safer financial system. There would be no cost to
society whatsoever.”
The above arguments are met with criticism both by the private sector (unsurprisingly) and
fellow economists. Charles Calomiris (2013, p. 14) writes: “In their well-intentioned zeal to make the
case for how beneficial, simple, and costless it would be to mandate dramatic increases in bank equity
ratios, they overstate the benefits and understate the costs associated with their proposed reforms.”
Calomiris cites several reasons why the costs that banks are facing are usually greater and only indirectly
related to the returns expected and received by investors. Admati and Hellwig’s work acknowledges two
of these reasons. First, the current tax system subsidizes debt, and much of the literature on the optimal
capital structure of a firm takes these “skewed incentives” for granted. Second, equity issuance occurs in
a market that is subject to a fundamental information asymmetry between management and (potential)
shareholders. Investors may perceive a firm’s decision to issue equity as a signal that management has
adverse private information about the state of the company which leads it to believe that the market is
over-valuing the stock of the company at a given point (Myerson, 2013; Myers & Majluf, 1984). One way
of overcoming this adverse selection effect is for public authorities to make equity issuance an
obligation. This is what occurred in May 2009 when the Fed published nominal requirements of capital
that had to be raised by banks that failed its Supervisory Capital Assessment Program. Hanson et al.
(2011, p. 10) review the process and conclude: “Here is a case where a strong regulatory hand appears
to have had highly beneficial effects. Indeed, by being tough and giving banks no choice, regulators
probably made it easier for banks to do the capital raising.”
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A central stone of contention is the Modigliani-Miller Theorem (Modigliani & Miller, 1958). It
states that the cost of capital is independent of a firm’s capital structure. A larger equity base reduces
cash flow per share, but at the same time it reduces the volatility of earnings and the likelihood of
bankruptcy. As a consequence, investors require a lower risk premium. However, the Theorem is based
on two central assumptions: exogenous total cash flow (no taxes, no bankruptcy cost, perfect contracts)
and perfect markets (Titman, 2002). The case for the cost neutrality of a high equity ratio rests on the
argument that these assumptions hold in reality.
The private sector disagrees with Admati and Hellwig’s argument. A recent report by the most
important bank lobby organization (Institute of International Finance, 2011, p. 45) states: “Most
Industry practitioners question the validity and applicability of the M-M theorem. This may reflect a
huge collective failing of insight and understanding by the Industry, but it seems more likely to reflect
the outcome of experience.” Years before the outbreak of the global financial crisis, Titman (2002)
offered his intuition on why the relative cost of debt vs. equity financing differs. The author notes that
capital markets not fully integrated. Investors are constrained by institutions (pension funds have
restrictions regarding the equity share of their portfolio, for example) and lack of experience. As a
consequence of this market segmentation, risk is priced differently in bond and equity markets.
This structural argument is compounded by concerns over capital market cycles. In this regard,
Calomiris coincides with some of the concerns expressed by the banking lobby (Protard, 2010). He
points out that equity markets fluctuate and that during periods of depressed equity prices, high funding
costs force banks to raise the price of lending or reduce assets. Furthermore, bankers argue that the
cost of equity financing is high due to (1) investor perception of risk in the banking sector as a whole, (2)
limited near-term supply of capital, and (3) perceived “regulatory risk”, that is uncertainty about future
regulation (Calomiris, 2013).
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The empirical picture confirms that these considerations are not irrelevant. A variety of studies
has estimated the increased financing costs that come with to Basel III capital requirements and how
banks would pass on them on to customers. The transmission channel of macroeconomic relevance is
that increased lending rates would raise the price and decrease the availability of bank credit, with
negative repercussions for investment, growth, and employment.
The bank lobby presented the study with the most dramatic result: according its predictions,
banks will raise loan rates by 364 basis points (bp) on average, thus reducing economic expansion by 0.7%
per year and employment by 7.5m people by 2015 (IIF, 2011). The
The large majority of studies undertaken by academics estimates a much lower, albeit non-
trivial impact on lending rates, credit, and growth (B. Allen, Chan, Milne, & Thomas, 2012; BIS, 2013;
Elliott, 2009; Kashyap, Stein, & Hanson, 2010). In an IMF review of the field, Oliveira and Elliott (2012, p.
6) state: “The Institute of International Finance is an association representing over 400 financial
institutions across the world. Its study, although admirably comprehensive and detailed, shows a far
larger cost to financial reform measures than seems plausible.” The estimates of an impact study
undertaken by the Basel Committee predict a 66bp increase in lending rates and a slowdown of
economic growth by merely 0.08% less. According to the study, the economic benefits of reducing the
likelihood of another global financial crisis significantly outweigh these costs (BCBS, 2010a).
Facing the apocalyptic projections of the banking lobby and growth concerns among politicians,
regulators suggested an extension of the phase-in period of Basel III. In a letter to G20 leaders in 2010,
then FSB Chair Mario Draghi (2010) states: “We should provide transition arrangements that enable
movement to robust new standards without putting the recovery at risk, rather than allow concerns
over the transition to weaken the standards.” (p.2). Subsequently, full implementation of Basel III was
extended to 2019 and financial lobby organizations welcomed the adjustments (Schneider, 2010b).
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Four years after the start of Basel III implementation, an empirical study finds that banks
increased their capital ratios mainly through the accumulation of retained earnings rather than equity
issuance. Lending rates have remained stable or even decreased, and a tightening of qualitative lending
standards was only observed in the eurozone in the wake of the Greek sovereign debt crisis. According
to the authors, the negative credit growth of recent years thus cannot be attributed to a shortage in
loan supply but rather to lackluster demand, especially in the crisis-stricken European Union (Cohen &
Scatigna, 2014).
In sum, the discussion over the optimal level of capital requirements in Basel III reveals a wide
spectrum of opinions. It helps clarify the assumptions of traditional theories of corporate financing and
the conditions under which they hold. Empirical research to date has shed further light on the real
adjustment costs to banks, undermining the claims of the bank lobby that Basel III imposes unbearable
costs on the banking system.
Another take on Basel III from a regulatory capture perspective focuses on the increasing degree
of complexity of prudential standards. What Haldane (2012a) calls the “Tower of Basel” has grown from
30 pages (Basel I) to 300 (Basel II) and now to over 600 pages (Basel III). Undoubtedly, the regulatory
design of the original Basel Accord was rather crude, and subsequent upgrades have improved the
alignment of risk exposures and capital requirements.
But the finer granularity in prudential regulation is tied to greater complexity and thus lower
transparency in two crucial relationships. First is the one between regulators and the regulated (S.
Johnson & Kwak, 2010). Tsingou (2010) sums up the issue in the following words: “It has been amply
documented that as finance became more complex, public officials found it more difficult to keep up
and compensation structures contributed to a shortage of competency in the official sector.” (p. 32).
There is no evidence that this dynamic has changed in the wake of the crisis. In fact, the suspicion that
complexity helps the financial sector escape supervisory scrutiny lead regulators to call for the
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introduction of simpler, more transparent regulatory tools, such as the leverage ratio (Haldane, 2012a;
Hoenig, 2013).
Second, complexity contributes to slack between principal and agent. Detailed information
about the operations of a given sector is a prerequisite for effective regulation, but obtaining this
information is costly. Legislators endow specialized agencies with the responsibility of supervision
because they lack the time, resources and expertise required for this task. However, the information
asymmetry between the agency and the principal provides the former with leeway to pursue its own
agenda (Laffont & Tirole, 1991). Increasing complexity compounds this problem of information
asymmetry, reducing the principal’s power to subject the agency to scrutiny. For example, Fed Governor
Daniel Tarullo (2008) expresses his concern that rather than increasing risk sensitivity, the complexity of
Basel II might just make the regulatory process more impenetrable for outsiders. In a similar vein,
Rochet (2010) reviews the internal ratings-based approach of Basel II and concludes: “The above
regulatory formula is far too complex to permit anyone external to the relationship between bank and
supervisor to judge whether the supervisor has done its work properly.” (p. 84). Thus, regulatory
complexity raises concerns of an erosion of democratic accountability. Major (2012) goes one step
further to claim that Basel represents the deliberate technocratic obfuscation and insularity from
democratic political pressure that is a hallmark of neoliberal depoliticized re-regulation (see also Dorn
2012).
In sum, criticism of Basel III from a regulatory capture perspective has focused on two
arguments, the insignificant departure from lax Basel II standards and the increase in complexity. The
debate between the financial sector and regulator regarding adjustment costs and the repercussion of
new requirements for credit, growth and employment shows that private lobby organizations made
efforts to water down regulatory standards. This dissertation however focuses on the gap between G20
commitments and their implementation, it does not assess the difference between the final Basel
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standard and a hypothetical tougher one. Once the final Basel standards with a longer phase-in period
were published, the industry expressed its cautious support and there is no evidence that industry
associations tried to slow down or hamper implementation. In other words, regulatory capture at the
negotiation stage is the subject of debate among scholars, not at the implementation stage. That Basel
III implementation has advanced successfully in line with the stipulated timelines can thus not be
explained from a regulatory capture perspective.
Cooperative decentralization
Because banks were at the center of the financial turmoil it is not surprising that prudential
banking regulation received much public attention in the wake of the crisis. Social movement
organizations and politicians in G20 countries and beyond called for stricter regulatory standards to
reign in reckless bank behavior. From the perspective of cooperative decentralization we can thus
expect transnational regulatory networks such as the Basel Committee to be sidelined by politicians who
respond to public pressures with unilateral initiatives.
Policymakers in some jurisdictions have indeed imposed requirements on banks that exceed the
globally agreed standard without consulting their peers abroad. It is important to note however that all
such instances of “super-equivalence” insert themselves into the Basel III framework. Basel standards
are designed to be minimum requirements and all agreements in the history of the Basel Committee
have provided regulators with leeway to set higher standards in their jurisdiction. The quantitative study
at the end of the chapter analyzes the differences in Basel III implementation and identifies predictors of
over-compliance.
The only case where over-compliance with Basel III can be regarded as a unilateral measure that
undermines the global standard is the United States. The Federal Reserve Board in its new role as
banking supervisor obliges large foreign banking organizations to establish intermediate holding
companies in the US and subjects these to super-equivalent capital and leverage requirements. The so-
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called FBO rule was debated in end-2012, proposed in 2013 and finalized in February 2014 (Comizio,
2013; Federal Reserve Board, 2012, 2014; “US banks must boost capital under leverage rule,” 2014). And
even though the FBO rule can be understood as one among several unilateral structural measures that
undermine efforts of globally harmonized bank resolution (as discussed in chapter six), it subjects banks
to prudential rules that are fully compatible with the Basel III framework. Responding to complaints by
foreign banks, the Basel Committee itself declared its support for the US initiative (International
Regulator 5, 2014).
In sum, contrary to the expectations of the cooperative decentralization approach, widespread
politicization of banking regulation in the wake of the crisis did not undermine the efforts of regulators
to develop a global standard. Politicians in member jurisdictions avoided unilateral measures that would
have undermined Basel III, waiting instead for the Basel Committee to find a regulatory consensus and
implementing it in a consistent way.
Sector differences
The approach that highlights sector differences as the reason for uneven reform progress finds
support in the area of prudential banking regulation. It posits that the banking sector is easier to
regulate than other financial markets, and in line with this expectation, Basel III is a successful item on
the G20 reform agenda. Together with the two great power theories developed by Simmons and
Drezner, this is the third approach to global financial governance that is supported by empirical evidence
in Basel III reform progress.
Government networks
The final approach under scrutiny in this chapter focuses on the institutional pathway of
prudential regulatory reform. It highlights the reliance of government networks on soft law mechanisms
that enable them to circumvent domestic parliamentary veto players. The more independent the
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operations of a government network are from such institutions of the Weberian nation-state, the more
successful regulatory reform is expected to be.
The Basel Committee is indeed a quintessential government network. It is comprised of banking
regulators from member jurisdictions and neither the agreements made in the BCBS nor the
organization itself carry any weight in international public law. Member countries do not “sign” the
agreement. Instead, Basel III was published as a non-binding declaration of intention to implement the
global standard unilaterally in each jurisdiction.
The domestic implementation process eschews legislative bodies in the large majority of Basel
member countries. In countries such as Argentina, China, and Saudi Arabia, regulators at the central
bank or a specialized banking supervisor adapted Basel III to domestic conditions and published the final
rules in the national register (BCRA, 2013; PBOC Research Institute, 2012). Japanese regulators
implemented Basel III domestically by publishing so-called “legal announcements” (kokuji) (Aosaki,
2013).
In the United States, Basel III rules were published in 2012 in the form of three so-called notices
of proposed rulemaking (NPR) and one final rule. NPRs were subject to a comment period in which all
interested parties were free to submit feedback on the rule proposals. The regulatory authorities then
finalize the rules and publish them in the Federal Register (Davis Polk, 2012; Harper, 2010). The
circumvention of legislative bodies is particularly interesting in the United States. While the Basel
Committee was developing a new regulatory standard for banks, lawmakers in the US negotiated and
finalized an encompassing law on financial regulation, the Dodd-Frank Act. However, the law mentions
neither the Basel Committee nor capital adequacy standards. With the exception of the Collins
amendment that stipulates that capital buffers under the advanced approach must not be lower than
under the standard approach, the Dodd-Frank Act does not interfere in prudential banking regulation.
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Instead, it explicitly endows regulatory agencies with the powers to engage in “international policy
coordination” (Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010, sec. 175).
That Congress did not play a role in Basel III implementation does not mean however that this
was an easy process. The United States features a unique system of regulatory fragmentation where
supervisory authority is divided between three agencies the OCC, the FDIC, and the Fed. A fourth bank
supervisor the OTS was dismantled in post-crisis reform but all other agencies struggled successfully to
retain or even expand their turf. The three US banking supervisors are not united in their regulatory
outlook and preferred degree of regulation. Therefore Basel III implementation only came about as the
result of a lengthy inter-agency negotiation. US regulators impose a leverage ratio that exceeds Basel
standards. When asked about the reasons for this decision, a US Regulator responds: “You want to know
the real reason? I don’t know if it’s ever been said. This was the price of getting the FDIC to agree to
Basel III. The FDIC did not adopt Basel III at the same time that the OCC and the Fed did. This was the
price of their adopting it. That was the cost.” (US Regulator 4, 2014).
Whereas domestic implementation of Basel III in the United States was achieved by way of gold-
plating the global standard, the opposite was the case in the European Union. The EU is one of the few
member jurisdictions where domestic implementation was subject to parliamentary debate and
approval.
A year after Basel III standards were published, interstate negotiations reopened in the
European Union as member states disagreed on how the global standards should be translated into
European legislation via the Capital Requirements Directive and Regulation (CRD IV). The intra-European
re-enactment of global regulatory negotiations was not merely a regional side-show. First, European
Union countries comprise a third of the Basel Committee (9 out of 27 jurisdictions, with the EU itself as a
28
th
member). Second, as the result of a decade-long process of centralization and internal market
integration, the European Union today is regarded both as a powerful actor in international financial
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negotiations and as a “hardening agent” of international soft law (Campbell-Verduyn & Porter, 2014;
Newman & Bach, 2014; Posner, 2009; Posner & Véron, 2010; Quaglia, 2014).
After an intensive negotiation period that culminated at a summit in May 2012, German and
French negotiators obtained a series of concessions that range from special treatment for (French)
banks that own insurance companies and the inclusion of silent participations as capital measures for
public German banks, so-called Landesbanken. Furthermore, the European implementation of Basel III
provides greater flexibility in the application of the leverage ratio and imposes an upper limit on capital
requirements (Barker & Masters, 2012a, 2012b). On the other hand, the CRD IV applies not only to the
internationally active banks that Basel rules were designed for, but to all 8300+ banks that are chartered
in the European Union. British and Swedish regulators, along with representatives from the European
Central Bank (ECB) and the Basel Committee had expected and bargained for tougher prudential
standards. Howarth and Quaglia (2013) quote the British Finance Minister George Osborne as saying
that “We are not implementing the Basel agreement, as anyone who will look at this text will be able to
tell you.” (p. 336). In return for French and German concessions, British and Swedish negotiators
obtained a greater degree of discretion in the national application of (higher) capital requirements and,
in the case of the UK, the guarantee that the implementation of the Vickers Reform will not be blocked
by a EU veto (Barker, 2012).
The Basel Committee confirmed Osborne’s admonition in December 2014. All BCBS members
are subject to a new peer review process, the Regulatory Consistency Assessment Programme (RCAP)
(BCBS, 2012c). Established in 2011, the RCAP combines remote and on-site review to assess the
completeness and consistency of Basel III implementation. Of the 9 jurisdictions assessed to date, the
European Union is the only one that is considered “materially non-compliant”. The Basel Committee has
published a list of necessary changes to align European regulation with global standards, including the
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treatment of insurance subsidiaries, much to the displeasure of the European Commission and
Parliament (BCBS, 2014g).
In sum, the trajectory of prudential banking reform confirms the hypothesis of the government
network approach. Global standards were successfully negotiated in a government network that relies
extensively on soft law instruments. Domestic implementation avoided parliamentary interference to a
large extent in almost all member jurisdictions. The major exception is the European Union, where the
partial unraveling and re-negotiation of Basel III in the European Parliament and the Commission led to a
legal transposition that was found inconsistent with global standards by the review team of the
government network.
In conclusion, reform progress in the area of prudential banking regulation is congruent with the
expectations of four of the eight approaches to global financial governance discussed here. Great power
theories correctly predict the protagonism of the leading financial centers and their strategic use of club
standards to promote consistent implementation. From a sector-based perspective, Basel III covers a
market segment of global finance that is much easier to regulate than others. And finally, the
government network approach is both able to explain the fast and consistent implementation of
transnationally developed standards in jurisdictions that circumvented domestic legislative bodies, and
their failure to do so in the European Union.
Both the decentralized cooperation and the redistributive concerns approaches highlight the
importance of adjustment costs and inter-jurisdictional differences in the optimal degree of regulatory
stringency. Even though both fail to explain the success of Basel III, they provide an interesting and
useful perspective on global regulatory negotiations. The following quantitative study seeks to shed
more light on the determinants of such differences in country preferences regarding banking regulation.
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Shades of Golden: over-compliance with Basel III
Because the negotiations on financial standards such as Basel III are conducted behind closed
doors, it is hard for outsiders to obtain verifiable information on the positions of member country
regulators. Journalistic accounts of the negotiations provide some insight but are of insufficient
reliability and granularity for empirical research. However, each Basel III member published its own rules
to implement the global standard. These rules contain valuable information that permits scholars to
draw inferences on the negotiation position of member jurisdictions. The agreements at the global level
establish a binding floor that represents the lowest common denominator among parties, but post-
agreement implementation gives members leeway to implement Basel at a level closer to their
preferences if they are above that floor. A look at over-compliance (super-equivalence, or gold-plating in
the jargon, each with its own connotations) can thus provide valuable insight into the differences in
country preferences regarding the optimal level of prudential banking regulation. This section presents
an empirical study of the predictors of over-compliance with Basel III.
Prudential banking regulation is costly for member states but exhibits positive externalities for
cross-border financial stability. In this sense, prudential regulation is a global public good that is under-
provided by governments. Consequently, Basel III negotiations can be understood as a multi-player PD
game (Dell’Ariccia & Marquez, 2006). Institutional features of the Basel Committee such as RCAP are
designed to detect and sanction free-riders once the agreement is reached and implemented
domestically. No mechanisms are in place to deal with over-compliance because this outcome is both
unlikely and desirable, albeit only to a certain degree. Yet a significant portion of BCBS member
jurisdictions have implemented Basel III in ways that exceed the globally agreed standards. Several
country-level characteristics help explain this type of over-compliance. These domestic characteristics
can be grouped into the following four categories: exposure to the crisis, adjustment costs, structural
differences, and macro-economic concerns. The following paragraphs examine each category in detail.
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Exposure to the crisis plausibly shifts national preferences towards tighter regulation. It can
reduce the relative influence of the defenders of the status quo and bolster politicians and regulators
that seek to raise the regulatory bar (Moschella & Tsingou, 2013a). Politicians are likely to be concerned
if rising unemployment reduces tax revenue and voter approval. Furthermore, governments in countries
affected by the financial meltdown had to implement costly bailout and stimulus programs that drained
government finances for years. Furthermore, social movement organizations put additional pressure on
government. Mattli and Woods (2009) posit that what they term “common interest regulation” can only
be achieved when there is broad societal demand for it. The effectiveness of social movement
organizations in changing policy outcomes is notoriously hard to assess, but it is plausible to assume that
societal demand for tighter regulation is greater when a country has been hit hard by the fallout from a
financial crisis. Pro-regulation social movements or what Walter (2014a) calls “punish-the-banks
coalitions” rose to prominence in the epicenters of the global financial crisis, the United States and
Britain (Goodstadt, 2009; Quaglia, 2012). In an empirical test using data from 35 countries over a 25-
year period, Mody and Abiad (2003) show that the occurrence of financial crises is associated with
subsequent tightening of regulation.
Adjustment costs are a central explanatory concept in the international political economy of
regulation, especially in finance (Drezner, 2007). In order to comply with higher capital standards, banks
must deleverage, retain earnings, or issue equity. Each of these adjustment methods is costly, as the
section on the economics of Basel above showed. Because the gap between pre-Basel III capital levels
and the new requirements is unique to every financial institution, adjustment costs vary across banks
and across jurisdictions. This heterogeneity of adjustment costs has consequences for the political
economy within each jurisdiction. Basel III requirements for example often pit small bank trade
associations against those of large banks (Lall, 2012). This intra-jurisdictional tension is not salient at the
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international level however, as negotiators represent the aggregated interests of their domestic
constituents (H. Milner, 1992).
The average capital levels of large banks in a given jurisdiction are a plausible predictor for
country preferences in Basel III and subsequent CRD IV negotiations. French and German banks for
example were less capitalized than their British and American peers in the wake of the global financial
crisis. This gap grew larger in the aftermath of the crisis due to differences in bailout programs. The UK
government’s massive purchase of bank equity as part of the bailout boosted the capital levels of many
British banks. In the United States, banks were able to re-capitalize rapidly thanks to the government
bailout and high earnings in the post-crisis years. Howarth and Quaglia (2013) show that German and
French government bailouts were much more limited. Furthermore, French banks would lose up to a
third of Tier1 capital if wholly owned insurance companies were not taken into account. The French
insistence on including the capital of insurance subsidiaries on a consolidated basis is thus not surprising.
On the other hand, jurisdictions with banks that feature high levels of capital pre-crisis can be expected
to push for higher capital requirements during Basel negotiations and implement them domestically
afterwards.
Structural differences in domestic banking systems add to and modify adjustment costs.
Applying global capital requirements to financial institutions that do not rely on equity financing, such as
French mutual banks, cooperative and savings banks, and German Landesbanken, poses a formidable
challenge for rulemakers. For example, Howarth & Quaglia (2013) show that CRD IV applies the Basel III
ban on counting hybrid debt as capital, with the exception of silent participations, the one instrument
that is relevant for Landesbanken. Such adjustment of global rules to local specificities has been
criticized as creating loopholes and providing certain financial institutions with unfair advantages
(Admati & Hellwig, 2013; Barker & Masters, 2012a).
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Another relevant structural difference concerns bank ownership in a given jurisdiction. The
degree to which banks are foreign-owned has an ambiguous effect on the preferred degree of
prudential regulation. On the one hand, foreign banks may find themselves in a weaker position in the
domestic political economy, with fewer channels to influence policymakers. On the other hand,
countries that are largely reliant on foreign banks, such as Mexico, may be concerned that tighter
regulation will lead to a deterioration of the price and availability of loans to local business. The FSB
reports on the effects of regulatory reform on emerging markets and developing economies consistently
express this concern (FSB, 2012a, 2013b, 2014b).
The relationship between government ownership and the desired level of banking regulation is
similarly ambiguous. It is plausible to assume that regulators in jurisdictions with mainly government-
owned banks are more aligned with the preferences of the industry at large. Conversely, governments
can prefer tight prudential regulation in economies with a predominantly public banking sector because
they can use alternative channels to compensate and ensure the profitability of banks, for example in
China (Steinberg and Shih 2012; Knaack, forthcoming).
Jurisdictions also exhibit significant differences in the degree of concentration of the banking
sector. But again, competing theories exist regarding how concentration relates to a jurisdiction’s
optimal degree of prudential regulation. Defenders of the concentration-stability hypothesis argue that
a small number of large banks is easier to monitor by authorities, and that muted competition in the
banking market reduces corporate incentives for risk taking. As a consequence, regulators would not
push for tight regulatory standards. (Acharya, 2001; Berger, Demirgüç-Kunt, Levine, & Haubrich, 2004;
Keeley, 1990; Repullo, 2004). On the other side, scholars assert that concentrated markets are subject to
moral hazard. They are dominated by a small number of too-big-to-fail banks whose risk-taking makes
the financial system more fragile (F. Allen & Gale, 2004; Boyd & De Nicolo, 2005; Schaeck, Cihak, &
Wolfe, 2009). Testing these hypotheses in a fixed-effects model using data from 81 countries, Kara
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(2013) finds that government ownership and concentration are negatively associated with stringent
capital requirements. Thus, he provides support for the argument that governments align with publicly
owned banks, and for the concentration-stability hypothesis.
Macro-economic concerns are at the heart of the political economy of financial regulation due
to the systemic importance of the financial sector as a whole. The prevention of financial crises is the
goal of prudential regulation not because banks merit special care, but because of the devastating
spillover effects any financial meltdown has on the overall economy. At the same time, the financial
sector lobby always couches its arguments over the burden of regulation in concerns about the knock-
on effects on business, growth, and employment. In the negotiations surrounding Basel III, this
argument is convincing only to the degree that bank credit is an important source of financing for
business. However, countries vary significantly in how much companies rely on bank credit to finance
investment. In Great Britain and the United States for example, capital markets are more relevant than
banks as a source of capital. The inverse holds true for France and Germany (Howarth & Quaglia, 2013;
Walter, 2014b).
The performance of the economy in the wake of a crisis plausibly has an impact on the
willingness of policymakers to promote tighter financial regulation. Post-crisis recovery can be slow for
reasons entirely unrelated to financial sector performance, such as ill-fated austerity policies or
government budgeting failures. Nevertheless, a post-crisis slump tips the balance between growth and
financial stability, making the availability of loans for investment and growth a greater priority than the
prevention of the next financial crisis. Arguably, the European Union is a recent example of this
phenomenon. In the aftermath of the Lehman collapse, the social and economic costs of the crisis
motivated European policymakers to substantially revoke their laissez-faire attitude towards the
financial sector. As Bieling (2014) asserts: “Then, however, the public absorption of large parts of these
costs and the emergence of a so-called ‘sovereign debt crisis’ became one of the core reasons why the
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interim ambitions to implement far-ranging and comprehensive financial re-regulation suffered defeat.”
(p. 351).
Figure 4.5 GDP growth, selected G20 countries

Source: IMF WEO
The growth-stability dilemma is only one element in the complex relationship between banks
and government. In an encompassing book on the politics of financial property rights, Calomiris and
Haber (2014) explore three conflicts of interest between the two parties. The first one concerns the
reliance of the government on banks as a source of public finance, indirectly through the
macroeconomic channels described above, but also directly given the considerable amounts of
government debt on the balance sheet of banks. In line with this argument, Admati and Hellwig (2013)
highlight the fact that bank lending to OECD governments has carried a 0% risk weight in every Basel
agreement, even though more granular assessments of sovereign debt risk are available.
The second conflict of interest arises because government enforces credit contracts that
discipline debtors on behalf of banks, but at the same time it relies on debtors for political support. This
is a particularly contentious issue in the mortgage market, where governments have connived in lending
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to subprime borrowers for the sake of financial inclusion and widespread home ownership. Indeed, the
risk weights assigned to mortgage lending became a stone of contention in the negotiations of Basel III
and CRD IV.
The final conflict of interest resides in that the government allocates losses among creditors in
the case of bank failures, but it relies on some creditors for political support. Bank failure triggers a
negotiation among stakeholders such as bank owners, minority shareholders and depositors, but leaves
the involved parties with “plenty of leeway to fleece taxpayers” in the words of Calomiris and Haber
(2014, p. 37). This is a relevant conflict in every domestic political economy, but its gravity is
compounded at the international level, as the chapter on ending TBTF shows. In sum, more than just
explaining the existence of certain loopholes in prudential regulation, the complex relationship between
banks and government in the macro-economy helps explain why jurisdictions differ in their regulatory
preferences.
Over-compliance with Basel III can take several shapes. Jurisdictions may choose to increase
CET1, Tier1, or Tier 2 capital requirements. Furthermore, they can exceed Basel III standards in leverage
and liquidity ratios, and impose more conservative definitions of capital and risk weights. Another
option is front-loading, that is the speeding up of implementation ahead of the globally agreed
timetable. For the purposes of this study, all but the last are considered over-compliance because they
will have a permanent, not transitional effect. What drives regulators in a given jurisdiction to over-
comply in one sub-area of Basel III and not another is an intriguing research question that unfortunately
cannot be addressed within the scope of this paper.
After the conclusion of the Basel III agreement, several BCBS members have publicly announced
rules that are super-equivalent to the global standards. Switzerland applies a so-called “Swiss finish”,
raising the requirement for equity to 10% and overall capital to 19% of risk-weighted assets. In a similar
fashion, the United Kingdom raises the CET1 requirement by three percentage points, but specifically for
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ring-fenced banks (Bank of England PRA, 2014; HM Treasury, 2013). Australia and Canada add one
percentage point to the equity requirement for systemically important banks, Singapore adds two (IMF,
2014). Indian authorities decided in 2013 to add one percentage point to the equity requirement for all
banks, although implementation will lag behind the global schedule (Reserve Bank of India, 2014). The
United States published super-equivalent rules twice in 2014. Regulators decided in February 2014 to
exceed the leverage ratio stipulated in Basel III, requiring G-SIBs to hold 5% of their assets in equity and
6% for bank holding companies with FDIC-insured subsidiaries. The authorities followed up with a higher
capital surcharge for G-SIBs in December (Hamilton & Moore, 2014; “US banks must boost capital under
leverage rule,” 2014). These well-publicized rules complement other gold-plated technicalities, such as
stricter risk weights and capital definitions (BCBS, 2014d). Sweden has already decided to front-load
Basel III implementation, and is expected to issue super-equivalent requirements similar to Switzerland,
soon (Finansinspektionen, 2013; C. Jones, 2011; “Sweden will go beyond Basel III capital rules, says
Ingves,” 2013). Finally, higher equity requirements are mandated by the regulators of the PR China, but
not of Hong Kong (Knaack, forthcoming; (BCBS, 2013e). In sum, 9 out of 27 member jurisdictions
decided to issue super-equivalent Basel regulations to date.
Table 4.2 Over-compliance with Basel III
Advanced Emerging
Australia  Netherlands Argentina
Belgium Singapore  Brazil
Canada  Spain China 
France Sweden  India 
Germany Switzerland  Indonesia
Hong Kong SAR United Kingdom  Mexico
Italy United States  Russia
Japan Saudi Arabia
Korea South Africa
Luxembourg Turkey

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As shown above, over-compliance takes many shapes. Since to date no granular theory of gold-
plating is available, the model proposed here simplifies by constructing a binary variable of value 1 for
the existence of any domestic rule that exceeds Basel III standards and 0 otherwise.
Given that the dependent variable is binary, standard OLS regressions are not applicable
because the homoscedasticity assumption is violated and errors do not have a normal distribution.
Instead, the use of discrete choice maximum likelihood models is appropriate. The first model in this
paper is the following probit regression using data from all 27 individual BCBS members:

Probit (Y) = β 1bailout+β 2stimulus+β 3gdp+β 4leverage+β 5stock+β 6gov+β 7concent+ε

Exposure to the crisis can be captured in various variables that measure the severity of the
economic shock and the magnitude of the necessary government response. The first variable (bailout)
measures the direct government support for the financial sector in 2008-2009 in the forms of capital
injection, asset purchase or lending by the Treasury as a portion of 2009 GDP. The numbers are still
changing today for two reasons: First, the crisis in the eurozone that started in 2010 forced several
European countries to bail out their financial sectors, in particular Ireland, Belgium, Germany,
Netherlands, Spain, and (a second wave in) the United Kingdom. Second, as economies recover from the
crisis, governments tend to sell the financial sector assets purchased during the bailout. Switzerland for
example has been so successful at recovering the assets it acquired from UBS that its 29bn franc
financial crisis emergency program now posts an overall profit (M. Allen, 2013). A similar result is
expected in the United States, where of the 4.8% of 2012 GDP that was utilized under the 2008 TARP
program 4.2% have been recovered so far (IMF, 2013). However, governments were not able to
anticipate this outcome in 2009/10 when Basel III was being negotiated. Furthermore, the recovery
process is uneven, with recovery rates of last year ranging from 87% (United States), to 22% (UK), 16%
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(Germany), 11% (Ireland) and even 0% (Cyprus). In order to represent the state of financial sector
support net of recovery during the negotiation stages of Basel III, neither additional bailouts nor cost
recovery after 2010 is included.
The second variable (stimulus) captures the government response to the financial crisis more
broadly. It measures the increase of total government spending as a portion of GDP from 2008 to 2009.
The inter-country variation in this variable should capture the size of fiscal expansion that governments
undertook in 2009 to stimulate the economy. I argue that the implications of direct bailouts and
stimulus programs for the domestic political economy of regulatory reform are similar. Unlike the
financial sector bailout, stimulus programs had a wider range of beneficiaries in each country. But at the
same time, these expenditures will not be recovered in any direct way and, just like the bailouts, they
represent a cost to the taxpayer that could have been avoided had the financial sector not triggered the
crisis.
The final indicator of exposure to the crisis (gdp) measures the difference between 2009 GDP
growth as projected in April 2008 by the institution that did not anticipate the crisis (IMF) and the actual
rate of change in GDP in 2009.
Adjustment costs are linked to the capital levels of banks in a given jurisdiction as Basel
negotiations unfolded in 2009. The variable leverage measures the average of banks’ capital as a portion
of un-weighted assets in a given jurisdiction, as provided by the IMF’s Financial Stability Indicators tables.
Statistics on bank capital as percentage of risk-weighted assets are available, too, but because risk
weighting changed between Basel I and II and not all countries had adopted Basel II at the onset on the
crisis, the leverage ratio may be more useful.
Macroeconomic concerns are difficult to operationalize in their complexity. The importance of
the capital market as an alternative to banks in the provision of capital to companies however is
represented in the variable that measures stock market capitalization as a portion of GDP (stock).
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Measuring the present value of equity is not a perfect indicator of the importance of market finance for
firms in the real economy but it is highly correlated with other relevant proxies such as the total value
traded in equity markets (B. Allen et al., 2012)
Structural differences are captured in two variables in the model that measure the percentage
of banking assets that are government owned (gov), and the concentration of the banking sector
(concent). An additional specification, introduced below, adds the share of foreign banks in the domestic
market (foreign).
Data for all three variables is taken from the dataset compiled by Barth, Caprio, and Levine
(2013), henceforth abbreviated as BCL. The authors designed a World Bank survey that was sent to
financial regulatory authorities in all countries in four waves, in 1999, 2004, 2007, and 2011.
One index constructed by BCL, the capital regulatory index, is of particular interest for the
purposes of this paper. The capital regulatory index is the sum of two variables that measure initial and
overall capital stringency, respectively. The first variable measures “whether certain funds may be used
to initially capitalize a bank and whether they are officially verified”, whereas the latter measures to
what extent “the capital requirement reflects certain risk elements and deducts certain market value
losses from capital before minimum capital adequacy is determined”. The capital regulatory index
ranges from 0 to 10, higher values indicate greater stringency. Unfortunately, the questionnaire uses
closed answers. The question about which capital adequacy regime is in place only refers to Basel I. This
was the case even in the 2011 survey. Furthermore, BCL compare pre- and post-crisis results and report
that capital requirement stringency has decreased in Austria, Mexico, and the UK (J. Barth et al., 2013).
Due to this questionable result and the shortcomings of the survey, a binary over-compliance variable as
constructed in this paper is considered preferable over the 2011 BCL capital regulatory index.
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The results of the probit regressions are presented in Table 4. The first model focuses on the
indicators of crisis exposure, adjustment costs, and macroeconomic concerns only. The second model
incorporates structural differences.
Table 4.3 Regression Results 1
Predictors of over-compliance (1) (2)
bailout .384** (0.036) .558** (0.042)
stimulus -.002 (0.987) -.029 (0.855)
gdp .417** (0.030) .672** (0.045)
leverage -.126 (0.293) -.064 (0.687)
stock .005 (0.211) .004 (0.313)
gov -.015 (0.492)
concent .026 (0.427)
constant 1.548 (0.218) .618 (0.832)
Observations 27 27
Pseudo R
2
.41 .46
p-values in parentheses. ** p<0.05, * p<0.1

The results show that exposure to the crisis is a significant predictor of over-compliance with
Basel III. The specific costs that governments incurred to bail out the financial sector and the general
costs of the ensuing economic contraction appear to be independently associated with Basel-plus
regulation. This association remains significant when structural differences among jurisdictions are
included in the model.
Unfortunately, the small number of observations requires any conclusions from this exercise to
be taken with utmost precaution. The underlying data lacks the statistical power to include other
potentially relevant predictors. In addition, the limited degrees of freedom of the model prevent
necessary robustness checks. Even though the current model specifications only explain slightly above
40% of overall variance, including further variables rapidly over-determines the probit regression.
In order to overcome this bottleneck and test the above hypotheses on a wider population, a
second dataset was compiled. It includes not only BCBS members but also non-member jurisdictions
that have started to implement Basel III. The data relies on a recent study conducted by the Financial
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Stability Institute (FSI), a body under the Bank for International Settlements. The FSI finds that of the 90
jurisdictions surveyed, 89 are implementing the new global standards or expressed intention to do so
(FSI, 2014). Jurisdictions vary widely in their implementation progress in the 8 categories established by
the survey, including Pillar 1 provisions for credit risk, operational risk, Pillar 2 and 3. Only the 17
jurisdictions that have final rules in force in at least two of the eight categories have been included in
the second dataset, bringing the total number of observations to 44.
1

The greater population size increases statistical power, but it reduces data quality in certain
respects. First, super-equivalent rules are considered as stated by the surveyed jurisdiction, no external
validation is provided. The same applies to the stated degree of Basel III implementation. Third, the data
necessary for the variable bailout was not available across the dataset. With these caveats in mind, the
second model estimates the following regression:

Probit (Y) = β 1stimulus+β 2gdp+β 3leverage+β 4stock+β 5gov+β 6concent+β 7foreign+β 8adv+ε

It includes all of the previous variables except bailout and adds two structural variables, the
market share of foreign banks (foreign) and a dummy variable that assigns 1 to developed countries and
0 otherwise (adv). The results are shown in the table below:

1
Additional countries are (+ stands for declared super-equivalence): Belarus, Bolivia, Colombia, Georgia, Iceland,
Kenya, Kuwait, Lebanon, Macedonia, Malaysia, Morocco (+), New Zealand, Oman, Pakistan, Peru, Philippines,
Qatar (+), Thailand, and Uruguay.
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Table 4.4 Regression results 2
Predictors of over-compliance (3) (4)
stimulus .112 (0.308) .056 (0.663)
gdp .191* (0.087) .409** (0.036)
leverage -.167* (0.061) -.041 (0.692)
stock .006** (0.049) .008** (0.031)
gov .020 (0.179) .027 (0.195)
concent .008 (0.586) .014 (0.512)
foreign -.029* (0.053)
adv 2.038* (0.075)
constant -.250 (0.866) -1.454 (0.479)
Observations 44 44
Pseudo R
2
.29 .48
p-values in parentheses. ** p<0.05, * p<0.1

The results of the regression in the greater dataset confirm the importance of crisis exposure as
a consistent predictor of over-compliance. Furthermore, including a wider variety of Basel III-
implementing jurisdictions highlights the important role of macroeconomic concerns. Countries with
larger capital markets, where business is less reliant on bank credit, are more likely to impose tougher
prudential standards. In addition, advanced economies with a relative capital-abundant endowment are
more likely to restrain the banking sector with gold-plated Basel III regulations. And there is a somewhat
significant negative relationship between foreign bank presence and over-compliance. The latter result
provides cautious support for the hypothesis that dependence on foreign banks is associated with
heightened concerns that tighter prudential regulation will restrict credit availability in a given
jurisdiction. Surprisingly, the empirical work above does not provide support for the relevance of
adjustment costs.
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But again, any conclusion from the calculations above must take into account the multiple
limitations of the data and the methodology. In addition to the data quality concerns mentioned above,
a fundamental limitation of this exercise resides in the absence of counter-factuals. In the real world of
global financial regulation, experimental settings are almost unattainable, and causal inferences are
hard to make. The above results should therefore never be interpreted as a cause-effect relationship but
merely as indicators of association.
Conclusion
Basel III is not only an essential element of financial regulatory reform in the wake of the crisis. It
can also be considered the most successful item on the global reform agenda. Even though the phase-in
timetable and the new capital requirements are considered too lenient by some critics, de facto
implementation is faster, more rigorous, and wider than anticipated. A third of Basel Committee
members has decided to exceed the global standards, decorating their jurisdictions with plates in
different shades of golden. Furthermore, the adoption of Basel III standards has spread to over three
times as many countries as are members in the BCBS. No other element of post-crisis financial reform
has progressed to a comparable level.
Much of the criticism that the new prudential standard has attracted focuses the gap between a
hypothetical stricter, more radical Basel III and the actual agreement. While this perspective has its
merits in drawing attention to indicators of regulatory capture and political bargaining, it tends to
overlook a more fundamental shift in the intellectual foundations of prudential banking regulation. In
the wake of the crisis, the Basel Committee has more than doubled its membership, incorporating 15
new jurisdictions that vary greatly in macroeconomic fundamentals, relationship between government
and the financial sector, and attitudes vis-à-vis regulation. In spite of this substantial increase in
heterogeneity, members of this government network managed to agree on the definitions,
measurements, and policy responses to a set of financial market failures that were anathema before the
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crisis. The increase in the number and rigor of micro-prudential instruments and, more fundamentally,
the shift to a macro-prudential outlook on the banking sector can be considered highly significant, if not
revolutionary.
This intellectual “insiders’ coup-d’état” took place behind the walls of central banks and
regulatory agencies, and the translation of this conceptual shift in regulatory philosophy into tangible
policy instruments will be long and contentious. In the meantime, much scholarly attention focused on
the interstate negotiations around Basel III. The new agreement represents the lowest common
denominator, less ambitious than several Basel members had hoped for. Nevertheless, many
jurisdictions have already passed the Basel-mandated quality test of domestic implementation, with the
notable exception of the European Union.
A considerable portion of BCBS members, including some EU countries, revealed a higher
preferred degree of prudential rigor by issuing super-equivalent Basel rules domestically. Empirical
research presented in this chapter indicates that these countries have likely been hit harder by the
financial crisis than others, and that they are less likely to rely on the banking sector as an intermediary
between finance and investment. This can be interpreted as an indicator that policymakers did not “let a
good crisis go to waste”. Further research should identify the predictors of super-equivalence with finer
granularity and parse out the micro-foundations between exposure to crisis and over-compliance. In
addition, much work is needed to analyze the political economy of macroprudential regulation as the
conceptual shift is being translated into policy instruments.

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Chapter 5: OTC Derivatives

Prior to the crisis, derivatives contracts that are traded not on exchanges but over the counter
(OTC) received scant attention by policymakers and academics, let alone the general public. This
changed drastically when the role of derivatives in the fall of investment banks such as Bear Stearns and
Lehman Brothers became clear.
In 2009, G20 leaders pledged to bring OTC derivatives under regulatory control. Reform
progress over five years later shows however that this is one of the most problematic items on the G20
agenda. Implementation of the commitments made is lagging behind even the leading jurisdictions, and
it is currently not clear when global OTC regulatory standards will be implemented in all member
countries, if ever. This chapter traces the evolution of OTC derivatives reform in the G20 and the FSB to
explain why this is the case. It identifies the origins of coordination failure between the leading
jurisdictions, the United States and the European Union, and tests 8 approaches to global financial
governance using the empirical material at hand. The chapter shows that while the expectations of four
of these approaches are consistent with the empirical evidence, the government network perspective
carries most explanatory power in this issue area. Weak governance networks and the protagonism of
legislators are the main reasons for the dismal performance of OTC derivatives reform.
Coordination failure in OTC derivatives regulation
Recognizing the need to bring OTC derivatives markets under supervisory control, G20 leaders at
the Pittsburgh Summit in September 2009 made the following pledge:
“All standardized OTC derivative contracts should be traded on exchanges or electronic
trading platforms, where appropriate, and cleared through central counterparties by
end-2012 at the latest. OTC derivative contracts should be reported to trade repositories.
Non-centrally cleared contracts should be subject to higher capital requirements.” (G20,
2009c, p. Annex 1 pt. 13) .
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Yet almost five years since that statement was made and more than a year after the deadline
passed, reform progress is partial at best. The considerable gap between policy goals and
implementation is well documented in the series of seven progress reports that the FSB has submitted
to the G20 to date. Concerns started surfacing as early as 2010. The progress report to G20 Finance
Ministers and Central Bank Governors in October 2010 recognizes, “Much work and considerable
coordination lie ahead in this area.” (FSB, 2010a, p. 2).
The lack of progress in OTC derivatives reform prompted the FSB to blow the whistle in a
progress report one year later. To make sure that no stakeholder oversees the message, the executive
summary of the document starts with the following lines:
“As of now, with only just over one year until the end-2012 deadline for implementing the G-20
commitments, few FSB members have the legislation or regulations in place to provide the framework
for operationalising the commitments. […]This report concludes that jurisdictions should aggressively
push forward to meet the end-2012 deadline in as many reform areas as possible.” (FSB, 2011c, p. 1).
By the time the deadline passed, not a single G20 member was close to implementing the
commitments made at the Pittsburgh Summit. According to the September 2013 progress report, less
than half of interest rate and credit derivatives have been cleared by central counterparties. And even
though almost all trades in these two asset classes have been reported to trade repositories, commodity,
equity, and FX derivatives are neither centrally cleared nor reported with high frequency. Very few
jurisdictions expect to have mandatory clearing obligations in effect “in the near future”, and regulation
regarding margin requirements for non-centrally cleared trades is not even in the consultation stage
outside the European Union and the United States. The report highlights the holes in the global
regulatory patchwork of OTC derivatives markets: “Reforms to legislative frameworks and implementing
rules are still underway in many jurisdictions, with few having frameworks in place that will support
implementation of all of the G20 reform commitments.” (FSB, 2013d, p. 4).
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Even the latest progress report, submitted to G20 leaders at the Brisbane Summit in November
2014, shows a rather bleak picture. To date, barely more than half of FSB member jurisdictions have
rules in place that require OTC derivatives transactions to be reported to trade repositories. Because
most jurisdictions are currently phasing in reporting requirements, however, trade reporting can be
considered a success story in comparison to other items on the OTC derivatives reform agenda.
Figure 5.1 OTC derivatives reform progress

Sources: FSB (FSB, 2014c, p. 9, 2014d, p. 9)
Progress has been slow in central clearing of OTC derivatives, where full requirements are
currently effective in only two countries, Japan and China. Many other FSB members restrict clearing
obligations to selected asset classes or merely rely on incentive mechanisms to encourage central
clearing. Even in jurisdictions and asset classes where central clearing counterparties are in place, only
13
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about half of eligible OTC derivatives contracts in terms of notional outstandings are centrally cleared.
Worse, only a few jurisdictions expect to have mandatory clearing obligations in effect “in the near
future”, and even though almost all members have the appropriate legal framework in place, 30% of the
24 FSB jurisdictions have not taken any action towards formulating clearing rules to date (FSB, 2014c, p.
9).
Significant progress has been made in the area of capital requirements that banks must hold for
their derivatives exposure. This is because capital requirements are under the purview of the Basel
Committee and will be implemented as part of Basel III. In contrast, rules on margin requirements that
apply to derivatives trades themselves independent of who the contracting parties are partially effective
in Saudi Arabia and India and have only entered the drafting stage in the United States, Japan, and the
European Union in late 2013. They are still not even being proposed in any other jurisdiction. Similarly,
almost half of FSB members have not taken action to bring OTC derivatives onto exchanges or trading
platforms. In sum, the report shows that even by end-2015, three years after the original deadline, OTC
derivatives reform will be far from complete (FSB, 2014c).
Why is the gap between G20 commitments regarding OTC derivatives regulation and the reality
of their implementation so large? This chapter shows that the main obstacle to progress in this area of
financial regulatory reform lies in the failure of the two dominant centers of global finance, the United
States and Europe, to engage in regulatory harmonization. Because the vast majority of OTC derivatives
transactions take place within or between these two jurisdictions, other countries have an incentive to
wait. In the language of international regulatory diplomacy, they are “continuing to monitor their
markets and are seeking to align their regimes with those of other jurisdictions when considering
whether and which requirements to adopt in this commitment area”, as the FSB (2014c, p. 7) reports.
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Which of the eight competing explanations outlined in chapter 2 offers sufficient inferential
leverage to explain this phenomenon? The following sections show that the hypotheses of four
approaches are congruent with the empirical evidence.
Regulatory Hegemony
Hegemony theories of both the Simmons and Drezner variety concentrate on the interests of
the great powers. OTC derivatives markets are centered around two financial hubs in the United States
and Europe whereas other jurisdictions play only a minor role. Both were gravely affected by the global
financial crisis and policymakers on both sides of the Atlantic recognize the negative externalities that
non-adherence to the new rules by other countries would entail. Furthermore, the differences between
the United States and Europe in the approach to OTC derivatives regulation are matters of detail not
philosophy as a subsequent section will show in greater detail.
Given this alignment in the interest of the great powers, both Simmons’ and Drezner’s
approaches lead to the prediction that the global financial crisis will lead to the emergence of a
harmonized set financial regulatory standards. The US and the EU are expected to drive the
development of harmonized rules in a minilateral club such as the G20 and the FSB and to push for
subsequent global implementation, making sure that all relevant jurisdictions adhere to the dominant
standards and that none resorts to free-riding. Thus they fail to explain the shortfall in reform progress
on this item of the G20 reform agenda.
Epistemic Communities
In contrast, the epistemic communities approach to global financial governance provides a
possible explanation for the empirical evidence. Before the crisis, OTC derivatives markets were only
regulated in peripheral emerging economies such as Brazil (Yazbek, 2009; Lima de Carvalho, 2011). In
the United States in contrast, OTC derivatives were explicitly exempted from regulation. There was
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political momentum to bring this asset class under regulatory purview following the turmoil with highly
leveraged institutions in the 1990s, and CFTC Chairman Born was proposing concrete measures to do so
until the now-famous 13 Bankers and Assistant Treasury Secretary Lawrence Summers spoke out against
her advances (S. Johnson & Kwak, 2010; Roig-Franzia, 2009). The industry was successful at lobbying
Congress to exempt OTC derivatives from regulatory supervision with the 2000 Commodity Futures
Modernization Act. Thus, before the crisis regulatory experts have dedicated relatively little time and
energy to finding out how to best regulate this market. That does not mean however that regulatory
proposals were non-existent. Roughly half a year before the collapse of Lehman Brothers, the FSF and
external financial experts recommended the establishment of central clearing and reporting
requirements for OTC derivatives (FSF, 2008a; L. Alexander, 2008). OTC derivatives reform in the G20
and the FSB can be understood as the intellectual heir of these early recommendations. Nevertheless,
the transnational community of derivatives market experts had not developed a consensual knowledge
base that could compare to that of banking regulators. Therefore, the lack of reform progress can be
attributed to the scant development of a transnational epistemic community in the field of OTC
derivatives prior to the crisis.
Redistributive Concerns
At first sight, the redistributive concern approach seems to provide great inferential leverage to
explain the dismal performance of OTC derivatives reform. In particular, it can be argued that concerns
about competitiveness play a major role in the current spat between the United States and Europe.
Unlike the field of banking regulation, it is not firms but trading infrastructures that compete in the OTC
derivatives markets. In particular, London and New York are major competitors as trading hubs of
derivatives today. London’s Canary Wharf emerged as the main hub for these trades in the late 1990s
because the regulatory environment of the United Kingdom provided a lucrative arbitrage opportunity
for American firms.
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These concerns are compounded by differences in the timetables of OTC derivatives rulemaking
and implementation. While US regulators have taken the lead in the implementation of Dodd-Frank, the
European Union lagged about a year behind (CFTC & SEC, 2012). As shown above, other G20 countries
are deliberately delaying OTC derivatives reform until finalization of the rules in the two main markets.
This in turn generates problems for the United States. In a 2012 testimony to the US Senate Banking
Committee, a high-level US regulator stated that: “Given our commitment to convergence with
international standards, our primary concern with the ongoing efforts to reform OTC derivatives
markets is one of timing. If the U.S. is unable to implement market reforms in a coordinated and
contemporaneous fashion with all significant derivatives market jurisdictions, we face the risk that
trades will move to an unregulated market.” (Walsh, 2012, p. 19).
Both U.S. officials like Geithner (cited above) and civil society organizations believe that the
post-crisis derivatives regulation contains more loopholes in Europe than in the United States. A hasty,
“outcomes-based” assessment of functional equivalence would thus represent a competitive
disadvantage for the U.S. In line with this idea, Coffee (2014) draws the conclusion that “for the United
States, substituted compliance will mean a loss of market share, revenues, and jobs as trading moves
overseas to marginally less regulated markets.” (p. 45).
A closer look at cross-border inconsistencies in OTC derivatives regulation however does not
provide a clear picture of such a tilted playing field. For example, Dodd-Frank requirements cover a
smaller product range of the derivatives market, and minimum risk management standards for central
clearing counterparties are weaker than those in Europe (Eurofi, 2014). Other regulatory differences do
not seem to provide any jurisdiction with a competitive advantage. A U.S.lobbyist explains: “Let's take
reporting, for instance. In the US at CFTC there is one counterparty that's responsible for reporting to
SDR [Swap Data Repositories] and that's in the regulation. In Europe both parties report. Okay, is it
better or worse? I don't know. It's different. But what that causes is great confusion.” (US Lobbyist 2,
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2014). Given the complexity of the OTC derivatives market and existing rules, only a thorough legal
analysis of the finalized regulatory environment will provide necessary insight to answer this question in
the future.
In sum, there is evidence that the authorities are concerned with the redistributive implications
of the new rules. However, neither side can currently rely on high-quality information regarding
adjustment cost differences. Therefore, it is hard to argue that redistributive concerns themselves are a
significant obstacle to regulatory harmonization across the Atlantic.
Government Networks
From a government network perspective, OTC derivatives reform is faltering because it
developed along institutional pathways that did not harness the strengths of transnational networks.
This approach provides three distinct explanations for the reform shortcomings. First, the government
network in charge of coordinating regulatory efforts in this area was formed ad hoc and proved to be
weak and inconsequential. Second, legislators in the United States and Europe took the lead,
marginalizing the coordination potential of the FSB and developing OTC derivatives rules without
engaging in meaningful interaction with their peers abroad. Pre-existing legislation represents an
additional obstacle to cross-border harmonization. Third, government networks in the OTC derivatives
field are incomplete even today because a fragmented regulatory system in the United States prevents
the most important agency from full engagement with the FSB. The following paragraphs will develop
each of these explanations in greater detail.
Following the above-mentioned G20 commitments at the Pittsburgh Summit in September 2009,
the FSB was put in charge of coordinating the formulation and implementation of OTC derivatives
reform. In April 2010, the Board set up the OTC derivatives working group (ODWG), comprised of
regulators from nine member jurisdictions, officials of several international financial institutions and
representatives the standard-setting bodies for banks (the Basel Committee), financial markets (IOSCO)
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and settlement systems (CPSS). By bringing together only a handful of the most involved jurisdictions
and only financial market regulators and central bankers, the composition of the ODWG makes it a
quintessential government network. This innovative institutional design gave rise to the optimism that
is manifest in Helleiner’s (2014c) words: “Both consensus formation and the development of specific
new international regulatory standards for OTC derivatives were greatly facilitated by the density of
transgovernmental networks among technocratic officials.” (p. 11).
Yet by relying on technocratic consensus among regulators, the group was oblivious of the
political obstacles to its functioning. A US regulator recalls that the absence of high-enough-level
representatives encumbered the coordination process from the beginning: “The European Commission
was basically out there saying, whatever you guys do, if it doesn’t include us, forget about it. […] Frankly
we couldn’t come to an agreement because every arrangement that we came up with, it was basically
[…] the market regulators at least in the US had the biggest clout and the European Commission again,
Brussels has the biggest clout but they’re not a member of Basel or CPSS or IOSCO per se. So we
ultimately came up with the kind of a fudge solution which wasn’t particularly appealing.” (US Regulator
1, 2012).
In 2011, when the lack of progress in the ODWG became evident, FSB Chairman Mark Carney
decided to establish the so-called OTC Derivatives Coordination Group, a more high-profile group that
brought together the chairs of the standard setting bodies and Carney himself in order coordinate “the
international work to achieve the progress on the safeguards that is needed by mid-2012” (Carney,
2012b, p. 3). But even though this group had more authority in the regulatory world, it ignored the
political realities on the ground. A US regulator explains: “They’ve got basically four central bankers or
one bank supervisor and three central bankers. And the SEC, the CFTC and the European Commission
which are frankly the major players in the OTC Derivatives Regulation are not there. […] So there still is a
question as to who’s going to have the big stick come December 31
st
.” (US Regulator 1, 2012).
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The failure of any jurisdiction to deliver on the G20 commitments regarding OTC derivatives by
the 2012 deadline serves as an indicator that the stick of Carney’s Coordination Group was not big
enough. The group itself never appeared again in subsequent progress reports. In its stead, a new group,
the so-called OTC Derivatives Regulator’s Group gained importance. It largely overlaps with the ODWG
but is comprised solely of officials with direct supervisory authority over the ten major derivatives
markets. The Regulator’s Group deals specifically with all the cross-border conflicts, inconsistencies,
gaps and duplicative requirements that have arisen in OTC derivatives regulation over the last years.
Even though it was formed outside the FSB and is not part of the Board’s organizational system, it is
welcomed by FSB members and reports regularly to G20 leaders.
A possible contender as a forum of regulatory harmonization is the global securities standard-
setting body IOSCO. It brings together experts in financial market regulation and uses a multilateral
memorandum of understanding for mutual recognition on a principles basis and information sharing
since 1983. However the agreement is restricted to cases of market manipulation and does not provide
a sufficient foundation for cross-border cooperation for the purpose of prudential supervision. In
addition, with 124 members this government network is too wide and unwieldy for the implementation
of G20 commitments. A U.S. regulator provides insight into the challenges his agency is currently facing
in this area: “I mean basically it’s the way the laws are written are very specific and we’ve got a whole
group within the international office, 20, 30 people that do nothing but figure out how to work their way
through the information sharing on enforcement. We haven't gotten anywhere near as far, don’t have
nearly the experience on supervisory information and less far on just aggregate data, you know, big
picture data and it’s just not something that the [agency] shares. I mean we just don’t have a history of
sharing. We have a history of sharing in the enforcement space but not nearly as much in supervisory
cooperation and even less when it comes to things like data.” (US Regulator 1, 2014).
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In sum, one of the reasons for the disappointing reform performance of OTC derivatives
regulation is that government networks in this issue area were not well-composed and not powerful
enough to steer global reform efforts.
The second explanation in line with the government network approach highlights the existence
of legislative and legal barriers to cross-border harmonization. In successful areas of financial regulatory
reform such as Basel III, new global standards are developed by a government network before they are
implemented domestically, either through new legislation (as in the European Union) or without (United
States). In contrast, OTC derivatives markets regulation was driven by domestic legislation: Dodd-Frank
in the United States and EMIR/MiFID 2 in the European Union.
Proposed in June 2009 and signed into law by President Obama in 2010, the Dodd-Frank bill
significantly increases the perimeter of financial regulation, including the OTC derivatives market in
particular. It is important to note, however, that this initiative was driven by the US Congress, not by the
G20. Persaud recognized as much in 2010: “The US bill on financial regulation currently before the
Senate makes no acknowledgement at all of what the EU, China, India, Brazil and Russia are up to.
Across a wide set of issues, from financial regulation, bankers’ pay and bank taxes to competition policy,
national regulators are going down different avenues from their G20 colleagues.” (Persaud, 2010, p.
638).
The cross-border inconsistencies in recent lawmaking are compounded by differences in pre-
existing laws. This is especially clear in the field of trade reporting, where data protection and bank
secrecy laws prevent cross-border information sharing. The G20 Pittsburgh Declaration includes a
commitment that all OTC derivatives trades be reported to trade repositories. But even though trade
repositories now exist in all FSB member jurisdictions, no jurisdiction (with the temporal exception of
Australia which chaired the G20 process in 2014) has recognized the trade repositories of other
countries for unconditional information exchange (FSB, 2014c). This means that, outside of bilaterally
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negotiated information sharing agreements, data on OTC derivatives transactions cannot be shared or
aggregated, thus impeding any analysis of transaction flows and corresponding risk at a global level.
The global nature of derivatives markets exacerbates the inconsistencies of current and past
lawmaking. Unlike the banking sector where regulators attach regulatory requirements to licenses and
charters in a given jurisdiction, derivatives markets represent an infrastructure that defies a territorial
approach to regulation (K. N. Johnson, 2011). Market participants cannot easily be excluded, and even
though the main participants in the OTC derivatives markets are big financial firms, their broker-dealer
operations can change location rather easily, at least on paper. Riles (2011) provides the example of a
derivatives transaction between a Japanese and a British bank, posted to their subsidiaries in the
Cayman Islands and involving a swap between Chinese Yuan and Singaporean dollars. In which
jurisdiction does this trade take place, the author asks, and what law should apply?
Lawmakers both in Europe and the United States have found an answer to this question: theirs
and only theirs. Both Title VII of the Dodd-Frank Act and Article 23 of the European Market
Infrastructure Regulation (EMIR) stipulate that entity- and transaction-level requirements apply to
counterparties irrespective of location when the trade has a ‘direct, substantial and foreseeable effect’
on the jurisdiction (Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010; Coffee, 2014; EU,
2012). This assertion of extraterritorial authority has been the main source of friction between
regulators on both sides of the Atlantic for the last two years.
In early 2012, proposed rules that envision the extraterritorial application of the Volcker Rule
irritated political leaders in Europe. EU officials had previously voiced their concern that Dodd-Frank did
not even grant the European Central Bank exemption from its rules (Shipkevich, 2011). The British
Finance Minister George Osborne wrote a letter of concern to Fed Chairman Bernanke in January, and
the EU Commissioner for financial services Michel Barnier argued a month later that it was “not
acceptable that U.S. rules have such a wide effect on other nations.” (Onaran, 2012; Standish, 2012). In
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diplomatic fashion, Treasury Secretary Geithner responded that “because in some areas U.S. reforms are
tougher or just different from the rules forthcoming in other markets, we need to figure out a sensible
way to apply those rules to the foreign operations of U.S. firms and the U.S. operations of foreign firms"
(H. Jones, 2012).
The biggest move into extraterritoriality however did not concern the Volcker Rule but OTC
derivatives regulation. This was not initially the case. EU Commissioner Barnier and CFTC Chairman
Gensler appeared to work closely together in the early days of OTC derivatives reform. After one of
many meetings in September 2010, Gensler and Barnier (2010) even stated: “We have proven on OTC
derivatives regulation that close transatlantic cooperation can work.” Furthermore, a joint paper by the
SEC and CFTC in February 2012 that highlighted the need for further cross-border cooperation to
identify gaps and inconsistencies in OTC derivatives regulation was welcomed by foreign regulators
(CFTC & SEC, 2012; Greene & Potiha, 2012; Helleiner, 2014a).
In July 2012 however, the CFTC issued a policy statement regarding “Cross-border Application of
Swaps Provisions” that extends the reach of US rules to a wide array of transactions and market
participants. Rules regarding market participants (“entity-level rules”) apply not only to so-called “U.S.
persons”, that is firms incorporated in the United States or their majority-owned and/or guaranteed
affiliates abroad. In addition, even non-U.S. entities are subject to the CFTC’s provisions regarding
capital adequacy, risk management, and swap data recordkeeping if they engage to a more than
minimal degree with counterparties in or related to the United States. Rules that apply to derivatives
trades themselves (“transaction-level rules”) exhibit a similar degree of encompassing extraterritoriality.
The rules proposed by the CFTC regarding swap clearing and processing, posting of margin (collateral),
reporting and others apply to every trade executed in the U.S. (no matter by what kind of firm) and
every trade that involves a U.S. counterparty (no matter where it is executed). For example, a London-
based affiliate of JPMorgan engaging in a swap with a Norwegian counterparty would be covered by U.S.
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rules. Even a swap between a French bank and a French pension fund is subject to CFTC authority if the
trade takes place in the bank’s New York affiliate. In fact, only transactions between two firms that have
no significant connections to the U.S. market are exempted from the CFTC rules (CFTC, 2012; Coffee,
2014).
European officials were dismayed by such a wide extraterritorial application of U.S. rules. In a
comment in August 2012, the European Commission expressed concern that the proposed guidance
“will maximize the potential for overlap and duplication of US regulatory requirements with those of
other jurisdictions, including the EU. An EU and a US firm that conclude an OTC derivatives contract will
be simultaneously subject to EU and US requirements. This will lead to duplication of laws and to
potentially irreconcilable conflicts of laws for market operators.” (European Commission, 2012, p. 2).
The CFTC released an update on its proposed guidance in December 2012, insisting on the
majority of its extraterritorial provisions. The European response this time was not restricted to a mere
comment letter. Instead, European Commissioner Michel Barnier brought this issue to a higher level by
drafting a letter to Treasury Secretary Lew. The letter, signed in April 2013 by Barnier and the Finance
Ministers of Brazil, France, Germany, Italy, Japan, Russia, South Africa, Switzerland, and the United
Kingdom, openly criticized “the lack of progress in developing workable cross-border rules as part of
reforms of the OTC derivatives market.” The undersigned clearly took aim at the CFTC’s extraterritorial
provisions by stating that “we hold the view that as a principle, local regulations should not be extended
beyond national borders.” (Barnier, 2013). The change not only of tone but also of stakeholders
deserves attention. While the 2012 comment letter was signed by a European bureaucrat and sent to
the CFTC, essentially a bilateral exchange among regulators, the 2013 letter was a highly visible
altercation among G20 politicians. The regulatory agencies that were targeted with the comments were
“copied”, but so were the legislative commissions that oversee the CFTC’s operation in the United States,
the Agriculture Committees in the House and the Senate. In a paragraph below, this paper highlights the
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political influence that these Committees exert on the CFTC. Again, what had started as a technocratic
exchange of opinions within a government network of regulators had acquired significant political
salience. Secretary Lew dismissed both content and form of the letter, calling it “ill-informed” and “not a
helpful way to promote conversations with two independent regulatory agencies” (Stephenson & Lynch,
2013).
The CFTC finalized its guidance in July 2013 with provisions that, while less extraterritorial than
the initial guidance, would still bring a large portion of European derivatives markets under American
regulatory control (CFTC, 2013b). In September 2013, the head of the UK Financial Conduct Authority
published a piece of unusually candid criticism in the Financial Times: “Does it make hard-nosed,
practical sense for any one national regulator to attempt to regulate all derivatives activity with any link
to its jurisdiction? […] The clear risk is that a patchwork quilt of national and regional rules runs the risk
of becoming unworkable. A mess.” (T. Braithwaite & Mackenzie, 2013).
The hoped-for solution to sort out this patchwork quilt is “substituted compliance”, a legal
concept that stipulates deference to the rules of another jurisdiction whenever they are deemed
“functionally equivalent”. Substituted compliance is a relatively new concept and one that has not
received widespread acceptance among regulators. Coffee (2014) remarks that: “the attitude of U.S.
financial regulators towards ‘substituted compliance’ has approached the schizophrenic. Unlike
securities and derivatives regulators, banking regulators have largely ignored or disdained substituted
compliance, preferring to rely on a more traditional territorial approach.” (p. 13). As argued above, this
divergence in attitude among regulators matches the difference between financial markets where gate-
keeping instruments such as licenses are available (banking) and where they are not (securities and
derivatives market infrastructures).
Nevertheless, both in earlier comment letters and in the April letter, regulators and politicians
outside the United States have expressed support for substituted compliance as a solution to cross-
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border regulatory duplication problems in OTC derivatives markets. In principle, this is also the approach
envisioned by the CFTC. In its proposed guidance, the agency clearly stipulates which transactions are
strictly subject to U.S. rules and which ones are eligible for determination of functional equivalence as a
prerequisite for substituted compliance. This common ground among regulators on both sides of the
Atlantic formed the basis for the so-called “Path Forward” initiative. Made public in July 2013, the
agreement between CFTC Chairman Gensler, European Commissioner Michel Barnier, and the European
Securities Market Authority (ESMA) envisioned a joint approach in determining equivalence in
regulatory regimes in order to pursue substituted compliance and mutual recognition (CFTC, 2013a). The
FSB’s OTC Derivatives Regulators’ Group in its commitment to “avoid, to the extent possible, the
application of conflicting rules to the same entities and transactions” and to “eliminate the application
of inconsistent and duplicative requirements”, have explicitly endorsed the initiative (ODRG, 2013).
But what started as a promising attempt at regulatory coordination ran out of steam only half a
year later. Whereas the European authorities support an outcomes-based approach that assesses
equivalence in rather broad terms of contribution to systemic risk, the CFTC employs a much more
meticulous rule-by-rule approach that is designed to identify loopholes and prevent regulatory arbitrage.
As the end-2013 deadline for determination of equivalence passed, the CFTC had only cleared a few
rules for substituted compliance. In a statement of dissent, CFTC Commissioner O’Malia expressed his
disappointment: “If the Commission’s objective for substituted compliance is to develop a narrow rule-
by-rule approach that leaves unanswered major regulatory gaps between our regulatory framework and
foreign jurisdictions, then I believe that the Commission has successfully achieved its goal today.” (CFTC,
2013c). The last in a series of setbacks, the CFTC issued new guidance in November 2013 that again
asserts extraterritorial authority over cross-border swaps. The European Commission responded with
“surprise” regarding the new rules “which seem to us to go against both the letter and spirit of the path
forward agreement.” (Brunsden, 2013). The Path Forward initiative continues, but beyond the issuance
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of temporary no-action relief orders that push forward the implementation date of over 130 of the
CFTC’s rules, the authorities have not made progress towards regulatory coordination regarding the OTC
derivatives market.
In principle, the legal and legislative obstacles described above can be overcome by political
initiative, and no political reform statement to date would be of greater authority than an explicit joint
commitment by the heads of state of the G-20. However, a U.S. lobbyist calls the power of the G20 to
overcome these obstacles into question: “G20. Okay. And then all these countries go off and figure out
how they can meet that and there's a whole lot that goes on between Pittsburgh and ‘We've got to go
and do this.’ In the US, you have 535 members of Congress that are listening to constituency. You've got
six or seven regulators. In many countries, Asian jurisdictions, and some European, they have a historic
reason why they don't want – for privacy. A G20 commitment doesn't change any of that.” (US Lobbyist
2, 2014).
In other words, legislators and legislation remain deeply domestic affairs that appear to
represent formidable obstacles to cross-border harmonization. However, the following paragraphs show
that even government networks of the executive branch exhibit crucial weaknesses.
The third explanation for reform failure from a government network perspective is that
government networks themselves are incomplete due to a fragmented agency system. Specifically,
regulatory oversight of the OTC derivatives market in the United States is divided. According to the
Dodd-Frank Act, the Commodity Futures Trading Commission (CFTC) is required to regulate swaps,
whereas the Securities Exchange Commission (SEC) regulates “derivatives defined as security-based
swaps” (CFTC & SEC, 2012). This rather parochial separation of regulatory powers raises eyebrows not
only in the United States. Regulators in other G-20 countries struggle to identify their American
counterpart when trying to implement the OTC derivatives reform agenda. Tucked away in a footnote,
even the joint CFTC-SEC report acknowledges this problem:
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“The regulatory distinctions between the terms “swap” and “security-based swap” as used in
Title VII are not co-extensive with terms used in foreign jurisdictions. Accordingly, the term ‘OTC
derivatives’, which is used in this Report to refer to Swaps across various jurisdictions, includes products
that may, or may not, fall within the DFA’s [Dodd-Frank Act] scope.” (CFTC & SEC, 2012, p. 4, footnote 9).
Why was regulatory authority over this financial market not assigned to a single agency? A
historical institutionalist approach to this issue provides an answer to this question. Created in 1934, the
SEC was a lesson learned from the 1929 stock crash and the Great Depression. Its mandate is to exercise
regulatory control over brokers and companies that trade their securities at the stock exchange. The
CFTC in contrast was established in 1975 to regulate derivatives markets of commodities. Farmers have
used futures for decades as an insurance against price volatility of their crops. It was thus an obvious
choice to place the CFTC under the oversight of Agriculture (Ag) Committees in the House of
Representatives and the Senate.
Over the last 10 years, the overall market for OTC derivatives has grown 665% in notional value.
The commodity-based contracts that farmers rely on, however, have hardly increased in that period,
and today they represent less than 1% of all OTC derivatives (Engelen et al., 2011, p. 42f.). When the
Obama administration considered bringing all OTC derivatives under regulatory control with the Dodd-
Frank Act, it would have been a common-sense solution to subsume the activities of the CFTC under the
authority of a strengthened SEC. However, the Ag Committees in both chambers of Congress started a
fierce turf battle to ensure not only that the CFTC continued to exist, but that it would have wide
regulatory authority over the OTC derivatives market. The Obama administration finally recognized that
without the goodwill of Ag Committee members the Dodd-Frank Act would never be passed. For the
Committee members, propping up the CFTC has significant benefits because it attracts campaign
contributions from the financial sector (US Legislature Aid, 2012). In the 2008 and 2010 election cycles,
Senate committee members have received $41.6 million from Wall Street, whereas agribusiness only
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made $17.6 million in campaign contributions. The situation is similar for House committee members
(Puzzanghera, 2009). This means that there was a multimillion dollar incentive for certain US legislators
to maintain a bifurcated domestic regulatory regime in the derivatives market.
The two agencies differ significantly with respect to their budget and degree of integration into
government networks. The SEC has been actively involved in transgovernmental exchanges with
securities regulators in Europe, Japan, and elsewhere. It is a founding member of and protagonist in the
securities standard-setting body (IOSCO) since 1983. The CFTC in contrast only holds the status of an
associate member. Furthermore, the SEC has been the American regulator at the table of the FSF since
its inception in 1999. It also holds one of the seats in the FSB Plenary today, with the other two reserved
for the Treasury and the Fed. The CFTC in turn has only occasionally participated in the FSF. The
situation changed to some extent with the creation of the FSB. The agency has a seat at both the OTC
derivatives working and regulator’s groups, but its chairman Gary Gensler has not been in extensive
contact with this crucial government network. A U.S. regulator recalls: “Gensler has been invited from
time to time to the steering committee meetings where they’ve been talking about OTC derivatives in
particular.” (US Regulator 1, 2014). Arguably, if CFTC regulators had established the long-term
professional ties that lubricate transgovernmental interaction, some of today’s coordination failures
across borders could have been avoided.
In addition, the CFTC has a much smaller budget ($208 million in 2013 as compared to the SEC’s
$1.35 billion), and thus much fewer resources to engage in regulatory cooperation with its counterparts
abroad. A U.S. regulator explains: “It’s kind of an interesting state of affair as where, I mean [the CFTC]
got 90% of the market, mas o menos, [the SEC got] 10% but [the latter] got nine people to work on
things for every one person that [the former] have. So [the SEC] can afford to throw more resources at
it.” (US Regulator 1, 2014).
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A CFTC Commissioner recently provided a glimpse of how his agency is dealing with the task at
hand: “Our staff is on its knees, some reaching for the exit doors and others already having bailed,” Mr.
Chilton said (Abrams, 2014). This dire situation threatens the independence of the agency. A civil society
representative points out: “The House Republicans have proposed to cut the CFTC budget. They hold
them up before Congress, and wag their fingers up, and they write letters, they use various points of
leverage to try to get them to dilute their rules.” (US Civil Society Representative 2, 2012). With a scant
history of cross-border engagement, facing significant pressure from the legislature and burdened with
formulating the rules for the largest share of the derivatives market on a meager budget, CFTC officials
have understandably dedicated few resources to coordination with their counterparts abroad.
In sum, the government network approach identifies three issues that complicate cross-border
harmonization of OTC derivatives regulation. The government network that was set up to coordinate
OTC derivatives regulation did not have the right composition and authority to do its job properly.
Second, legislators and pre-existent legislation represent formidable obstacles to cross-border
cooperation. And the government networks that are expected to overcome these obstacles are
incomplete and weak due to domestic institutional fragmentation.
Cooperative Decentralization
It is not easy to analytically separate the cooperative centralization approach from the network
perspective discussed above. OTC derivatives regulation certainly evolved from a marginal topic to a
highly politicized issue in the wake of the crisis.
Prior to the crisis AIG, a US government-sponsored enterprise had issued $500bn worth of credit
default swaps (CDS) without having to post any collateral (BIS, 2014b; FCIC, 2011; Public Citizen, 2012).
After the collapse of Lehman brothers, the Fed found itself obliged to guarantee AIG’s
derivatives obligations to counterparties, a bailout worth $182bn of taxpayer’s money. This AIG debacle
has chiefly contributed to the politicization of derivatives regulation, arguably motivating legislators in
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the United States to take action (Helleiner, 2011). In fact, Helleiner (2014c) cites derivatives regulation
as a salient case of cooperative decentralization.
The evolution of regulatory bickering across the Atlantic in the field of OTC derivatives
regulation can thus be read both as a confirmation of the network and the cooperative decentralization
approaches.
Regulatory Capture
From a regulatory capture perspective we can expect OTC derivatives reform to be derailed by
the lobby efforts of the private sector. Large derivatives dealers are expected to see net income reduced
by $2-3bn in Europe and Japan, according to an IMF study (Oliveira Santos & Elliott, 2012). The BIS
conducted a macroeconomic impact assessment in 2013, estimating the annual cost of OTC derivatives
reform at a higher range of between 15 and 32bn euros (BIS, 2013). Nevertheless, special interest
groups in the OTC field have refrained from full-out opposition against regulatory reform along the lines
of the IIF study on Basel III. Even more surprisingly, they have been a staunch supporter of the global
harmonization of derivatives rules.
Even faster than European and other foreign regulators, the financial sector was the first to
voice opposition to extraterritoriality. In a letter to Commissioner Barnier and Secretary Geithner from
July 2011, eight financial trade associations expressed concern that rules proposed in Europe and the
United States would “leave the global derivatives business with ambiguity and problematic extra-
territorial challenges and issues of legal uncertainty and misunderstanding which might give rise to
material risk.” In the same letter, the lobby firms remind the officials that the “G-20's goal of addressing
key systemic risk issues cannot be met without international coordination on market infrastructure,
regulatory transparency, and counterparty credit risk.” (ISDA et al., 2011).
More recently, the finance lobby has become more aggressive in reminding regulators to the
G20 reform agenda. In December 2013, three trade associations filed a law suit against the CFTC,
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contending that its proposed guidance on cross-border swaps is unlawful. The plaintiffs challenge not
only the agency’s use of guidance and staff advisories instead of a formal rulemaking process, but claim
that the CFTC “imposed a series of rules that are contrary to the spirit and the letter of international
cooperation and may harm global markets”. In order to substantiate this claim, the lobby organizations
make ample reference to the Path Forward initiative and the statements of European regulatory
authorities (SIFMA, ISDA, & IIB, 2013; Chon, 2013).
In sum, four years after G20 leaders gathered in Pittsburgh to declare their joint political will to
stand up against the interests of the financial sector and bring OTC derivatives markets under
coordinated supervisory control, the financial sector itself is able to exploit statements of the G20 and
those made by regulators of one jurisdiction to challenge the regulatory authorities of another.
Is the financial sector’s expressed preference for regulatory coordination merely hypocrisy?
Regulatory arbitrage has been an important element of “financial innovation” in the run-up to the global
financial crisis, and regulatory coordination under the aegis of the FSB or under the Path Forward
initiative is designed to minimize arbitrage opportunities. However, uniformly strict requirements are
considered less of a burden than duplicative requirements or even market fragmentation along
jurisdictional lines. A U.S. regulator explains: “From one perspective where they make their money is
arbitrage, but in another perspective where they make their money is volume. So yet to trade off
volume versus arbitrage and compliance costs add to that. So all things being equal, you’d rather have a
bigger pool with less rules.” (US Regulator 1, 2014).
On the other side, civil society organizations have supported the actions of the CFTC. In a
response to the above-mentioned letter by Barnier and his colleagues, 25 organizations from around the
world defend extraterritoriality. The letter states: “If, as you suggest, the reach of national regulation
cannot extend beyond national borders, then national regulators will be helpless when faced with the
global reach of financial institutions.” (Action Aid International, 2013, p. 2). The organizations regard
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coordination around a “shared high level of financial oversight” as a goal and the CFTC’s actions as a
step towards this goal. Members of the same coalition have identified loopholes in EU regulation
regarding derivatives (WEED, 2013).
With these alignments in the field of OTC derivatives regulation, it would be mistaken to claim
that the financial sector has undermined global reform progress. Therefore, the regulatory capture
hypothesis is not supported by the empirical record in this area of the G20 reform agenda.
Sector differences
Proponents of a sector perspective on global financial governance point to the differences
between global standard setters in banking versus securities regulation. While the BCBS is a tight, small
and efficient club, IOSCO has struggled to make a mark in global regulatory harmonization. The
shortcomings of OTC derivatives reform can be attributed to the difficulties of cooperation in financial
market regulation in general. Thus, the case of OTC derivatives supports the sector difference approach.
Conclusion
In conclusion, the reality of OTC derivatives reform can be explained by four approaches to
global financial governance, although their explanatory power varies substantially. The sector and
epistemic community approaches focus on the relative absence of transnational expertise and the scant
pre-crisis efforts of developing consensual knowledge of how to regulate derivatives markets. However
experts in both the US and the EU have worked hard to develop this expertise and establish a rather
sophisticated regulatory framework. The reason for reform shortcomings in this area five years after the
crisis is not the absence of regulation but that of regulatory coordination.
In contrast, both the government network and cooperative decentralization approaches are able
to provide micro-foundations that are consistent with the evolution of the OTC quagmire. The latter
approach has particular explanatory power in highlighting politicization as the driver of legislative action.
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The government network approach in turn is more encompassing. It shows that the FSB was sidelined in
the OTC derivatives field because it lacked a strong government network in this area. Furthermore,
regulatory fragmentation in the United States poses difficulties for the establishment of such a network
even after years of institution-building in the FSB. The OTC case shows that government networks fail to
deliver if they are not well matched along functional and jurisdictional lines to the distribution of power
and authority on the ground. The membership of the OTC Derivatives Working Group and the
Coordination Group were skewed in favor of unwieldy global standard setters led by central bankers and
against the financial market regulators that were actually writing the rules, especially the CFTC and the
European Commission. Tellingly, the group that has received praise in recent G20 declarations for its
important work on cross-border inconsistencies is the Regulator’s Group, the financial market regulators’
government network that was formed ad hoc and outside of the FSB institutional structure.
More profoundly, the OTC derivatives case indicates that nation states represent the largest
obstacle to successful transnational global governance. In particular, national legislatures tend to have
much less incentive to engage in cross-border cooperation than the executive branch of government
does. With legislators lagging behind and domestic laws impeding cross-border harmonization and
regulatory cooperation, the reality of global financial governance is much more fragmented along
jurisdictional lines than the advocates of government networks envisioned.

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Chapter 6: The never-ending too-big-to-fail story

One of the key features of the global financial crisis was the failure of large globally operating
banks that had to be bailed out by governments, imposing costs on public funds that were ultimately
borne by tax payers. In the wake of the crisis, G20 leaders became increasingly vocal about reducing the
expectation that failing banks can count on public support. They authorized the FSB to devise a set of
policies in order to make sure that no financial institution in the future is too big to fail (TBTF).
The FSB devised a framework to deal with systemically important financial institutions (SIFI),
harnessing the efficiency of a government network. However policy efforts bifurcate in 2013, about
three years after initiation of the ending TBTF reform package. Some policies are successfully entering
the implementation stage along the agreed timeline while others stalled in the negotiation stage and are
unlikely to become operational in the near future. The division between the former and the latter is not
random. It corresponds to the two sides of the FSB’s “bookends’ strategy” to increase bank resilience on
the one hand and make them resolvable without taxpayer support on the other. The resilience
“bookend” of ending TBTF that comprises policies to identify systemically important financial
institutions and increase their going-concern loss absorbency is on track. But FSB members have missed
all deadlines on the resolution “bookend” of banking reform.
This chapter argues that the different degrees of government network involvement in the two
bookends explain the difference in reform progress. The successful elements of the ending TBTF reform
package were developed by the Basel Committee, highlighting the effectiveness of government
networks. All reform policies connected to bank resolution in contrast failed to reach completion due to
obstacles in existing legislation and the inaction of national legislators in removing these obstacles.
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Reform is further undermined by the reticence of legislators to provide regulators with a sufficient
mandate to engage in cross-border cooperation, and by providing legal certainty for cross-border
insolvency of financial institutions. Facing a slowdown of TBTF reform and the proliferation of
uncoordinated unilateral structural measures, the FSB is taking innovative action. Its new initiative to
increase the loss absorbency requirement of global banks emulates the institutional pathway of the
Basel process, thus circumventing national legislators and legal obstacles to a large extent. This chapter
argues that this is the result of an institutional learning process.
The argument presented in this chapter is subjected to scrutiny by providing a series of
competing explanations. It shows that epistemic communities, redistributive concerns, regulatory
capture, and cooperative decentralization approaches do not provide sufficient inferential leverage to
explain the pattern of TBTF progress and failure. A concluding section examines caveats to the TBTF
policy package and draws lessons for the relationship between government networks and nation states.
Early progress in ending too-big-to-fail
Moral hazard in the domestic financial sector was not a salient issue until the collapse of major
investment banks during the global financial crisis. While the US Fed was able to arrange and guarantee
the sale of Bear Stearns in March, Countrywide in July, and Merrill Lynch in September, the inability to
repeat this kind of arrangement with another troubled bank, Lehman Brothers, sent financial markets
into shock and triggered the most substantial state intervention program of modern times, including
bailouts, forced mergers and fire sales of failing financial institutions. G20 leaders were initially cautious
in their statements, however. The declarations of the Washington and London Summits (G20, 2008,
2009a, 2009b) mentions neither moral hazard nor too-big-to-fail (TBTF) financial institutions. At the
Pittsburgh Summit in September 2009, G20 leaders stated: “We should develop resolution tools and
frameworks for the effective resolution of financial groups to help mitigate the disruption of financial
institution failures and reduce moral hazard in the future.” (G20, 2009c, para. 13 Annex 1).
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The language of G20 documents regarding too-big-to-fail became gradually starker, with the
June 2010 Toronto declaration asserting that “We are committed to design and implement a system
where we have the powers and tools to restructure or resolve all types of financial institutions in crisis,
without taxpayers ultimately bearing the burden, and adopted principles that will guide
implementation.” (G20, 2010a, para. 21). Finally, at the Seoul Summit five months later, G20 leaders
made their commitment to end too-big-to-fail explicit: “We reaffirmed our view that no firm should be
too big or too complicated to fail and that taxpayers should not bear the costs of resolution.” (G20,
2010b, para. 30). This commitment has appeared in every G20 declaration since. While the G20 heads of
state appear to be ever more vocal about ending too-big-to-fail however, the gap between this
commitment and the reality of regulatory reform in this issue area remains considerably wide.
The late appearance of ending TBTF on the G20 agenda may be explained by two factors. First,
the fall of Lehman Brothers shattered conventional wisdom about the relationship between the size and
resilience of a bank. Because the operations of large banks cover a wider geographic area and spectrum
of business lines, they have a greater ability than small banks to diversify risk, at least in principle
(Dicken, 2007; Hughes & Mester, 2013; Navaretti & Venables, 2006). That this potential for risk
diversification does not necessarily lead to a greater resilience vis-à-vis exogenous shocks became
painfully clear during the crisis, attracting the attention of economists and regulators alike (D. Arner,
2011). Second, moral hazard issues became more salient in the wake of the crisis. When investment
banks such Merrill Lynch and Bear Stearns faced insolvency, resolution authorities opted for a so-called
“purchase and assumption” approach. Instead of breaking up and winding down the failing firm,
authorities facilitated the purchase of its economically critical parts by another bank.
This approach was successful in preventing contagion and maintaining a minimum degree of
market confidence in times of crisis. In fact, only after this strategy failed because no buyer for Lehman
Brothers could be found during the weekend before September 15, 2008, the American subprime crisis
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turned into the global financial crisis (FCIC, 2011). The purchase and assumption strategy however leads
to a further increase in market concentration, thus reducing competition and creating even bigger
financial conglomerates. The Bank of England’s Andrew Haldane (2012b) summarizes: “In other words,
resolving big banks may have helped yesterday’s too-big-to-fail problem, but at the expense of
worsening tomorrow’s.” (p. 8). Indeed, a study by SNL Financial in December 2014 revealed that the top
5 banks in the United States control 44% of all industry assets, up from less than 10% in 1990 (Menkin,
2014).
Figure 6.1 Bank Mergers and Acquisitions, United States 1990-2009

Recent empirical work shows how much the financial crisis has exacerbated the TBTF problem.
Big banks enjoy more favorable funding conditions in capital markets because investors believe that
public authorities will bail them out in case of insolvency (Afonso, Santos, & Traina, 2014; Santos, 2014).
Credit rating agencies differentiate between “standalone” and “support” ratings for bonds issued by
banks, and the resulting differences in bond spreads provides large banks with a funding advantage that
amounts to the equivalent of annual profit for British banks in 2010, according to one study (Haldane,
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2010). The Bank of International Settlements (2012) reports that this TBTF subsidy has increased
significantly after the crisis: “A comparison of all-in and stand-alone ratings reveals that rating agencies
deem the official support for banks to have increased substantially between 2007 and 2011. At end-
2011, such support lowered the spreads that banks had to pay for longterm bonds by an estimated 1–2
percentage points, or by 10 times more than prior to the crisis.” (p. 76). Although the TBTF subsidy in
bond markets has decreased since then it remains above pre-crisis levels (Brewer III & Jagtiani, 2013;
Carney, 2014b; IMF, 2014) The expectation of a government-sponsored bailout also weakens market
discipline. Creditors are less inclined to subject company decisions to scrutiny, thus giving management
the chance to pursue riskier strategies in the search for higher returns. This moral hazard issue became
evident not only in the case of US banks (Afonso et al., 2014).
Figure 6.2 Asset concentration in the US banking market, 1990-2014

Source: Menkin (2014)
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The development of a policy response to the TBTF problem took shape in transnational
government networks that have a track record in dealing with global financial firms. Indeed, it was the
failure of a large bank with cross-border repercussions that sparked the very creation of the first
government network in the realm of financial regulation. When Herstatt failed in 1974, the bank left
certain foreign exchange trades unsettled – a risk to foreign counterparties that is still dubbed Herstatt
risk today. In order to deal with similar situations in the future, the Basel Committee was formed in the
same year in order to find a consensus on the distribution of home and host country responsibilities. The
product of deliberations among banking supervisors from the G10, the 1975 Basel Concordat provides
general guidelines for responsibility over the solvency and liquidity of a bank’s foreign operations (BCBS,
1975). Subsequent financial crises have triggered the Basel Committee to further develop and amend
cross-border supervisory cooperation. In response to the Latin American debt crisis of the 1980s, it
revised the Concordat to include the concept of consolidated supervision as a home country
responsibility (BCBS, 1983). A decade later, after a financial scandal around BCCI, a Luxembourg-based
bank with operations in the UK and the US, the idea of supervisory colleges that bring together home
and key host supervisors was born (BCBS, 1992). Cross-border cooperation was further strengthened
with the establishment of Basel II (BCBS, 2003). Even though the Basel Committee agreements
eschewed any explicit designation of a lender of last resort for international banks in favor of “calculated
vagueness” (Verdier, 2013), it developed an increasingly sophisticated transnational system of shared
understandings and allocation of responsibilities in the event of cross-border bank failures (K. Alexander
et al., 2006; Davies & Green, 2008).
The Basel Committee is a member of the Financial Stability Forum, another government
network that took the lead in coordinating a policy response to financial market turmoil in the early
stages of the global financial crisis. Shortly after the fall of Northern Rock in February and Bear Stearns in
March 2008, the FSF submitted a report on Enhancing Market and Institutional Resilience to G7 Finance
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Ministers and Central Bank Governors. The report reflected the optimism at the time that the subprime
crisis can be dealt with by merely fixing certain aspects of the financial system. Regarding bank failures,
the report states: “During the recent turmoil, cross-border cooperation has worked satisfactorily overall
between authorities, and arrangements for dealing with problems at a cross-border institution have not
been tested.” (FSF, 2008a, p. 49).
Nevertheless, the FSF recommended that national authorities should strengthen legal powers
and clarify the domestic division of responsibility for bank resolution. It further encouraged regulators to
increase cross-border information sharing and to form supervisory colleges for “significant cross-border
firms”, most of which were indeed established by the end of 2008. The recommendations regarding
cross-border information sharing in supervisory colleges were repeated in follow-up reports (FSF, 2008b,
2009a) and formed part of a set of high-level Principles for Cross-border Cooperation on Crisis
Management that the FSF (2009b) published in time for the G20 London Summit in April 2009. It is
noteworthy that unlike earlier FSF documents, the 2009 FSF Principles eschew the question of legal
authority altogether. They also stop short of requiring resolution plans for cross-border firms and merely
“encourage firms to maintain contingency plans and procedures for use in a wind-down situation” (para.
8).
A slightly bolder proposal was published by the Basel Committee. It had established a Cross-
border Bank Resolution Group in December 2007 in order to review member jurisdictions’ allocation of
responsibilities, legal framework for bank resolution, and experiences with recent bank failures. Its
report, published in March 2010 highlights legal obstacles to cross-border cooperation. The Basel Group
points out that an international insolvency framework for financial firms is non-existent at present and
unlikely to be established in the future: “Indeed, few countries, if any, have tools for resolving domestic
financial groups – as distinct from individual deposit-taking institutions – in an integrated manner in
their own jurisdictions.” (BCBS, 2010b, p. 4). Thus, as a prerequisite for cross-border cooperation,
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national resolution authorities should be endowed with the legal powers to wind down financial
institutions fast and efficiently without recourse to domestic courts.
Building on earlier efforts of cross-border coordination by the G10 Joint Taskforce and the
European Union (2008), the Basel Committee explored the idea to apply a quintessential instrument of
transnational government networks: a Memorandum of Understanding for cross-border banking crises.
However, Basel Committee members were not able to support this option: “Without more convergence
and binding agreements – and in the absence of aligned incentives – coordination between national
authorities has proved challenging.” (BCBS, 2010b, p. 7). In the end, the Basel Committee merely
recommends national authorities to “develop procedures to facilitate the mutual recognition of crisis
management and resolution proceedings” (p. 1).
Figure 6.3 Degrees of Cross-Border Cooperation

Arguably the most ambitious proposal for dealing with cross-border bank failure comes from the
IMF (2010). The Fund recognizes that the existing institutional framework exacerbates moral hazard
because public bail-outs are a better alternative to uncoordinated national approaches and lengthy
insolvency procedures. In order to address this problem, the IMF points to two corner solutions: an
international treaty that would oblige countries to defer to resolution procedures in the home
International treaty
National mandate
for cross-border cooperation
Mutual recognition of
foreign resolution procedures
Information sharing,
joint resolution planning
Unilateral actions
CROSS-BORDER COOPERATION
FSB 2010
IMF 2010
BCBS
2010
FSF 2009
de facto during GFC
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jurisdiction, and alternatively the de-globalization of financial institutions and fragmentation of the
financial system along jurisdictional lines. Since the former is unfeasible for political reasons and the
latter undesirable for economic reasons, a pragmatic middle-ground approach is needed.
The IMF coincides with the government networks cited above in highlighting legal shortcomings:
“National frameworks in some jurisdictions do not sufficiently empower their supervisors or the relevant
resolution authorities to share information with their counterparts in other jurisdictions.” (IMF, 2010, p.
9). However, the Fund does not merely encourage regulatory cooperation or mutual recognition of
domestic regimes, but calls for countries to “ensure that their domestic legislation requires national
authorities to coordinate their resolution efforts with their counterparts in other jurisdictions to the
maximum extent consistent with the interests of creditors and domestic financial stability” (IMF 2010,
18, emphasis added). Furthermore, the IMF calls for the development of “core-coordination standards”
that would facilitate resolution coordination among those jurisdictions that comply with these standards.
Such a framework of enhanced coordination is portrayed as a sine qua non for addressing TBTF: “A
resolution framework will be ineffective unless it is accompanied by a robust cross-border coordination
mechanism.” (IMF, 2010, p. 5).
The FSB followed up with a policy proposal that builds and extends upon the IMF approach. In
October 2010, ahead of the G20 Seoul Summit, the FSB (2010c) published the framework for ending
TBTF that would guide all efforts in this policy area to date. The so-called “SIFI framework” covers a wide
range of policy initiatives, that address three major issues: identification of SIFIs, loss absorbency, and
resolution. First, the FSB authorizes the Basel Committee to develop a methodology for assessing
systemic importance in order to identify SIFIs. Second, financial institutions that qualify as global SIFIs
should be subject to higher loss absorbency requirements as developed, again, by the Basel Committee.
At this early stage of the policy-making process, loss absorbency referred to instruments that could be
drawn on while the bank was still operational (going-concern). The third item on the SIFI agenda
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concerns the resolution of failing SIFIs. It repeats the recommendations made by the FSF, BCBS and IMF
as to changes in legislation that give national authorities the power to resolve a failing financial
institutions and bail-in creditors (Draghi, 2010). However, it goes beyond the previous government
network consensus in recommending that authorities should have the powers to require an institution
to change its legal and operation structure in order to facilitate recovery and resolution. Regarding
cross-border cooperation, the FSB also adopts a strong position, making the following recommendation:
“The mandates of resolution authorities should be framed so that they are fully obliged to seek
cooperation with foreign resolution authorities.” (FSB 2010, 4, emphasis added). FSB members are
recommended to establish cross-border crisis-management groups (CMG) for each global SIFI, make
resolvability assessments, share information, develop a recovery and resolution plan (RRP) and sign a
cooperation agreement (COAG) for the institution under supervision. A final element of resolution
policies concerns the entanglement of SIFIs in derivatives markets. At the time however research into
the link between derivatives exposure and ending TBTF was not advanced enough to make specific
recommendations, and the FSB merely refers to work undertaken by the ODWG (see chapter 5)
regarding central clearing of derivatives. The FSB also set timelines, expecting the majority of policy
work on these issue areas to be complete by end-2011. The following paragraphs examine the uneven
advance of the different policy initiatives that constitute the FSB SIFI framework.

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Figure 6.4 SIFI Framework and Progress 2010

Developing a global consensus on how to define and measure systemic importance was by no
means an easy task, but government networks accomplished the job with remarkable speed and
efficiency As Baker (2013b) has pointed out, a macroprudential perspective and concerns about
systemic risk remained at the margins of the regulatory discourse until the global financial crisis. At the
time of the London Summit in April 2009, the G20 asked the IMF and the newly reconstituted FSB to
develop a workable definition and measurement of systemic importance.
Andrew Haldane, Chief Economist at the Bank of England, likened the banking sector to the car
industry in that both entail private benefits and social costs, that is negative externalities. In the
automobile case, air pollution is the negative spill-over that the industry itself does not internalize.
Haldane continues: “The banking industry is also a pollutant. Systemic risk is a noxious by-product.”
(Haldane, 2010). In the wake of the crisis, economists proposed a variety of ways to measure and create
a “shadow price” for systemic risk (Acharya et al., 2011).
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In their November report to the G20 Finance Ministers and Central Bank Governors, IMF and the
FSB in conjunction with the BIS suggested three key criteria for measuring systemic importance: size,
substitutability, and interconnectedness (FSB, IMF, & BIS, 2009). The report uses the cautious language
that is typical for scientific forays into new territory, highlighting that the concept of systemic
importance depends on the purpose of policies, time, and whether it is applied to institutions or
markets.
The Basel Committee followed up with a more sophisticated definition of systemic importance
specifically for banks, adding two more criteria (global activity and complexity) and developing twelve
indicators to measure it. In time for the G20 Cannes Summit and ahead of the end-2011 deadline, the
FSB and the Basel Committee had reached consensus on a methodology for the designation of global
systemically important banks (G-SIB), compiled a list of 29 G-SIBs, proposed a staggered system of
capital surcharges that would increase the resilience of these banks, and estimated the macro-economic
impact of this policy (BCBS, 2011b; FSB, 2011d; FSB & BCBS, 2011; İ. Ötker-Robe et al., 2010).
Table 6.1 2014 List of G-SIB
Bucket (G-SIB surcharge) Name
5 (3.5%) [deliberately left empty in order to discourage further growth]
4 (2.5%) HSBC, JP Morgan Chase
3 (2.0%) Barclays, BNP Paribas, Citigroup, Deutsche Bank
2 (1.5%) Bank of America, Credit Suisse, Goldman Sachs, Mitsubishi UFJ FG, Morgan
Stanley, Royal Bank of Scotland
1 (1.0%) Agricultural Bank of China, Bank of China, Bank of New York Mellon, BBVA,
Groupe BPCE, Group Crédit Agricole, ICBC, ING Bank, Mizuho FG, Nordea,
Santander, Société Générale, Standard Chartered, State Street, Sumitomo Mitsui
FG, UBS, Unicredit Group, Wells Fargo
Source: FSB (2014h)
Whether a bank is considered systemically important or not depends on a score that consists of
a weighted average of 12 indicators. These indicators intend to capture five dimensions of systemic
importance, that is size, interconnectedness, substitutability within the financial institutional
infrastructure, complexity, and cross-jurisdictional activity. If the bank’s score crosses a certain threshold
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it is subject to a G-SIB surcharge, that is an additional capital requirement of between 1 and 2.5% (BCBS,
2014f).
Two elements of the G-SIB surcharge are remarkable. First, banking regulators from very
different financial systems reached a cross-border consensus on what systemic risk is and how to
measure it, in a matter of months. Second, they agreed to depart from the conventional wisdom that
size, interconnectedness, and complexity of banks represent a valuable contribution to the stability of
the financial system. Instead, they adopted a framework to that deals with these features as a negative
externality of financial systems around the world. Insofar as higher capital requirements are costly for
banks (an issue discussed below), the G-SIB surcharge thus represents a “Pigouvian tax” that matches a
bank’s contribution to this negative externality (Acharya et al., 2011; Pigou, 1920). The recognition and
“pricing” of systemic risk represents a major departure from Basel II and the pre-crisis consensus among
financial regulators. Haldane (2012b) remarks pointedly: “We are all Pigouvians now, even if most of us
cannot spell it.” (p. 5).
Moreover, at the same G20 Summit the FSB presented the 12 Key Attributes for Effective
Resolution Regimes, a new global standard to end TBTF that was endorsed by G20 leaders. It codifies
much of the earlier proposals made by government networks. The Key Attributes (KA) state that “The
statutory mandate of a resolution authority should empower and strongly encourage the authority
wherever possible to act to achieve a cooperative solution with foreign resolution authorities” (FSB
2011a, KA 7, emphasis added). This formulation falls short of the earlier call for “full obligation” to cross-
border cooperation, but it is more strongly worded than the initial proposals by the FSF and BCBS.
The Key Attributes also contain the main cross-border elements of the SIFI framework, calling
on G20 members to enable resolution authorities to establish crisis management groups (CMG), sign
institution-specific cooperation agreements (COAG), conduct regular resolvability assessments and
develop recovery and resolution plans for each G-SIFI (RRP). The FSB further highlights the importance
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of overcoming obstacles to cross-border information sharing by dedicating an entire Key Attribute (KA
12) to it, in addition to its inclusion in the recommendation to establish crisis management groups.
The advance of global policymaking to end TBTF until this point can be regarded as a success
story for the operation of government networks. In an extremely short time span of less than three
years, regulators in the major economies identified systemic risk as a negative externality in global
financial markets, drawing lessons from the crisis, and developed a consensus on how this externality
can be defined, measured, and addressed with a set of globally coordinated policies that impose costs
on private actors. This is a remarkable feat, especially when compared to other cross-border
externalities such as global warming.
In line with the tenets of hegemonic inter-state theories of regulation, the great powers
dominated the regulatory process, developing club standards for greater bank resilience and resolution
that would then be implemented by a group of states that is small enough to facilitate consensus and
big enough to minimize the negative externalities of non-adherence outside the club (Drezner, 2007;
Simmons, 2001).
Implementation gaps
But great power theories of regulatory politics fail to explain why some parts of the ending TBTF
reform package have successfully entered the implementation stage along the agreed timeline while
others have stalled in the negotiation stage and are unlikely to become operational in the near future.
The division between the former and the latter is not random. It corresponds to the two sides of the
FSB’s “bookends’ strategy” to increase bank resilience on the one hand and make them resolvable
without taxpayer support on the other. This paper argues that the resilience “bookend” of ending TBTF
is being implemented successfully because government networks were able to develop these policies
unencumbered by legislative actors. In contrast, FSB members have missed all deadlines on the
resolution “bookend” because legislators and legislation pose significant obstacles to implementation,
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especially of the cross-border elements of regulatory reform. Not coincidentally, all four areas require
cross-border coordination to be effective.
The FSB published the results of a thematic peer review in April 2013, more than a year after the
resolution policies of the SIFI framework were expected to be in place. The report candidly
acknowledges that “progress has been relatively slow both because the issue is complex and because in
many jurisdictions the powers necessary for implementing a preferred resolution strategy have not yet
been provided.” (FSB, 2013a, p. 3). Implementation gaps are evident in four areas: resolution powers,
information-sharing in crisis management groups, cooperation agreements for resolution planning, and
powers to impose a stay on early termination rights. The situation has not changed significantly since
the completion of the peer review, as the most recent progress report on ending TBTF from November
2014 acknowledges (FSB, 2014f).
Figure 6.5 SIFI Framework and Progress 2013

Bail-in
The first problem area of TBTF reform concerns the statutory power of resolution authorities to
bail-in creditors when a financial institution fails. All FSB members have insolvency laws for the orderly
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wind-down of companies, but as Huertas (2011) asserts: “Bankruptcy is not for banks”. This is because
banks rely on “runnable financial liabilities” that are likely to be impaired or liquidated during a drawn-
out insolvency process led by courts (McAndrews, Morgan, Santos, & Yorulmazer, 2014). The two
alternatives are a bail-out using public funds and the intervention of a resolution authority that has the
power to restructure the liabilities of a distressed financial institution by writing down its unsecured
debt or converting it to equity (bail-in) (IMF, 2012). Eliminating the former alternative is the purpose of
ending TBTF reform, but the bail-in alternative is facing obstacles in domestic banking, insolvency, and
company law (BCBS, 2010b). The FSB recognized this issue in 2013: “Very few authorities have the
statutory power both to write down and to convert liabilities of a failing institution.” (FSB, 2013e, p. 9).
These problems are compounded when dealing with the complex and large financial institutions
that all SIFIs are. As Paul Tucker (2013), Chair of the FSB’s Resolution Steering Group points out: “Even
once the statutory resolution regime is in place in all key jurisdictions, many financial groups are going
to need to restructure themselves in order to achieve resolvability – financially, legally, organizationally”
(p. 12). Some members of the regulatory establishment argued for a size cap, break-up, and
simplification of financial institutions and activities, but their suggestions were not heeded (Engelen et
al., 2011; Haldane, 2010). The lack of a legal mandate prevents resolution authorities in most
jurisdictions from requiring firms to make changes to their organizational structures in order to improve
resolvability (FSB, 2013e). To make things worse, global banks have become bigger and even more
complex in the wake of the financial crisis (Carmassi & Herring, 2014; Cetorelli, McAndrews, & Traina,
2014; I. Ötker-Robe, Narain, Ilyina, & Surti, 2011).
The final obstacle to a credible bail-in regime is that legal provisions in key jurisdictions
disregard the need for cross-border coordination among resolution authorities (BCBS, 2011c). In a
progress report from 2012, the FSB warns: “The absence of a clear mandate of resolution authorities to
seek cooperation with their foreign counterparts and the lack of legal capacity to give effect to foreign
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resolution measures may pose significant impediments to cross-border resolutions, if not addressed.”
(FSB, 2012b, p. 7). For example, Title II of the Dodd-Frank Act endows the new Orderly Liquidation
Authority (OLA) with bail-in powers but does not mandate it to consult with resolution authorities in
other jurisdictions. Similarly, the European Bank Recovery and Resolution Directive (BRRD) gives
statutory force to bail-in regimes (Art. 50) and allows for cross-border cooperation but enables the
resolution authority to act unilaterally (Art. 87) in the resolution of the subsidiaries and even branches
of non-EU banks if necessary (EU, 2014; Goodhart & Avgouleas, 2014; Wishart, 2014). Thus even after
legislative reforms in key jurisdictions, legal frameworks of FSB members to date fall short of the
provisions of Key Attribute 7 to empower and strongly encourage cross-border cooperation.
Crisis-Management Groups (CMG).
The second policy with significant implementation gaps concerns the operation of crisis-
management groups (CMG). FSB members committed to establishing supervisory colleges for each G-
SIFI where home and key host authorities share firm-specific prudential information. Even though CMGs
for all G-SIFIs have been established by 2012 it is hard to assert that they are operational. When asked
about the status of CMGs in 2014, a US Regulator responds: “You checked, yes, we’ve got a college, okay,
but one of the guys here talks about having our annual quarterly meeting of the college, because it’s just
a waste of time. And you talk about, we’re doing a review, scheduled review next month and we’ve done
a review last month and that’s about as much information as you share.” (US Regulator 1, 2014).
Two kinds of obstacles prevent CMGs from becoming a meaningful instrument in ending TBTF.
The first is of legal nature. CMG members do not have the statutory authority to share firm-specific data
with their foreign counterparts. This is because much of the information that is necessary to make
meaningful resolvability assessments are protected by privacy laws, and legal reform in many FSB
member jurisdictions failed to include provisions to override these laws for prudential purposes. In its
peer review report, the FSB (2013e) points out: “Unless home and host authorities have the capacity to
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share such information, it is unrealistic to expect them to meaningfully discuss cross-border resolution
strategies and plans or to cooperate effectively in a crisis.” (p. 10).
The other obstacle to the operation of CMGs is cultural. While global banks have established
multinational management teams that facilitate the exchange of sensitive information and coordinated
action in all jurisdictions where the firm operates, regulators have not. Even though financial supervisors
have established a professional consensus and confidence in their peers in government networks such
as the Basel Committee or the FSB, this trust does not extend to recent newcomers or outsiders of the
club. A US regulator provides a telling example of this issue in a CMG: “Poland is such a small percentage
of Citibank, but Citibank is such a huge percentage of Poland that the Polish authorities would quite
rightfully want to be part of a supervisory network on Citibank. And Citibank authorities in London and
New York would quite rightly say, we don’t need these guys. We’d just rather not and keep it small.” (US
Regulator 1, 2014). This problem is compounded by the resource constraints and lack of expertise of
regulators in some jurisdictions (FSB, 2012b). In order to address this issue, the FSB has published
guidance on the conditions of inclusion into a CMG and the modalities of information exchange with
non-CMG members (FSB, 2014a).
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Figure 6.6 Ending TBTF reform progress

Source: FSB (2014f)
Cooperation Agreements
A third implementation gap is evident in the cooperation agreements that G-SIFI supervisors
were expected to sign by end-2011. The FSB (2012b) extended the deadline by a year, but even by the
end of 2014 only one COAG has been signed (BBVA Research, 2014; FSB, 2014f). The FSB has not
specified any deadline and it is far from clear if and when this element of the FSB SIFI framework will be
completed. Financial regulators in Scandinavian countries have taken the lead on cross-border
cooperation. In 2010 they signed a cooperation agreement on “cross-border stability, crisis
management and resolution”, increasing legal certainty about supervisory cooperation in times of crisis
(Nordic-Baltic Cross-Border Stability Group, 2010). However, no G-SIFI is headquartered in this region.
In conjunction with COAGs, supervisory colleges were expected to develop recovery and
resolution plans together with the G-SIFI under supervision but this work has only started and an initial
resolvability assessment for G-SIFIs under FSB guidance will not be completed until mid-2015 (FSB,
2013g, 2014f).
24
20
4
4
10
17
11
5
4
20
7
8
7
9
13
13
6
4
6
0% 20% 40% 60% 80% 100%
identification G-SIFI
G-SIB surcharge
bail-in powers
recognition of foreign bail-in
powers to change firm resolvability
info-sharing
resolution planning
stay on early termination rights
effective implementation stage no action
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In the United Kingdom, the Financial Services Act 2010 required deposit-taking banks to submit
resolution plans to supervisors by 2012 (FSB, 2012b). Similarly, in the United States banks are required
by Title II of the Dodd Frank Act to provide resolution plans to domestic supervisors. But again, this
requirement makes no mention of foreign resolution authorities, and it only applies to US-chartered
financial institutions. The 8 G-SIFIs that are headquartered in the US submitted their first version of so-
called “living wills” to the Fed and the FDIC in 2012. Due to an odd omission in the legal text, the
supervisors are not obliged to provide any feedback to the financial institutions. A US regulator notes:
“The companies have not gotten feedback from the FDIC. No, they have not gotten letters that say what
the Fed and the FDIC have thought about them. Because they haven’t concluded what they thought
about them.” (US Regulator 4, 2014). Because no changes were suggested the banks submitted
unaltered versions of their living wills one year later, when they were rejected by the US authorities.
Foreign host supervisors of these G-SIFIs do not appear to have played any role in the assessment.
In addition, a larger group of 31 US-headquartered banks are expected to submit recovery and
resolution plans as part of the stress test of the Fed’s Large Institution Supervision Coordinating
Committee. But again, there is no evidence that US regulators share any of these plans with their peers
abroad (Marino, 2015). When asked about the connection between the work of the Orderly Liquidation
Authority (OLA) and the FSB’s work on CMGs and resolution planning, a US regulator responds: “I think
that’s one of the things that the Senior Supervisory Group talks about. I think it happens on that
informal level. To my knowledge there isn’t a formal way there.” (US Regulator 4, 2014).
In other words, even though US-chartered G-SIFIs have provided resolution plans for two
consecutive years now, CMGs that oversee these banks have neither been able to make a resolvability
assessment nor agree on a COAG. In a Congressional hearing, the Director of the Fed’s Division of
Banking Supervision and Regulation on Cross-Border Resolution described “completing firm-specific
cooperation agreements with foreign regulators that provide credible assurances to those host-country
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regulators to forestall disruptive ring-fencing” as one of the “key challenges” for the authorities (Gibson,
2013). Asked about the current state of COAGs in 2014, a US Regulator admits: “It is a disappointment
they aren’t farther along. I just don’t know. I think it’s a matter of priority.” (US Regulator 4, 2014).
In a critical assessment of the lack of progress in cooperation agreements, Paul Tucker points to
national legislation and legislators as the main obstacle: “If that progress has not been faster, which is an
understandable concern, it is for the good reason that the required reforms involve an agency of the
State, the resolution authority, having powers that affect property rights. In democracies, that is rightly
debated thoroughly to ensure that it has legitimacy and is subject to the right checks and balances.”
(Tucker, 2013, p. 4).
Temporary Stay on Early Termination Rights
The fourth and final implementation gap is the lack of authority to impose a temporary stay on
early termination rights. Modern SIFIs are entangled in a complex web of derivative contracts that
transcend jurisdictional boundaries, a phenomenon that was of little relevance for bank resolution in the
20
th
century. Haldane (2010) explains: “When Lehman Brothers failed, it had almost one million open
derivatives contracts – the financial equivalent of Facebook friends. Whatever the technology budget, it
is questionable whether any man’s mind or memory could cope with such complexity.” (p. 18f).
Derivative contracts contain a provision that allows a party to terminate the contract early if the
counterparty defaults. In the event of a bank failure, all counterparties thus have an incentive to close
out and seize the corresponding collateral before other agents do – the equivalent of a depositor run on
the bank. Because large banks typically have derivatives books with trillions of dollars in notional
exposure, the cost of early termination for the estate of the bank is massive and the equivalent of a
deposit protection scheme is not an option (T. Huertas, 2011). The Basel Committee addressed this issue
early on: “National resolution authorities should have the legal authority to temporarily delay
immediate operation of contractual early termination clauses […].” (BCBS, 2010b, p. 2). To date, the
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large majority of FSB members lack the statutory powers to impose such a stay, and the probability of a
disorderly wind-down of a bank’s derivatives exposure remains high.
Each of the four implementation gaps highlighted above relates to obstacles posed by legislators
and legislation in FSB member jurisdiction. In some areas, such as bail-in powers, legislators have failed
to transfer authority away from domestic insolvency courts to domestic regulators. Most problem areas
however transcend the domestic realm. Resolution authorities are unable to engage in meaningful
cooperation with their counterparts abroad because domestic legislation provides no mandate
(recognition of foreign resolution procedures, cooperation agreements) or explicitly prohibits cross-
border interaction (information sharing).
Competing explanations
One way of subjecting the argument advanced here to scrutiny is to compare its inferential
leverage with that of competing explanations. That regulatory hegemony approaches to reform cannot
account for the uneven progress of the ending TBTF agenda has been shown above. This section
examines four additional competing explanations: epistemic communities, redistributive concerns,
regulatory capture, and cooperative decentralization.
Epistemic Communities
Institutional development and corresponding regulatory capacity within epistemic communities
differ across market sectors and issue areas. Hence, the advance of regulatory reform in G-SIB
identification and loss absorbency requirements might be a function of its inclusion into the greater
Basel policy framework. Field research indicates that this explanation is popular among regulators:
“Basel III is a fully formed, if you like, area of international standards agreed. They’ve got very granular
standards that have been agreed, […] established a very consistent position across countries, but that
took what 30, 40 years to achieve from the original Basel Concordat.” (International Regulator 6, 2014).
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The proponents of this explanation argue that while the Basel Committee operates as an
epistemic community that has jointly developed a global consensus on the resilience of multinational
banks for decades, it has not dealt with the issues that come to the fore in bank resolution. A British
regulator explains: “The Basel Committee has been running since the mid-seventies. So people have to
start a common language for thinking about capital or solvency of banks and they have some common
language although it’s less-developed on liquidity of banks. But I’m not sure if there was any common
language about structural reforms. In a way, structural reform starts from looking at what structures you
already have and although major internationally active banks look somewhat similar across countries, I
guess there’s quite a lot of difference nationally that will become important in structural reform. (UK
Regulator 1, 2014).
It is true that neither the Basel Committee nor any other government network has dealt with
the corporate structure of global banks. The capital requirements of Basel III and its predecessors have
become successful global standards in part because they are agonistic with respect to structural issues.
What this argument overlooks however is that cross-border repercussions of bank failures are the very
reason for the establishment of the Basel Committee. In fact, the first Basel Concordat highlights the
need for cross-border cooperation, arguing that: “adequate supervision of foreign banking
establishments, without unnecessary overlapping, calls for contact and cooperation between host and
parent supervisory authorities.” (BCBS, 1975, p. 2). The Concordat, written with a typewriter in 1975,
calls for a direct transfer of information between authorities as a prerequisite for such supervisory
cooperation: “The Committee is aware that such transfers of information are often impossible because
of banking secrecy laws in host countries; but many of its members consider that the operations of
these laws should over time be modified as to permit them.” (BCBS, 1975, p. 4f). In other words, Basel
Committee members were aware of the legal obstacles to successful cross-border cooperation 40 years
ago.
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The Basel Committee did not limit itself to supervisory coordination of banks in good times.
Following the fall of BCCI, a multinational bank in 1992, the BCBS issued a report on legal differences in
liquidation that considers the advantages and disadvantages of a single vs. separate-entity approach.
Aware of the cross-border repercussions of liquidation in one jurisdiction, the Basel Committee calls on
its members to cooperate in the case of bank resolution: “Given the possibility that there could be many
liquidation proceedings related to the multinational bank, as the bankruptcy progresses, it would be
desirable for host supervisors to report to the home supervisor about developments in their jurisdictions,
and for the home supervisor to keep other interested supervisors informed on overall developments to
the extent possible.” (BCBS, 1992, p. 6). In other words, two decades ago the Basel Committee has
proposed firm-specific crisis management groups or supervisory colleges as a venue to improve cross-
border cooperation among resolution authorities.
The BCBS went even further, proposing that regulators could sign cross-border cooperation
agreements to facilitate the resolution of failing cross-border banks: “Contractual cooperation
arrangements could be entered into among the different liquidators, e.g. contractual pooling of assets
and claims. An international convention or regime covering cross-border insolvencies of multinational
banks could provide for such banks to be liquidated on a coordinated basis.” (BCBS, 1992, p. 14f). It is
interesting to note that in suggesting cooperation agreements and even an international treaty, the
Basel Committee of the early 1990s was bolder and more optimistic about the chances for cross-border
cooperation than during the global financial crisis 20 years later.
In sum, many of the areas that are lagging behind in today’s regulatory reform, cross-border
information sharing in supervisory colleges and cooperation agreements among regulators in particular
have been part and parcel of Basel Committee deliberations for decades. In fact, it is in areas that were
not part of the established consensus such as a surcharge for contribution to systemic risk that post-
crisis regulatory reform has been most successful.
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Redistributive Concerns
Another potential explanation for the lack of progress in some areas of the SIFI framework is
that redistributive concerns impede cross-border cooperation. In the event of a bank failure, public
authorities do not only provide temporary liquidity but also solvency support. Especially when a financial
institution enters insolvency for non-idiosyncratic reasons such as a wider financial crisis, the overall
costs of its resolution become clear months or even years later. For example, when the US Treasury
provided $700m to distressed financial institutions under the Troubled Assets Relief Fund (TARP), few
would have expected the program to close with a profit years later. Similarly, the Swiss bailout fund
posted a profit that was entirely unanticipated at the height of the financial crisis (see chapter 4). The
balance sheets of other solvency support programs looks less rosy.
Bank resolution authorities operate as lenders of last resort that ultimately have to count on the
backing of national governments with the fiscal capacity to take over the risk of debt writedowns. As
James (2013) notes: “In the domestic setting, the action is justified by the claim that it restores the
normal functioning of a national economy. In the international setting, it looks like taxpayers subsidizing
foreigners.” (p. 17). G-SIFIs have branches and subsidiaries in 44 countries on average (Carmassi &
Herring, 2014), and while they are global in life, to paraphrase Lord Turner’s famous words, it is unclear
which government(s) pick up the dead pieces when they fail.
In this situation, the host authority has an incentive to seize the operational subsidiary or even
branch of a failing global bank and bring its assets under custody before the home authority claims them
for the resolution procedure of the parent bank. Baxter et al. (2004) foresaw much of what happened
during the global financial crisis when they wrote: “when times are rough, [supervisors] will think like
administrative officials, rather than judges. They will grab whatever they can.” (p. 60). In similar fashion,
the Basel Committee notes that even in places with a cross-border insolvency procedure, such as the
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European Union, “each national authority is likely to attach most weight to the pursuit of its own
national interests in the management of a crisis.” (BCBS, 2010b, p. 4).
Ad hoc ringfencing in times of crisis can be detrimental to overall welfare, in particular when the
run for assets among resolution authorities endangers a possibly viable bank. Promoted by the FSB and
endorsed by G20 leaders, the efforts to establish cooperation agreements between home and key host
supervisors on the recovery and resolution of a G-SIFI aim to address this problem.
However, because the conditions of each individual bank failure are unpredictable, ex-ante
agreements face a double time-inconsistency problem: states can neither credibly commit to refrain
from bail-out nor from ad hoc ring-fencing (Chari & Kehoe, 2013; Committee on International Economic
Policy and Reform, 2012; Haldane, 2012b; T. F. Huertas, 2013). Under these circumstances, Verdier
(2013) asserts, “regulators will not believe each other’s promise to turn assets over to foreign
proceedings or abide by burden-sharing agreements.” (p. 1454).
There is no doubt that ending TBTF policies raise redistributive concerns, just like all other items
on the G20s regulatory reform agenda. Chapter 4 for example examined the intense negotiations among
regulators in setting Basel III capital adequacy standards. The loss absorbency policies that are part of
the SIFI framework gave rise to regulatory struggles along the same lines because banks in different
jurisdictions face different adjustment costs. A Brazilian regulator recalls: “I remember when we had the
discussion regarding the systemically important global financial institutions, the G-SIFIs, the reaction of
France because in the very beginning, the first lists, it had three banks and they fight a lot in order to
reduce the list in order not to have those three banks in the list. And so there is a discussion at is not
exclusively a technical discussion, it is a political discussion.” (Brazil Regulator 1, 2014).
Some, if not all banking supervisors see G-SIFIs headquartered in their jurisdiction as a sign of
strength and as a means of influence domestically and in global regulatory negotiations. A French
regulator explains how this perception of banks as national champions undermines the very goal of the
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SIFI framework: “Well ending too big to fail I think is not possible because those institutions are crucial,
not from a political point of view but this has been an element of decision in the past for bailing them out.
I mean they are of political importance too but they also are of economic importance.” (France Regulator
1, 2014). In spite of these concerns, the identification of G-SIB and allocation of additional going-
concern loss absorbency requirements are items on the SIFI agenda that were completed successfully
within the stipulated timeframe.
Recent cooperative moves among supervisors cast further doubt on the explanatory power of
redistributive concerns. In 2012, the regulators of the two largest financial markets and home
supervisors of 12 of the world’s 28 G-SIFIs outlined their intended resolution strategies in a joint white
paper. The FDIC and the Bank of England agreed to opt for a single point of entry (SPE) approach to the
resolution of a SIFI headquartered in their respective jurisdictions. In contrast to a multiple point of
entry (MPE) approach, liquidity and solvency support flow down from the holding company while losses
are transmitted from the subsidiaries and branches upwards, for example via the write-down of
subordinated debt to their parent company (FDIC & Bank of England, 2012).
In adopting an SPE approach, the resolution authorities commit to keeping subsidiaries open
and operational when the parent company enters resolution. In essence, the home supervisor extends a
guarantee to cover the losses incurred by branches and subsidiaries in all host jurisdictions. Moreover,
home supervisors commit to initiate resolution procedures if a critical amount of overseas affiliates are
in trouble even when the domestic parent company is still operational. This strategy is designed to
succeed in “limiting contagion effects and cross-border complications” (FDIC & Bank of England, 2012, p.
2), but it is not cheap. In essence, the home supervisor needs to extend a sufficient guarantee to keep all
subsidiaries open in order to discourage host supervisors from initiating their own resolution procedures.
If the authorities in the US and the UK had prioritized the minimization of potential resolution costs,
they would have opted for an MPE approach where home and host supervisors liquidate subsidiaries
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separately. Of course, other factors such as the legal structure and operational modularity of the bank
must be taken into account in determining the optimal resolution strategy. In any case, the advantage of
the SPE approach lies not in limiting potential resolution costs but in reducing the need for cross-border
cooperation to a minimum. UK and US authorities are not the only ones that have opted for an SPE
approach. A recent policy document reports that the supervisory colleges of only 3 G-SIBs have chosen
an MPE strategy (BBVA Research, 2014).
In sum, because resolution authorities face time inconsistency problems vis-à-vis troubled banks
and their counterparts in other jurisdictions, concerns about the potential public costs of G-SIFI
resolution are relevant. However there is no evidence for a logical connection with implementation gaps
in the SIFI framework. It is not a sufficient condition because significant redistributive concerns did not
impede the successful completion of G-SIB identification and loss absorbency requirements. Neither is it
a necessary condition because even the willingness of most home jurisdictions to cover losses abroad
under the SPE approach has not led to the successful conclusion of cooperation agreements. Stuck
between two evils, supervisors appear to prefer potentially costly unilateralism over the uncertainties of
cross-border cooperation in the event of a crisis.
Regulatory Capture
One of the most common explanations for the shortcomings of global financial reform is capture
by private special interest groups. Indeed, evidence of industry resistance vis-à-vis reform policies such
as Basel III is plentiful (see chapter 4). Trade associations have significantly increased lobbying expenses
to influence policymakers in order to reduce the anticipated costs of regulatory reform. In addition to
monetary channels of influence, there is evidence of cultural capture in dealing with failing banks (S.
Johnson & Kwak, 2010). FDIC Material Loss Reviews reveal that supervisors had identified problems in
79% of failed banks years before they had to be resolved. However, regulators were reluctant to break
cultural norms, fearing the opprobrium that necessary corrective actions would have entailed (J. R.
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Barth, Caprio, & Levine, 2012). Whether this kind of cultural capture persists or whether regulators have
learned painful lessons from the crisis that make them much more wary of troubled banks is open to
debate.
But in order to argue that the implementation gaps of the SIFI framework are caused by
regulatory capture it is necessary to provide evidence of industry resistance. In the particular area of
ending TBTF policy measures, the empirical picture does not support such claims.
In early 2011, the FSB circulated a consultative document on effective resolution of SIFIs that
would provide the foundation for the Key Attributes later that year. In a surprisingly rare gesture of
unity and collaboration among financial lobby organizations, the Global Financial Markets Association
(GFMA), Clearing House Association, American Bankers Association, Financial Services Roundtable,
Institute of International Bankers, and the Institute of International Finance (IIF) wrote a joint response
letter in support of the measures proposed by the FSB. The trade associations state: “We believe that a
global regulatory consensus on these issues is critical, that the FSB’s and the G-20’s cooperation is
necessary to achieve such consensus, and that their further support will be essential in order to
translate the proposed policy measures into legislative action.” (GFMA et al., 2011, p. 3).
The comment letter by the bank lobby does not merely voice general support for the FSB’s
policy work regarding ending TBTF. It expresses concern that the SIFI reform framework might stall due
to legislative obstacles, and prompts the FSB to push harder for legal changes in member jurisdictions:
“We urge the member countries of the G-20 to make the legislative actions recommended by the
Consultative Document a stated priority, and encourage such legislative actions to be explicitly added to
the implementation timeline. We also urge the FSB to conduct and publish a meaningful peer review of
the degree to which countries comply with its final recommendations, as well as publish annual peer
reviews to assess progress toward full implementation.” (GFMA et al., 2011, p. 3).
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This full-fledged support by private special interest groups is less surprising when considering
the alternatives to globally coordinated structural measures. In 2011 several countries started planning
unilateral measures to ring-fence certain banking activities without consulting government networks or
other jurisdictions (see section below). Global banks started to fear the massive adjustment costs and
regulatory uncertainties a patchwork of uncoordinated structural measures would bring about. In fact,
the bank lobby comment letter specifically speaks out against such unilateral policies: “We suggest that
regulators be discouraged from exercising any powers to ringfence local assets or discriminate against
foreign creditors. A non-discrimination rule would also enhance the goals of cross-border cooperation.”
(GFMA et al., 2011, p. 8).
In addition to uncoordinated structural measures, the industry also grew wary of overlapping
requirements and duplication of efforts regarding recovery and resolution planning. The IIF in particular
urged the FSB to strengthen its approach to crisis management groups and cooperation agreements:
"Having set out a strong design for speedy and effective resolution of significant financial institutions
within each jurisdiction, it should mandate - not just urge - effective cooperation among jurisdictions on
cross-border resolution," (“Banks urge coordination on cross-border clean-ups,” 2012).
Consulting firms and legal service providers to the finance industry even saw a business
opportunity in globally coordinated resolution planning. Davis Polk, a law firm, and McKinsey Co.
published a report in 2011, arguing that: “A best case international recovery or resolution would be a
universal or at least a coordinated territorial approach, involving the home country supervisor making
coordinated decisions on an international level.” (Davis Polk & Wardwell LLP & McKinsey & Co, 2011). In
order to facilitate cross-border coordination, the two firms offer a standardized “Master Living Will”, a
template for G-SIFIs that draws inspiration from the Master Agreement for OTC derivatives trades that
was developed by ISDA, the number one industry association in this field.
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When the FSB issued a new consultation document on the cross-border recognition of
resolution actions in 2014, financial lobby organizations expressed their dismay at the slow
implementation of the SIFI framework. In a comment letter, IIF and GFMA encourage the FSB to
strengthen its efforts to ensure a fast implementation of reform measures, and express concern that the
FSB policy framework to end TBTF is veering off track. In particular, the trade associations note: “It is
striking that the role of Cross-Border Cooperation Agreements (COAGs) and Crisis Management Groups
(CMGs) has not been given more stress in the consultative document.” (IIF & GFMA, 2014, p. 2).
It would be incorrect to argue that the interests of the industry are fully aligned with the FSB’s
SIFI framework. Lobby organizations have consistently expressed concerns about data privacy for
example. In the eyes of the industry, home supervisors should only share recovery and resolution plans
at a level of granularity that is necessary for coordination with host authorities. Broad-based sharing of
firm-level data, trade associations worry, would increase the risk of leaks or unauthorized access (GFMA
et al., 2011).
This caveat notwithstanding, the empirical picture shows that global banks are broadly
supportive of the FSB in this particular area of the global regulatory reform agenda. Financial trade
associations have not only expressed support for globally coordinated structural measures while fighting
fiercely against unilateral measures in individual jurisdictions. They have also helped the FSB overcome
the implementation gap regarding early termination rights.
In order to provide legal certainty over the temporary stay on early termination rights of
derivatives contracts, a statutory and a contractual approach supplement each other. Legislators in most
FSB jurisdictions to date have failed to provide supervisors with statutory powers to freeze derivatives
contracts of failing banks. In contrast, the trade association at the center of derivatives markets, ISDA,
offered help in this situation by amending the template that provides the legal foundation for most
derivatives trades, the ISDA Master Agreement. In addition, the trade organization brokered an
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agreement among 18 large banks that are major derivatives dealers to adopt the amended Master
Agreement (T. Braithwaite & Alloway, 2014).
By instituting changes in private transnational law governing derivatives trades, ISDA thus
helped the FSB close a major implementation gap. In principle, legislators could have addressed this
issue by providing supervisors with statutory powers to impose stays on termination rights in all
member jurisdictions, but they failed to do so. The FSB enthusiastically welcomed the industry initiative.
Chairman Carney stated: “When the protocol goes live in November, it will close off much of the cross-
border close-out risk that statutory stays have not been able to eliminate because their reach is limited
to national borders. This is a major achievement, by the industry.” (FSB, 2014g, p. 1f).
In sum, there is scant support for claims that shortcomings in ending TBTF policies are a product
of regulatory capture. The private sector has resisted greater loss absorbency requirements but these
policies are being implemented successfully. In contrast, the FSB has found a consistent supporter in the
industry regarding bank resolution policies. In an effort to increase the momentum for cross-border
coordination and avoid a proliferation of unilateral structural measures, trade associations have
orchestrated unison support for FSB efforts and even brokered a deal among major global banks in
order to close a major implementation gap.
Cooperative Decentralization
Fragmentation along jurisdictional lines due to politicization of regulatory reform is another
explanation for the slowdown in global efforts to end TBTF. Helleiner and Pagliari (2011) observe that as
financial regulation has gained political salience in the wake of the crisis, national legislatures and state
leaders have interfered in the regulatory reform agenda that was originally designed by technocrats. The
authors state: “Faced with newly engaged political leaders and resurgent domestic political pressures,
transnational networks of financial officials were increasingly forced to react rather than to lead the
international regulatory reform process.” (Helleiner & Pagliari, 2011, p. 182). As a consequence, global
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financial reform to date contains elements of both regulatory divergence and interstate cooperation, a
pattern that Helleiner and Pagliari term “cooperative decentralization”.
There is no shortage of evidence for this pattern. As early as 2009, the tension between cross-
border cooperation and domestic political concerns was a topic of debate at the Financial Services
Roundtable. Jörgen Holmquist, Director General at the European Commission pointedly asked: “Should
EU-US cooperation still be a priority when citizens and politicians on both sides of the Atlantic are asking
us, regulators, for urgent repair to our ‘domestic’ financial systems?” (Holmquist, 2009, p. 2).
The United States has led the way in devising policies for the domestic financial sector without
consulting its peers in the G20 or the FSB. A variety of structural measures from reinstating Glass-
Steagall to imposing caps on bank size or market share were debated in Congress in the wake of the
crisis (Sorkin, 2010; Wyatt, 2011). Eventually, legislators found consensus on the Volcker Rule. Passed
into law in 2010 as part of the Dodd Frank Act (section 619), the Volcker Rule has undergone numerous
changes before agreement was reached in December 2013. The rule bans banks from proprietary
trading with the sole exception of US government debt instruments. The narrow scope and
extraterritorial reach of its original version irritated regulators around the world (see chapter 4),
including the FSB Chairman and Bank of Canada Governor and at the time. Carney (2012a) wrote: “If
adopted as currently drafted, the Volcker Rule may limit market-making and risk-management activities
by Canadian banks; limit trading in Canadian government bonds; and hinder the implementation of
global initiatives to promote financial stability.” (p.3). In response to criticism from abroad, the
reformulated Volcker Rule was relaxed to allow the use of debt instruments issued by foreign
governments under certain circumstances (Mattingly, 2012; Thomson Reuters Accelus, 2013).
The second jurisdiction to propose structural measures without consulting the G20 or the FSB
was the United Kingdom. Asked about the reasons for this unilateral move, a British regulator responds:
“There is a very strong political imperative to get something done. It was very important to a politician. A
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new government came in 2010, they wanted it to be clearly seen to be doing something. They created a
commission to work on this and that commission naturally has a UK focus as it is created by the UK
government.” (UK Regulator 1, 2014). The Vickers commission presented a report on financial regulatory
reform in September 2011, and its prescriptions formed the basis for the new Financial Services Act of
2012.
The Vickers Commission and its policy recommendations were designed for the United Kingdom
only, but they had clear spill-over effects across the Channel. Policymakers in Continental European
countries started to devise and implement their own unilateral structural measures, with as little
concern for cross-border coordination as their British counterparts.
A French regulator recalls: “A real trigger for France to work on separating activities was the
Vickers report. When Great Britain went for its own rule and we considered we worked a lot on this and
considered it and we thought that we should do the things the other way around. They were ringfencing
retail bank we wanted to ringfence market activities that we consider potentially dangerous for the
stability of a bank so that’s what we did and also in Germany.” (France Regulator 1, 2014)
Half a year after the Vickers Report was published, EU Commissioner Michael Barnier convened
a high-level expert group led by Finnish central banker Erkki Liikanen. Just like its counterparts in the UK
and the US, the Liikanen Commission was under considerable domestic pressure to act fast. A European
regulator explains: “Liikanen was sort of left running after the field and so much time had passed until
the Liikanen group was set up and then it worked. In the meantime, domestic pressures in Germany and
in France and in others started growing considerably. People [were] saying ‘why the hell—look at the
Americans, look at the British. We haven’t got anything.’ So, they started doing something domestically.”
(EU Regulator 3, 2014). Published in October 2012, the Liikanen Report provides the blueprint for
structural policies in the financial sector that are currently under review at the European Commission
(2014).
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What are the similarities and differences of the proposals made by Volcker, Vickers, and
Liikanen? All three men propose the separation of retail and other banking activities. Deposit-taking
institutions are not allowed to deal as principal in securities and derivatives and invest in hedge or
private equity funds. According to the European proposals retail activities are “ringfenced”, that is
protected from any losses incurred by other operations in the banking group. The Volcker Rule however
goes further by prohibiting the existence of retail banking and proprietary trading under the same
holding company. Market-making, that is activities that enable clients to conduct certain transactions in
the future, is allowed for retail banks in the United States but not in Europe. These regulations apply to
banks of all sizes in the United States whereas the EU and UK rules stipulate minimum thresholds, albeit
at different levels. In the UK, ring-fenced retail banks face capital requirements that are higher than
Basel III while the Liikanen Report recommends higher capital ratios for separated trading businesses
(Coffee, 2014; Viñals et al., 2013)
The comparison between these three regulatory initiatives reveals the multiple fault lines and
inconsistencies across borders. This is especially worrisome in Europe, where Liikanen-inspired
regulation will apply to the United Kingdom whereas the banking union and its single supervisory
mechanism applies only to the eurozone. The cross-border inconsistencies of the three proposals reveal
the utter lack of coordination among legislative authorities even among the Western core countries. It is
unclear whether other jurisdictions around the world will follow a particular Western model or propose
yet another set of structural measures. Since most G-SIFIs are headquartered in the US or Europe, the
regulatory measures are going to have repercussions for the global financial system.
Some analysts argue that cross-border inconsistencies are beneficial in that they induce global
banks to converge on a “highest common denominator” to satisfy prudential rules in all jurisdictions
where they operate. For example, a combination of Vickers’ and Liikanen’s Basel-plus requirements may
enhance the resilience of European banks. Alternatively, the first-mover advantage of the British, French,
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and Germans might force EU policymakers to water down the Liikanen proposal in order to
accommodate all previous structural measures. This is what an EU regulator suggests: “And that was
when the Germans and the French said to the Commission and to Liikanen, especially to the Commission:
‘Liikanen can write what he wants, but if your proposal means that we’ve got to change our domestic
way of dealing with this, think again.’ Then the British came along and said us too: ‘We’ve got Vickers
and we’re already implementing, so if you think that we’re in midstream and we’re going change our
approach to ringfencing activities—forget it.’” (EU Regulator 3, 2014)
If the purpose of pre-emptive structural measures was to reduce complexity in the financial
system, they have failed. A recent Thomson Reuters report notes: “The mismatch, overlap and underlap
of the three sets of proposals is likely to create banks that are more, rather than less, complex.”
(Thomson Reuters Accelus, 2013, p. 34).
Figure 6.7 Number of Subsidiaries, G-SIB (Selection)

Source: Carmassi and Herring (2014)
1407
1003
1170
2435
292
1954
371
1234
804
1052
1161
844
417
1088
1910
1739
2592
2297
242
2124
420
1565
1095
1311
799
913
458
1343
Bank of America
Barclays
BNP Paribas
Citigroup
Credit Suisse
Deutsche Bank
Goldman Sachs
HSBC
JP Morgan Chase
Morgan Stanley
RBS
Société Générale
UBS
average
2007 2013
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Concerned with the inconsistencies and negative spill-overs of such uncoordinated policymaking,
the G20 commissioned the FSB to study what they diplomatically termed “Cross-border consistencies of
structural banking reform”. The FSB conducted a member survey, asking the supervisors of each
jurisdiction to describe structural measures planned or undertaken, and to assess their expected cross-
border repercussions. The report mentions the different structural measures issued in France, Germany,
and Belgium and notes: “For these three countries, and also for the UK, the interaction between the
already adopted national reforms and future EU rules remains to be seen” (FSB, 2014e, p. 11). Overall,
the report merely summarizes the assessments made by member jurisdictions, eschewing the candid
judgments that characterize FSB peer reviews. But even in its cautious language, the report reveals
some of the discord unilateral actions in the US and Europe have caused: “More generally, some
authorities observe that a contradiction is emerging between international initiatives on cross-border
recognition of resolution actions and national restrictions on the activities of foreign subsidiaries.” (FSB,
2014e, p. 13).
While the FSB was reviewing existing inconsistencies, the global hodgepodge of structural
measures was further exacerbated by a new round of unilateral initiatives. In February, the Fed
announced that foreign banks with $50bn or more in assets must place subsidiaries operating in the US
under the umbrella of a separately capitalized “intermediate holding company” (Federal Reserve Board,
2012; “Inglorious isolation,” 2014).
British authorities have made a similar unilateral move in late 2013, announcing a proposal that
would force all foreign banks with “critical economic functions” to convert their branches in the UK into
separately capitalized subsidiaries. This rule would apply only to non-European banks because EU laws
guarantee the right of banks to establish branches anywhere within the Union (“Too much of a good
thing,” 2013).
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Both rules are designed to give greater autonomy to domestic authorities and to reduce the
need for cross-border cooperation with foreign regulators. Unsurprisingly, the FSB regards these
measures as a warning sign that global regulatory cooperation is retroceding. Mark Carney addressed
this issue head-on in a letter to G20 Finance Ministers and Central Bank Governors. In February 2014,
the FSB Chair wrote:
“A lack of mutual trust can lead to concerns about spill-overs from failing cross-border
institutions and prompt jurisdictions to safeguard their markets unilaterally through
actions such as ring-fencing, compulsory stand-alone subsidiarisation, or extra-territorial
application of domestic rules. Such measures can be avoided only if Ministers and
Governors commit to tackling spill-overs through applying global standards that build
confidence in both the quality of cross-border supervision, and that failures of cross-
border institutions will be handled fairly, predictably and smoothly.” (Carney, 2014a, p.
3).
He urges G20 members to refrain from unilateral measures that will further exacerbate
fragmentation and calls on policymakers to ensure that legislative action will not endanger the openness
of the financial system. That the proliferation of unilateral measures coincides with the slowdown of
progress in the ending TBTF agenda lends support for what a regulator in an interview called the “bicycle
theory of regulatory reform”: the slower it moves forward the more unstable it is (International
Regulator 4, 2014).
Ashley Alder, Chair of IOSCO’s cross-border task force squarely blames national legislators for
this evolution of regulatory reform. She notes that in order to meet the targets set by the G20 and the
FSB, national legislators needed to empower regulators and sign legally effective treaties for cross-
border cooperation. Alder (2014) asserts: “Both of these are the job of governments who have
conspicuously failed to deliver - or even try. They have basically passed the buck to regulators whose
hands are tied by existing local legislation.” (p. 4.).
In sum, an undeniable trend towards cooperative decentralization has manifested in recent
years. While the governments that have pursued unilateral structural policies in the financial sector try
to assure others that their measures do not entail negative spill-overs and enhance overall financial
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stability, their actions have irritated government network leaders and spurred even more unilateral
actions.
The causal link between politicization and the incompleteness of the SIFI reform framework
however is tenuous at best. The argument that politicians eager to show protagonism discouraged
resolution authorities to share bank-related information in CMGs or dissuaded them from signing
cooperation agreements with their peers abroad is unconvincing. It would be just as far-fetched to
assert that domestic political pressures to reign in big banks prevented legislators from providing
regulators with the powers to bail-in bank liabilities, recognize resolution actions abroad, or impose a
temporary stay on termination rights.
Rather, the emergence of cooperative decentralization can be regarded as a partial response to
the slowdown of global regulatory reform. Faced with the inability of regulators to overcome legislative
obstacles to reform and the unwillingness of legislators to remove them, government leaders in the US
and Europe resorted to unilateral measures while still repeating their intention to support the FSB-led
global reform agenda at every G20 meeting.
PLAC, GLAC, TLAC – The Sound of Basel
That fragmentation along jurisdictional lines is not a cause for the slowdown of global regulatory
reform becomes even clearer when analyzing the latest episode in the never-ending TBTF story. Faced
with the lack of legislative progress in implementing the Key Attributes, the FSB changed course in 2013
and started a new initiative that tackles the TBTF problem by imposing changes on the balance sheets of
global systemically important banks. The initiative is designed to develop largely along the institutional
lines of Basel III, harnessing the power of government networks and circumventing domestic legislation
as much as possible.
In mid-2013, following a devastating peer review that highlighted the multiple obstacles to
ending TBTF and faced with a proliferation of unilateral structural measures, the FSB decided to retake
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the initiative and speed up SIFI reform with a new policy proposal. In its guidance on effective resolution
strategies, published in July 2013, the FSB employs the concept of loss absorbency capacity (LAC) for
failing banks for the first time. The document uses cautious language, stating that “authorities may need
to consider the introduction of requirements for firms to hold a sufficient amount of LAC” (FSB, 2013g, p.
7).
The concept of loss absorbency was part of regulatory debates in government networks for
years, but always as a measure to increase the resilience of an operational bank (going-concern), not as
a buffer to be used in the resolution of a failing one (gone concern). The Basel Committee considered
the inclusion of bail-inable debt for the G-SIB surcharge in 2011, but it discarded this option: “Given the
going-concern objective of the additional loss absorbency requirement, the Basel Committee is of the
view that it is not appropriate for G-SIBs to be able to meet this requirement with instruments that only
absorb losses at the point of non-viability.” (BCBS, 2011b, p. 23). Instead, it determined that the
additional loss absorbency requirement of G-SIBs can only be met with Common Equity Tier 1 capital.
The idea of a gone-concern loss absorbing capital requirement resurfaced in the report of the
Independent Commission on Banking (ICB) in the United Kingdom. The Vickers Commission recommends
a so-called Primary Loss-Absorbency Capacity (PLAC) requirement for G-SIB and ring-fenced banks
equivalent to 17% of risk-weighted assets. In order to meet the additional PLAC of 3.5-4% that exceeds
Basel III capital requirements, banks should issue unsecured debt with a maturity of at least a year. In
case of insolvency, these bail-inable liabilities could then be written down or converted into equity by
resolution authorities (Independent Commission on Banking, 2011).
Next in line was the Liikanen Commission. It recommended EU supervisors to issue what it called
a Minimum Requirement for Own Funds and Eligible Liabilities (MREL) that combines going-concern and
gone concern loss absorbency (Liikanen, 2012). The UK government endorsed the recommendations of
the Vickers Commission in 2012 and states that MREL “broadly resembles the PLAC requirement as
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envisaged by the ICB” (HM Treasury, 2012, p. 34). MREL requirements have subsequently been
incorporated into the Bank Recovery and Resolution Directive that applies to all EU member states
including the UK.
It is surprising that gone-concern loss absorbing requirements had not entered the FSB
discourse before mid-2013, even though European member jurisdictions were in the process of
implementing them. An international regulator recalls: “It really wasn’t part of the discussion until
shortly before the St. Petersburg Summit, you know, that being obviously the Key Attributes had been
developed by the FSB as a set of qualitative principles. We had higher loss absorbing capacity in the
shape of an extra layer of ordinary capital [as] a going concern concept.” (International Regulator 6,
2014).
The FSB submitted a proposal to develop a new global standard for gone-concern loss-absorbing
capital (GLAC) in September 2013, ahead of the St. Petersburg Summit where it was endorsed by G20
leaders (FSB, 2013f). In the beginning of 2014, the year that Australia chaired the G20, the outlook for a
rapid completion of regulatory reform was dim. The Australian host made clear that economic growth
and jobs creation were the issues at the center of the agenda, not financial stability and regulation. In
addition, policymakers in the US and Europe were engaged in a series of structural measures that were
not coordinated with the FSB in any way (see above). In this situation, the FSB Chair declared 2014 the
year of ending TBTF, prioritizing an agreement over GLAC in the hope that it would persuade G20
members to roll back recent unilateral measures: "The point being, that as we get to the end of this year
and make the progress we intend to, that then maps into adjustment of the resolution plans in firms and
potentially, one would hope, some adjustment in the applications of national decisions" (H. Jones &
Bruce, 2014).
The idea of GLAC (or TLAC as it was called later) is simple. The FSB devises a working group to
develop a global standard for loss absorbing capacity that G-SIBs are to hold on their balance sheets.
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Liabilities that are eligible for GLAC include subordinated unsecured debt that would count as Tier 2
capital, and more senior unsecured debt that can be understood as a new category of Tier 3 capital. The
FSB working group is composed not only of regulators but also finance ministers because governments
ultimately provide the fiscal backstop that makes resolution planning credible. Once agreement is
reached about the quantity and quality of loss absorbing capacity, the FSB issues a consultative
document, inviting comments from all stakeholders in FSB member countries. After adjustments are
made, the new standard is translated and implemented in all member jurisdictions as a Pillar 1
requirement, subject to comparability assessments and peer reviews. In addition, national regulators
have discretion in adding Pillar 2 requirements on top of the global baseline. As soon as the global
standard is implemented, large banks start adjusting their business plans to meet the new requirements
by a specified timeline.
Figure 6.8 SIFI Framework and Progress 2015

If this process appears very similar to that of Basel III, it is because it is designed to be. An
international regulator describes GLAC as “something that’s so closely involved with Basel III. So
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invariably [the BCBS has] to be involved, but it’s a funny relationship because 90% of what they [FSB] do,
what they did anyway, [was] in some form or fashion involved in banking, and that are things on which
[the BCBS is] working.” (International Regulator 5, 2014). In coordinating global regulatory reform
regarding the banking sector and beyond, the FSB has experimented with a variety of institutional
processes and designs such as guidance documents, thematic peer reviews and member surveys. Yet the
dismal state of ending TBTF reform in 2013 showed that the only successful and complete reform
policies were those undertaken by the Basel Committee. By incorporating government officials into the
policymaking process while channeling GLAC policies through the same institutional pathways as Basel
III, the FSB developed a strategy that enhances the legitimacy of its operations while maximizing
efficiency.
Nothing short of a stroke of genius, this policy process addresses a wide range of challenges, six
of which are highlighted below. First and most importantly, it circumvents legislators and legislation, the
main obstacles to TBTF reform. Legal frameworks that allow for loss absorbency requirements are
already in place in the US and Europe. The new global standard is subject to a consultation period but
not parliamentary deliberation, and the final rules will be issued by regulatory agencies alone.
Second, the new initiative also enabled policymakers to look beyond their respective
jurisdictions and engage in cross-border harmonization. As shown above, different varieties of loss
absorbing requirements were recommended prior to 2014, and it was unclear whether a new standard
would be congruent both with these proposals and the Basel III package. But instead of engaging in the
race for a first mover advantage (as in ring-fencing policies), policymakers used a G20 Finance Minister
and Central Governor meeting in September 2014 to negotiate a harmonized, common standard. A
European regulator recalls: “The Germans and the British and the French went to Cairns, with quite
different views. […]But they came back with a perfect joint agreement there. But that was this
agreement in Cairns reached simply by a rapprochement between the British, the Americans, the
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Germans, the French and possibly the Chinese on the compatibility of the BRRD instruments and GLAC,
which is now called TLAC.” (EU Regulator 3, 2014). The new standard for Total Loss-Absorbency Capacity
(TLAC) incorporates both the going concern requirements of Basel III and gone-concern capacity that will
be drawn upon when a bank fails.
In contrast to the other pending items on the TBTF agenda, the new standard has served to
inspire confidence and galvanize cross-border cooperation. An international regulator notes this change
in the attitudes of FSB members: “There was a growing realization that in order to reduce the risk of
fragmentation, to improve the confidence of countries in cooperating with each other, and to improve
their mutual confidence, we had an international framework which really could avoid taxpayers bearing
some of the losses and economic disruption, there needed to be more of a floor to give confidence that
there was actually a buffer of liabilities that could absorb the losses.” (International Regulator 6, 2014).
In the aftermath of the Cairns meeting, the European Banking Authority has started technical
work to make MREL requirements congruent with global TLAC standards (Durand, 2014). More recently,
the German governing coalition has considered delaying the implementation of its unilateral structural
policies (Jennen & Comfort, 2015). Even the Fed, the organization that unilaterally implemented a
subsidiarization of foreign banks in February 2014, decided to postpone its own rulemaking on long-
term debt requirements until a common standard was found. A senior official of the Fed’s Division of
Banking Supervision and Regulation stated that the “first best outcome” is international consensus on a
rule “that creates a level playing field and maximum confidence” (Tracy, 2014).
Third, TLAC makes it easier for supervisors to deal with bank complexity and to engage in cross-
border resolution planning. The FSB envisions loss absorbing capacity to be allocated in the banking
corporation in ways that facilitate either an SPE or MPE resolution strategy. It stipulates the amount of
TLAC that must be held in subsidiaries abroad, so-called internal TLAC. Regulators thus have to worry
less about the legal intricacies of a global bank or the (lack of) powers to force them to simplify their
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corporate structure. Instead they can focus on the positioning of bail-inable debt in within the
corporation and obstacles to its liquidation. Convertible debt also serves as a focal point for cross-border
regulatory cooperation (Cunliffe, 2014; H. Jones, 2014; PWC, 2014; Tucker, 2012). Supervisors in any
CMG are now expected to reach consensus on the trigger for debt conversion and to insert this clause in
cooperation agreements. Paul Tucker argues that this will bring clarity to the work of CMGs: “By framing
the trigger for “converting“ intra-group debt into equity, home and host authorities can hard-wire co-
operation; or if they fail to agree on a trigger, they at least discover ex ante rather than ex post that they
can’t rely on each other. This would usefully give a harder edge to discussions amongst home and host
authorities in supervisory and crisis-management colleges.” (Tucker, 2014, p. 8).
Fourth, by proposing TLAC requirements that essentially double those of Basel III the FSB might
appease FSB members and commentators who considered Basel standards to be insufficient. According
to the consultative document, TLAC would add 16-20% of risk-weighted assets to Basel III requirements,
a multiple of what the Vickers commission had envisioned. Furthermore, it contains a provision similar
to a leverage ratio that would require banks to hold TLAC equivalent to 6% of unweighted assets (FSB,
2014i).
Fifth, the new standard aims to eschew inconsistencies in domestic legislation by shifting the
burden of adjustment to the banks. The consultative document states that “any liabilities that, under
the laws governing the issuing entity, cannot be effectively written down or converted into equity by the
relevant resolution authority“ are not eligible for TLAC (FSB, 2014i, p. 16). This requirement allows TLAC
standards to be implemented even in jurisdictions where legislators have failed to provide supervisors
with sufficient bail-in powers, and it might serve to enlist global banks as a pressure group to lobby for
corresponding legal change.
The sixth and final advantage of the TLAC standard is that it harnesses the power of market
forces. G-SIBs will be required to publicize the amount, maturity, and composition of TLAC as well as its
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position in the creditor hierarchy. This increase in transparency is expected to subject large banks to
increased market discipline and eliminate the TBTF subsidy they enjoy. Creditors have less reason to
believe that they will be bailed out in case of a bank failure, and they have a higher incentive to subject
the riskiness of management decisions to scrutiny, thus potentially reducing moral hazard. Furthermore,
TLAC responds to and incorporates recent developments in the bond markets. Banks have started
issuing contingent convertible (coco) bonds that convert to equity when the firm’s capital ratio falls
below a predetermined threshold. Coco bonds represent a contractual approach to bail-in that
supplements the statutory measures some (but not all) FSB jurisdictions have put in place (Barkbu,
Eichengreen, & Mody, 2012; Flannery, 2005). Bond markets have reacted positively to the regulatory
proposal: banks issued $10 billion in TLAC-eligible debt in February 2015 alone (Gledhill, 2015).
It is noteworthy that the TLAC initiative is facing a number of common obstacles. The
establishment of a clear common standard brings redistributive concerns to the fore. Global banks have
different levels of TLAC-eligible liabilities and thus face different adjustment costs. Proposals by US and
UK regulators to aim for the higher end of the 16-20% requirement margins have been met with
resistance by French and Japanese supervisors (Uren, 2014). Continental European banks in general face
a greater shortfall while Swedish banks may have to reduce their current equity levels to fit TLAC
standards (Durand, 2015; Franklin & Jones, 2014; Schwartzkopff, 2014).
Independently, private special interest groups have used the TLAC consultation period to
express their disapproval of the FSB proposal. Bank lobby organizations speak out against additional
Pillar 2 requirements, complain that a 16% TLAC buffer would be excessive, and warn that the new
requirements will stifle economic growth by increasing financing costs for companies (Eyers, 2014; IIF &
GFMA, 2014; Moshinsky, 2015; The Clearing House, SIFMA, American Bankers Association, & Financial
Services Roundtable, 2015).
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These are points of resistance that were present in the negotiation of Basel III standards as well.
While the above-mentioned issues will influence the negotiation of the final standard it is unlikely that
they will derail or even delay the TLAC policy process altogether.
A few caveats are important to recognize at this point. While convertible debt instruments
employ a contractual approach, the majority of TLAC-eligible liabilities still rely on a statutory approach
to bail-in. As long as legislators have not provided legal certainty for the bail-in of debt instruments,
especially those issued foreign jurisdictions, bail-in in bank resolution is not credible.
What the TLAC initiative accomplishes is the allocation of losses ex ante. In its current form, it
transfers the burden of loss from one set of players, the taxpayers, to another, pensioners and savers
who are the ultimate holders of unsecured bank liabilities (Goodhart & Avgouleas, 2014). Whether this
is a politically palatable alternative to bail-outs is subject to debate.
Furthermore, the TLAC approach is incapable of solving some of the more fundamental issues
that systemically important financial institutions pose to overall economic stability. Requiring SIFIs to
issue bail-inable debt goes a long way in revealing the cost of their resolution ex ante, thus enhancing
market discipline. But adding de facto Tier 2 and Tier 3 requirements can be regarded as additional
measures to enhance their resilience. While creditors of a troubled G-SIFI will face write-downs or debt
conversion, it is still unlikely that a global bank will be broken up and wound down in the future. Paul
Tucker recognized as much in 2013: “It would be a nightmare to execute over a weekend a split of any of
these groups, with multiple entities across scores of countries, into those parts providing services that
must be sustained at all costs and a remainder that could be wound down as part of a resolution.”
(Tucker, 2013, p. 5).
In other words, current proposals to end TBTF are not addressing the concentration in the
banking market. The new regulatory proposals might even exacerbate this issue, as a French regulator
asserts: “What we are currently doing is we are pushing banks to become bigger and bigger because we
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are creating entry barriers in the market, we are creating operational costs if we allow some banks to fail,
other to acquire them, mergers and acquisitions are likely to happen. So this is not necessarily
straightforward but actually we have been pushing for having a smaller number of systemic institutions
but bigger banks with more power and more capacities in being too big to fail in the end. That’s a
contradiction we have in the system. Somehow we will need to have more players and smaller players at
the international level, not only in one place. So I think the best way to end too big to fail would be to
decrease the size of banks and have the G-SIB become something less of a G-SIB.” (France Regulator 1,
2014).
However, TLAC requirements impose a greater regulatory burden on G-SIBs in particular. If this
additional burden threatens the profitability of TBTF banks, as industry lobby organizations loudly assert,
we may actually see a move towards smaller banks in the future.
Conclusion
Ending too-big-to-fail has been an element of the G20 financial regulatory reform agenda since
2009, but six years later large global banks still enjoy implicit state guarantees. In spite of initial rapid
advances by the Basel Committee, progress in tackling TBTF banks has been mixed. The FSB has
coordinated a great amount of policy work to steer member jurisdictions in making the resolution of
global banks without resorting to public bailouts a realistic endeavor, but regulators have stumbled over
multiple obstacles in existing legislation. Furthermore, national legislators have not taken action to
remove these obstacles, and they have often failed to provide regulators with a legal mandate to engage
in the kind of cross-border cooperation that is necessary to make cross-border bank resolution credible.
A new initiative by the FSB seeks to circumvent these obstacles by emulating the Basel approach to bank
resilience. The TLAC approach has provided global regulatory reform with new momentum, convincing
key jurisdictions to put unilateral measures on hold and engage in cross-border harmonization, and the
new global standard is likely to be implemented successfully in due time.
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Many caveats remain and regulatory work to address the systemic importance of global insurers
and market infrastructures is still in its early stages. What the evolution of global regulatory form
regarding TBTF banks over the last six years has shown however is the friction between government
networks and the nation state as embodied in national legislation and legislators. The following chapter
will explore this tension with regards to the tradeoff between efficiency and representation that any
global governance arrangement inevitably confronts.
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Chapter 7: State versus network

In 2009, at the height of the global financial crisis, world leaders embarked on a reform of
financial regulation with a triple objective: reduce the likelihood of another global meltdown, contain
the systemic repercussions of future crises, and insulate uninvolved citizens from the costs associated
with financial market turbulences. Because this ambitious reform program represents a major departure
from the combination of unilateral action and low-level coordination that characterized global financial
regulation for the last 40 years, it merits special scrutiny by practitioners and scholars alike. The
advances and shortcomings of the post-crisis reform program allow researchers to draw inferences on
the dynamics and structural properties of G20-led and FSB-administered economic governance. It also
provides fertile ground for theory development on networked global governance in the 21
st
century.
This chapter starts with a summary of financial regulatory reform progress in all issue areas
covered in this dissertation. In six years of reform, some elements of financial reform have advanced
rapidly while in others, a wide gap between reform promises and implementation has opened. This
pattern of reform shortcomings and advances is not random. It reveals the different institutional
pathways that the G20 and the FSB have taken and their respective chances of success. Contrary to the
predictions of mainstream theories of global governance and regulatory cooperation, legislators and
legislation have emerged as the major obstacles to a successful implementation of the post-crisis reform
package. This pattern resonates with the tension between hierarchically organized territorial states and
horizontal transnational networks. The state is deeply involved in the structural shift from hierarchy to
network that is the underlying driver of globalization. Over the last decades, we can observe a dramatic
transformation from the interventionist to the regulatory state, and from domestic regulatory
governance to transnational networked governance. The recalcitrance of legislators and the marginal
importance given to transnational cooperation in new and old legislation becomes understandable
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when situating it in this framework of tension between state and network. The chapter then discusses
effectiveness and legitimacy issues that government networks raise. It concludes by making suggestions
regarding the design and the study of global governance arrangements in the 21
st
century.
The institutional pathways of reform
At the G20 summits in London and Pittsburgh in 2009, world leaders presented an ambitious
financial reform package. They made a commitment to submit the financial regulatory system that failed
so clearly during the global financial crisis to a massive overhaul. This reform was to be wide in scope,
encompassing large parts of the financial services sector, deep in regards to substantive departure from
the status quo, and built on a consensus among the world’s leading nations. The FSB, a government
network, was endowed with responsibility over coordinating the reform process and ensuring its
successful implementation. But even though G20 leaders committed to implementing the large majority
of their reform proposals by 2015 or earlier, financial reform progress has been uneven.
Global financial reform has advanced most in the area of prudential banking regulation. The G20
gave responsibility over the formulation of a new set of rules to the Basel Committee. Within less than
two years, the Basel Committee developed and published a new global standard, Basel III. Currently, all
G20 members have translated Basel III domestically, and banks are meeting the new standards several
years ahead of the 2019 deadline. Furthermore, even jurisdictions that are neither members of the G20
nor the Basel Committee are adopting the new standard.
In contrast, reform in OTC derivatives regulation has fallen short of G20 commitments. Even
three years after the deadline set by the G20, member jurisdictions have not developed a globally
coherent set of standards to regulate this market. The FSB workstream on OTC derivatives suffered from
inadequate staffing and insufficient authority, and the degree of regulatory coordination between
Europe and the United States in the development of derivatives standards ranged between insufficient
and absent. Post-hoc harmonization is undermined by complaints about extraterritorial authority and
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political negotiations. It is currently unclear when and how G20 members will meet their commitment of
bringing OTC derivatives markets under coordinated regulatory control.
In a third issue area, ending too-big-to-fail, reform progress is mixed. Measures to identify
systemically important banks have been developed by member jurisdictions and are effective since 2011.
Furthermore, loss absorbency requirements for big financial institutions are either in place or moving
fast towards implementation. On the other hand, global rules that facilitate the resolution of too-big-to-
fail firms are not effective, and it is unclear when G20 member jurisdictions will achieve a degree of
cross-border coordination that enables them to administer the orderly wind-down of a failed global
financial firm, if ever.
State-of-the-art theories of global financial governance cannot explain this pattern. The first two
approaches under consideration in this dissertation focus on the great powers as drivers of cross-border
regulatory cooperation. If policymakers in leading economies agree on the need to regulate an issue
area this approach predicts that they will develop a global standard and employ a variety of institutional
strategies to make sure all relevant jurisdictions adhere to it. Proponents of this theory expect small,
club-like institutions such as the G20 and the FSB to greatly facilitate a rapid implementation of global
financial reform. Yet even though actors and institutional environment are constant across the different
regulatory reform areas, reform progress is uneven. Great power theories predict that global
coordination might falter where the leading nations have divergent preferences, or where incentives for
global harmonization are low because non-adherence by other jurisdictions does not entail negative
cross-border externalities. In fact, all areas of financial regulatory reform under analysis here are driven
by a consensus among the great powers. The evident incongruence and overlap between standards in
OTC derivatives regulation for example is not the product of differences in reform objectives or
regulatory philosophies. In addition, the global financial crisis has made it clear to all involved parties
that non-adherence to any of the standards that are part of G20-led reform efforts would expose the
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great powers to negative externalities. For example, if concern about cross-border externalities were a
good predictor of reform progress, the G20 would have successfully implemented new regulation in the
area of cross-border bank resolution that was so costly for the United States and the UK in particular.
Yet this is one of the areas that are clearly falling short of the original reform commitments.
Another approach highlights the work of epistemic communities in developing global consensus
on the best set of policies in a given issue area as the driver of cross-border coordination. As a variant of
relative sequencing, this approach would predict successful implementation in reform areas where such
consensus had time to develop and shortcomings elsewhere. In reality, reform progress has been
remarkable in areas that were merely at the margins of the global regulatory discourse until the
outbreak of the crisis. Even though only few regulators regarded a macroprudential approach as
necessary to ensure global financial stability, macroprudential measures such as the counter-cyclical
capital buffer have been developed and implemented in the shortest time period. Similarly, few
regulators considered liquidity an area worthy of regulatory attention, yet globally standardized liquidity
ratios are currently en train to implementation. Measuring a bank’s contribution to global systemic risk
was an exotic endeavor prior to the crisis. Six years later however regulators do not only agree on a
measure of systemic risk but also on the regulatory instruments to address it. Conversely, some of the
oldest areas of financial regulatory deliberation still face seemingly insurmountable obstacles today. For
example, the Basel Committee has reached consensus on the need for cross-border cooperation in bank
resolution decades ago. Nevertheless, this area of financial reform is lagging behind and may fall short of
G20 commitments altogether.
Fourth, scholars assert that all global standards entail costs and benefits, and that concerns over
the distribution of adjustment costs across jurisdictions impede cross-border cooperation. In line with
this approach, reform shortcomings are expected in those issue areas where the costs of adjustment to
new regulatory standards are clear and unevenly distributed across jurisdictions. There is indeed plenty
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of evidence that redistributive concerns were salient in all areas of the G20 reform package. Yet
competitiveness concerns and pressures to reduce regulatory costs were most pronounced in those
areas where reform commitments are met on time, such as Basel III and the new gone-concern loss
absorbency proposal. Conversely, financial reform has stalled in areas where redistributive concerns are
diffuse, as in OTC derivatives regulation.
A fifth approach attributes reform shortcomings to regulatory capture. Private special interest
groups, the theory goes, employ a variety of mechanisms to influence policymakers. Because new
regulation entails significant cost to the private sector, it has an incentive to water down reform
proposals and minimize the departure from the status quo. In line with the predictions of this theory,
financial lobby organizations have indeed undertaken considerable efforts to convince policymakers that
regulatory reform would suffocate the industry and ruin economic growth prospects for years to come.
And there is evidence that the financial sector has dedicated considerable resources to watering down
reform proposals at the national and international level. Yet financial lobby organizations have not
questioned the global harmonization of regulatory standards. Instead, the record shows that they have
encouraged regulators to enhance cross-border cooperation, and lobby groups in the US have even
taken a regulatory agency to court for failing to comply with G20 commitments. This is not
counterintuitive because globally harmonized standards, even tough ones, are less costly for global
financial firms than fragmentation along jurisdictional lines.
That politicization in the wake of the crisis has led to cooperative decentralization is the central
argument of a sixth approach. Financial regulation, traditionally a parochial issue confined to the realm
of specialized technocrats has risen to prominence with the global financial crisis. This approach predicts
that national politicians, under pressure to respond to domestic societal demands for tougher regulation,
eschew the far and uncertain benefits of cross-border cooperation and promote unilateral measures
that would increase their chances of re-election. Although there is evidence that politicization of
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regulatory issues has put government networks in the defense, this dynamic cannot explain the pattern
of reform progress and shortcomings. Banking regulation for example was subject to intense political
debate in the wake of the crisis, but global standards were finalized and implemented successfully.
Politicians in recent years have issued unilateral structural measures to address too-big-to-fail banks, but
they subsequently made cross-border harmonization a priority in determining a new loss absorbency
standard for the same banks.
The seventh competing explanation is that reform progress depends on the financial subsector
to be regulated. Proponents of this approach argue that regulation of banks is easier than that of
insurance companies or financial market infrastructures, especially ones that were hitherto unregulated
such as OTC derivatives markets. While it is true that the regulation of the insurance sector and capital
markets has proceeded more slowly (often in accordance with longer timelines), this approach fails to
explain why some areas of banking regulation have stalled while others have not.
In sum, while all of the above theories of regulatory cooperation map onto certain elements of
the empirical picture, they do not provide sufficient inferential leverage to explain the pattern of global
financial regulatory reform. Based on a thorough empirical investigation, this chapter proposes an
alternative approach to understanding cross-border cooperation in financial regulatory reform in
particular and the conditions of global governance in general.
The relevant predictors of reform success and failure are not the incentives of the great powers
or the degree of influence of external actors such as special interest groups, but the institutional
pathways of reform. The empirical picture reveals that the biggest obstacle to state-led regulatory
reform is the state. This apparent contradiction can only be solved when breaking down the concept of
state into its constituent parts. While the executive branch of G20 governments has been the driver of
financial regulatory reform, legislators and legislation emerge as formidable obstacles to its completion.
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Even though all reform initiatives analyzed in this work were put on the agenda by G20 leaders
in 2009, they evolved along different institutional pathways in the negotiation and implementation
stages. Those initiatives that were negotiated in transnational government networks and implemented
with little or no involvement of legislative bodies are reaching successful conclusion within or ahead of
the timelines stipulated by the G20. On the other hand, all reform initiatives that endowed legislative
bodies with a protagonist role are failing, either because legislators are unwilling to remove existing
legal obstacles to global coordination or because they are unwilling to provide regulators with sufficient
authority to engage in cross-border cooperation.
Figure 7.1 Regulatory process

The success of prudential banking reform (Basel III) can be attributed to the decisive action of a
government network, the Basel Committee. New banking standards were negotiated among regulators
in the BCBS, and implemented in most jurisdictions with marginal involvement of legislative bodies. In
some jurisdictions minor legal changes had to be made, in others regulators merely implemented the
new standards by publishing domestic rules. The government network is also in charge of monitoring
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implementation and assessing whether it meets global quality guidelines. To date, the only jurisdiction
that failed the global consistency test is the one where legislators played a major role in domestic
implementation: the European Union. In spite of the European quagmire, jurisdictions within and
outside the G20 are implementing the new global standard, and the private sector is meeting regulatory
requirements ahead of the deadline.
In the area of OTC derivatives, government networks under FSB purview were weak and
inconsequential at the negotiation stage. Legislators in the leading jurisdictions gave domestic
regulators responsibility for the development of domestic rules without considering the role of the FSB.
Without a mandate to engage in regulatory harmonization with their peers abroad, domestic regulators
drafted rules unilaterally. Cross-border externalities of the new regulatory system were considered only
afterwards, culminating in acrimonious debates over extraterritorial authority and mutual recognition.
With different sets of rules written in the leading jurisdictions and in the absence of effective FSB-led
harmonization, other G20 members adopt a wait-and-see approach to avoid a mismatch between
globally dominant and their own domestic rules, further delaying the implementation of OTC derivatives
reform.
The FSB showed more protagonism in promoting a harmonized response to ending TBTF. It
established the forum for regulators and finance ministers to negotiate a novel global standard of key
attributes for bank resolution that was subsequently endorsed by the G20. Nevertheless, legal obstacles
obstruct the implementation of this global standard. Legislators are neither removing existing legal
impediments to cross-border insolvency procedures nor do they provide regulators with sufficient
authority to engage in meaningful cooperation agreements with their peers abroad. At the same time,
the FSB is successful at creating a new global standard for loss absorbency requirements of TBTF banks.
The standard is negotiated in a government network and currently subject to a consultation and
adjustment process under FSB purview. The reason why this new regulatory initiative is likely to become
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a success story of global financial reform is that it follows an institutional pathway that sidelines
legislators to the largest extent possible.
State of the art theories of regulatory cooperation and global governance fail to account for the
emergence of legislators as the main institutional impediment to global reform. They emphasize the
tension between states or between the state and private actors, but they overlook the decisive battle
that takes place between different pillars of the state: the executive and the legislative branch.
Globalization: From hierarchy to network
From a systemic vantage point, the recalcitrance of legislators in global financial regulatory
reform is part of a greater structural tension between state hierarchies and transnational networks that
Castells (2000) identified as the fundamental driver of globalization. This section starts by sketching the
outlines of Castells’ network theory. The following section develops the theory further, tracing the
double removal of regulatory authority away from legislators due to the emergence of the regulatory
state and the subsequent rise of transnational regulatory networks.
Castells’ theory starts with the observation that modern societies are structured around
hierarchical bureaucracies. Resources and subjects are integrated in vertical structures that are
dominated by a social elite and delimited by national borders. From political parties and trade unions to
corporations, government, and the media, nationally bound hierarchies represent the dominant and
pervasive structural organizing principle in the modern era (Castells, 2004). The multidimensional and
complex shift away from vertical structures and the emergence of horizontal networks is what Castells
describes as the rise of the network society. This process started as the result of three independent
processes in the late 1960s and early 1970s: the information technology revolution, the economic crisis
of both liberal market and planned economies, and the blooming of cultural social movements (Castells,
1998, p. 336ff).
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Shaken by economic crisis in the 1970s, advanced capitalist economies underwent a profound
structural transformation. Political leaders lowered cross-border barriers to production and trade by
liberalizing and privatizing large sectors of the economy, while technological advances reduced
transaction costs, allowing companies to operate as transnational networks. The rise of the network
enterprise in an increasingly informational, global, and networked economy over the last four decades
had profound repercussions for the global division of labor. Corporate transnational networks emerged
as the dominant organizational principle for the accumulation of wealth and power, and nowhere has
this structural transformation been clearer than in the financial sphere (Castells, 2000, pp. 77f, 503).
The power imbalance between globally networked capital and local labor precipitated the
demise of trade unions and the dismantling of the welfare state in many advanced economies.
Disengaged from economic activity as a result of successive rounds of privatization and liberalization
and constrained in its range of policy measures in a globally interdependent economy, the nation-state
is in crisis. It faces increasing difficulties in delivering the public goods that citizens still expect from the
state: protection from economic shocks, redistributive justice (Piketty, 2014), and management of the
economy in accordance with societal preferences that are aggregated in legitimate democratic
procedures. As Castells notes, „national governments in the Information Age are too small to handle
global forces, yet too big to manage people‘s lives.“ (Castells, 1997, p. 273).
In order to resolve this crisis of political legitimacy, the nation-state seeks to reconstruct power
at another level, thereby transforming itself into a network state. Castells (2009, p. 38ff) identifies three
such transformations: networks of states such as the EU, NATO, or ASEAN, supranational organizations
such as the WTO or the ICC, and the devolution of power to regional governments or NGOs. The
analytical lens Castells applies here is too narrow for two reasons. First, the distinction between
networks of states and supranational organizations lacks relevance because both are based on
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intergovernmental agreements that entail the sharing of sovereignty to a specified degree. Second, the
author oversees a more relevant phenomenon, the rise of government networks.
Unlike the organizations mentioned above, government networks are not constituted by
international treaty, they do not produce legally binding agreements, and they have no identity under
international public law (Slaughter, 2004). Yet government networks represent the nation-state’s best
chance to overcome the structural sources of its legitimacy crisis and regain some degree of control over
a global networked economy.
The sharing of sovereignty is an unavoidable corollary of the shift towards government networks,
but it generates tension within the nation-state. Castells (2009) finds organizational, technical, and
political coordination problems that accompany the rise of the network state. While the author
emphasizes the unwillingness of government agencies to engage in cross-border cooperation, this
dissertation argues that such agencies count on much better preparation and incentives to engage with
their peers abroad than other parts of the state. The empirical picture shows that the major impediment
to the successful operation of government networks are not regulatory agencies, but the constraints
imposed by legislators. Together with the judicial branch, legislative organs represent the vestiges of the
old, hierarchically integrated Weberian nation-state that are fundamentally incompatible with today’s
transnational network logic of organization.
In order to adjust to a globalized economy, the state has undergone successive rounds of
restructuring that have wrested control away from legislators. The power imbalance between the
executive and legislative branch grew with the rise of the regulatory state towards the end of the 20
th

century. The subsequent emergence of transnational networks among members of regulatory agencies
and the executive branch has further removed legislative control over policy areas. Therefore, framing
global financial reform at the FSB as the latest push away from domestic legislative control towards
transnational networked governance makes recalcitrance among legislators understandable.
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Faced with the powerful logic of transnational networks in the global economy in general and
finance in particular, the state has no option to regain control over the cross-border flows of power and
wealth other than to embrace a similar structural transformation, leaving the hierarchical, territorially
bound bureaucracies on which it was build behind. Government networks are the structural response to
the rise of the network economy, but the executive branch is the only pillar of the state that is in a
position to undergo this transformation. The result is a turf battle within the state. Losing influence vis-
à-vis the executive as it connects to global government networks, the legislative branch represents a
formidable obstacle to cross-border cooperation. The main points of contention in this battle are the
essential quality criteria of governance: effectiveness and legitimacy.
Before engaging in the debate on the effectiveness and legitimacy of government networks, the
following section traces the successive removal of power away from the legislative branch with the rise
of the regulatory state and the subsequent emergence of transnational regulatory networks.
The rise of the regulatory state
The evolution of the state from territorially bound hierarchy to transnational network can be
understood as a two-step development that is deeply intertwined with the larger process of
globalization. It originates in the transfer of responsibility over the management of the economy from
the central government bureaucracy to regulatory agencies at a domestic level. In the postwar era,
intervention in the market economy for the purpose of strategic economic guidance and redistribution
of wealth was an important function of the state. But from the 1970s onwards, with the model of the
interventionist state in crisis a major transformation took place. Large-scale privatization and
liberalization led to a retrenchment of the centralized government bureaucracy. Deregulation might not
be the most fitting term for this process because privatized sectors were quickly re-regulated. However,
rule-making authority changed hands from the central government to regulatory agencies. It is this
transformation of central government functions from taxing and spending to rule-making and the
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outsourcing of these functions to agencies that Majone (1997) identifies as the central characteristics of
the regulatory state.
Regulatory agencies have been in existence throughout the 20
th
century, and the United States
is regarded by Levi-Faur (2005) as the oldest regulatory state. However, the last three decades of the
century saw a rapid proliferation of regulatory agencies around the world due to policy diffusion,
increased competition among nation-states and the growing importance of the European Community
over its member states (Berg & Horrall, 2008; Gilardi, Jordana, & Levi-Faur, 2006; Jordana, Levi-Faur, & i
Marín, 2011; Majone, 1997; Way, 2005).
The rise of regulatory agencies implies a shift in authority away from legislators in several key
dimensions. Unlike the core state bureaucracy, the central task for regulators is not redistribution and
service delivery but to address market failures. Because the cost allocation of a regulation is much
harder to discern than that of redistributive intervention, the policy area of regulators is often regarded
as “apolitical”. Furthermore, agencies are one step removed from their political headmasters, attached
to the government only by arms-length agreements. Political parties rarely have formal mechanisms of
influence on regulators. Instead, agencies are often overseen by a bi-partisan “special commission”,
granting it further insulation from the party-political dynamics of the legislative branch. Finally,
regulation requires a high degree of technical knowledge, putting a premium on expertise. This in turn
provides regulators with a greater degree of power and discretion than other administrators. Expertise
is also the defining identity trait that allows regulators to transcend national borders and perceive
themselves as members of a transnational epistemic community.
In sum, the demise of the interventionist state and the proliferation of regulatory agencies have
changed the equilibrium between the different branches of the state profoundly. Regulatory
policymaking is largely incompatible with the logic of political parties that obtain, via democratic
elections, a mandate to undertake redistributive actions in line with their ideological preferences within
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a specific time frame. While not completely autonomous, regulators are one step removed from party
politics, and their allegiance is not necessarily bound to a single nation state. In addition, the policies of
regulatory agencies are rarely subject to legislative approval. Therefore, the rise of the regulatory state
represents a shift of policymaking authority away from parliament. Summarizing their empirical work on
the proliferation of regulatory agencies, Jordana et al. (2011) conclude: “the old Weberian bureaucracies
are changing” (p. 19). While the shift in the power balance between regulators and legislators with the
emergence of the regulatory state has generated tension (Heltman, 2015) it still remained within the
confines of the nation-state. This changed when regulators started forming transnational networks,
further stripping legislators of policymaking authority.
The rise of government networks
In a recent paper that outlines venues for research on post-crisis international financial
regulation, Helleiner and Pagliari (2011, p. 182) highlight the need for a better theoretical understanding
of the connection between transnational government networks and domestic politics. The present
dissertation in general and this section in particular address this demand. It argues that the recalcitrance
of legislators in financial regulatory reform is the result of a power struggle with regulators who wrest
policymaking authority away from the old vestiges of the state and concentrate it in transnational
networks that increasingly escape parliamentary control in any nation-state. It is part of a larger
transformation of governance structures from territorially bound hierarchies to transnational networks.
Regulators are at the center of this transformation and the executive branch is increasingly involved, but
legislators are lagging behind, unwilling and incapable of engaging in transnational networks themselves.
International relations scholars have developed a variety of theoretical approaches that seek to
explain the institutional evolution of interstate cooperation. Building on Keohane’s (1984) fundamental
insight that international institutions facilitate interstate cooperation, scholars at the beginning of this
century examined the uneven expansion of legalization and judicialization of international institutions.
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They raised questions of why international arrangements differ in the degree to which rules are legally
binding, their precision, and delegation (Abbott, Keohane, Moravcsik, Slaughter, & Snidal, 2000;
Goldstein, Kahler, Keohane, & Slaughter, 2000). This set of questions gave rise to a research program on
the rational design of international institutions. Scholars discovered that institutional design follows
from the nature of the governance problem states seek to resolve. More specifically, distributional
consequences of agreements, enforcement problems, the number of counterparties, uncertainty over
the policy environment and the verifiability of state actions are found to shape the institutional design
of interstate cooperation in significant ways (Abbott & Snidal, 2001; Duffield, 2003; Koremenos, 2008;
Koremenos, Lipson, & Snidal, 2001).
The rational design research program was further developed with subsequent work on the
determinants for delegation and agency in international organizations. Hawkins et al. (2006) start with a
sharp analytical framework that identifies delegation to an international agency as one of three
outcomes of a decision tree (see below). They then transpose principal-agent theory from the domestic
to the international level in order to explain under what conditions states choose to delegate the tasks
of interstate cooperation to agencies. Even though principal-agent theory was developed in the realm of
domestic politics it does not face the aggregation problem that plagues psychological approaches to
international relations, for example.
The choice of delegation to an agency can be understood as the result of a rational calculation
whereby the principal weighs the benefits of delegation against expected agency losses. There are
multiple benefits from delegation: because agencies are more specialized than principals, they have a
greater ability to collect information, provide expertise, and deliver certain services. Agencies also have
an advantage at managing policy externalities and dealing with the dilemmas of coordination and
collaboration that arise when states work together. They can also serve as an agenda-setting agent that
provides focal points for interstate negotiations, facilitate collective decision-making, and provide a
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forum for dispute settlement. Maybe most importantly, an agency can provide policy credibility in ways
that a principal cannot. This is a consequence of the well-known time inconsistency problem: a state
cannot credibly assure the outside world that it will not renege on a policy that entails short-term costs
and long-term benefits as political conditions change. Time-inconsistency is a central argument for
central bank independence, but it applies in similar ways to most areas of economic policymaking
(Gilardi, 2005; D. G. Hawkins et al., 2006; L. Martin, 2006).
The cost of delegation is agency slack. Because information is costly, the principal cannot
efficiently obtain full knowledge about the policy environment of the agency, its actions, and the
consequences of its actions. The agency can take advantage of this information asymmetry and pursue
its own goals even if they do not match the principal’s preferences. The scope for agency slack varies
with a host of institutional features such as voting rules, the heterogeneity of preferences among
principals, and monitoring procedures (Estache & Wren-Lewis, 2009; Laffont & Tirole, 1991).
Figure 7.2 State cooperation decision tree

Source: Adapted from Hawkins et al. (2006)
While international relations scholars have been successful at applying principal-agent theory to
the international level, they did not integrate an important institutional design into their framework.
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Government networks are an innovation in the design of international institutions that harnesses the
benefits and minimizes the costs of delegation. By restricting itself to classic inter-governmental
organizations, Hawkins et al.’s (2006) delegation framework falls short in two dimensions. First, it
ignores the importance of staffing. Classic international organizations rely on bureaucratic staff that is
employed on the basis of technocratic merit. Government networks in turn have little or no such
bureaucracy. The second shortcoming follows from the first point. Hawkins et al. model delegation as a
binary choice: agency or no agency. Government networks however exist in a spectrum between these
two extremes. This is because the principals can calibrate the degree of delegation by deciding the
extent to which staff consists of officials from member governments. The more an agency relies on
government officials, the more its operations resemble mere interstate cooperation. As a result, states
can design an institution that secures the benefits of specialization and credibility of an agency while
reducing the agency slack that comes with an international bureaucracy even in the presence of
consensus-based decision-making rules.
Government networks represent the optimal design for an international agency for some, but
not all parts of the state. Regulators have an incentive to engage in government networks in order to
meet their twin goals of stability and the preservation of international competitiveness for the domestic
industry (D. A. Singer, 2004, 2007). The executive branch regards government networks as a preferential
option because they minimize agency slack while facilitating cooperation and providing credibility in
ways that mere interstate cooperation cannot. It also increases the degree of autonomy of the executive
branch vis-à-vis other domestic institutions. No other institutional design of global cooperation provides
as good of a combination of control over supranational agents and autonomy from other domestic
government bodies as government networks.
The losers of the rise of government networks are the legislative and judicial branches of
government. As an earlier section of this chapter showed, power over an increasing range of policy
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areas has been wrested away from parliament with the rise of the regulatory state. The reliance of
government networks on soft law exacerbates this situation further. Legislators rarely had an active role
in designing global policies. But because hard-law agreements brokered by classic inter-governmental
organizations need to be sanctioned by parliaments in order to enter into effect, legislators at least have
a role as a veto player. In contrast, some institutional pathways chosen by government networks can
eschew domestic sanctioning procedures, thus stripping parliaments of this role. The situation is similar
for the judicial branch of the state. Courts have played an important role in scrutinizing existing
regulation and have even triggered new policies, for example in the European Union (Majone, 1997).
Government networks however are beyond the jurisdictional authority of any court.
Figure 7.3: Evolution from state to network

In sum, delegation to international agencies of any kind involves sovereignty sharing, but
sovereignty losses associated with government networks are borne unevenly by different branches of
the state. Legislators and the judicial branch see their area of authority circumcised whereas the
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executive and regulators are able to retain or even gain protagonism when engaging in government
networks. Existing legislation often limits the operations of government networks, however, and
legislators have the power to remove these obstacles.
Why do legislators not follow regulators and the executive branch and engage in government
networks themselves? Several institutional constraints make it unfeasible and undesirable for legislators
to engage in transnational cooperation. First, legislators are elected to represent a geographically
circumscribed constituency. As such, they are an essential element of the old hierarchical structures of
the Weberian nation-state. As a consequence, legislators tend to see international issues through the
prism of domestic interests. Because loyalty to their constituents is a major determinant of their
chances of re-election and because the benefits of international cooperation are diffuse, legislators tend
not to prioritize it. This problem is exacerbated by the time horizon of legislators. Unlike regulators,
legislators in most countries have four years in office and thus few incentives to establish long-term
relationships with foreign counterparts. Parliamentarians also tend to deal with a wide array of policy
issues. This makes it harder for them to identify their natural counterparts in other countries, and it
makes cross-border encounters more likely to occur within the classic confines of party affiliation.
Moreover, legislators tend to lack specialized expertise. Thus they do not have a venue to identify
themselves as part of a greater epistemic community at a distance from popular politics as regulators do
(Slaughter, 2004, p. 104ff).
In sum, the institutional myopia engrained in national parliaments provides legislators with no
incentives to engage in cross-border cooperation. Even legislators who understand the benefits of
tackling global problems at a global level are unlikely to be rewarded in the next election because the
benefits of cross-border cooperation are diffuse and may not manifest within a few years. As a
consequence, they tend to continue in their traditional role of keeping regulatory agencies and the
executive on a short leash. Removing legislative obstacles and giving regulators a mandate for
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government networks to operate better does not improve their chances of reelection. Worse, it also
takes policymaking power out of their hands. Institutionally incapable of engaging in government
networks and jealously guarding the political authority they still have, legislators represent the foremost
obstacle to the transformation of the state from a territorially bound hierarchy to a transnational
network.
The FSB as a government network
Nowhere is the tension between government networks and legislators clearer than in the realm
of financial regulation. The financial sphere can be understood as the spearhead of globalization
because financial networks have transcended national borders faster than other parts of the economy.
In a recent speech, the Bank of England’s Chief Economist shows how savings and investment flows
were largely contained within the nation-state from the Great Depression until the 1980s. Haldane
(2014) states: “For much of the 20th century, global finance was more patchwork than network.” (p. 5).
This changed dramatically over the last three decades as capital flows went global, unfettered by
national boundaries. Haldane concludes: “The international monetary and financial system has
undergone a mini-revolution in the space of a generation as a result of financial globalisation. It has
become a genuine system. This has altered fundamentally the risk-return opportunity set facing
international policymakers: larger-than-ever opportunities, but also greater-than-ever threats.”
(Haldane, 2014, p. 14).
Because financial policymaking entails substantial cross-border externalities and because it
requires specialization, the benefits of delegation to international institutions are considerable. In fact
some of the oldest international agencies can be found here, such as the World Bank and the IMF.
However, the Bretton Woods Institutions and the FSB represent very different kinds of agencies. While
the former were designed as classic inter-governmental organizations, created by an international treaty
and with carefully calibrated (and contested) voting rights, the FSB is a government network and
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decisions are made by consensus. According to principal-agent theory, this would increase agency
autonomy and open the potential for considerable agency slack (Cortell & Peterson, 2006).
Why does the institutional design of what Treasury Secretary Geithner called the “fourth pillar”
of global economic governance at the time (US Treasury, 2009) differ so much from the other three
pillars? This chapter argues that the FSB is designed as a government network because it is considered
an optimal design by state principals. In contrast to traditional international organizations, the FSB
harnesses the benefits of delegation while drastically reducing agency losses.
The institutional design of the FSB does indeed optimize the consequences of delegation. It
brings together financial regulators, finance ministers, and central bank governors, that is officials with
the degree of specialization required to issue high-quality global regulatory standards. The operating
costs of the FSB are covered by the bank of central banks, the BIS, giving it a considerable degree of
financial autonomy from member governments. On the other hand, the creators of both the FSF and the
FSB made sure that staff does not exceed a few dozen, in contrast to the IMF’s thousands of employees
(Blustein, 2012). The overwhelming part of FSB personnel consists of officials from member countries. In
addition, the Charter of the FSB ties the agency closely to the prime forum of interstate cooperation, the
G20 (Donnelly, 2012; FSB, 2009, 2012c).
Legislators of member states in contrast have no channel of representation in the FSB. Yet the
operations of the FSB overlap with legislators’ sphere of authority (Rosenau, 2007). Backer (2011)
provides a revealing summary of FSB activities: “It does not legislate but produces law; it does not
govern but it produces standards.” (p. 791). In the areas identified in the previous chapters however,
existing legislation represents obstacles to the cross-border operations of this government network. The
recalcitrance of legislators to remove these legislative obstacles is the main reason why global financial
reform in the FSB is not as advanced as regulators and G20 leaders would prefer.
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The tension between the FSB and national legislators does not come as a surprise to all. At the
outset of the financial regulatory reform process Dani Rodrik asserts: “It is hard to imagine that
America's Congress would ever sign off on the kind of intrusive international oversight of domestic
lending practices that might have prevented the subprime-mortgage meltdown, let alone avert future
crises.” (Rodrik, 2009). As financial regulatory reform unfolds, representatives of domestic interests
increasingly voice their resistance. In a response paper to a consultation document on bank resolution,
the leader of an American civil society group calls the creation of the FSB a “bankers’ coup” that
undermines national sovereignty. The author asks: “Where did the FSB get these sweeping powers, and
is its mandate legally enforceable?” (Brown, 2014). The FSB faces similar criticism from the right wing of
the political spectrum. In a blog post titled “What happened to American sovereignty at G-20?”,
Barnewall (2009) lashes out against foreign regulatory intrusion.
In May 2014, the US House Financial Services Committee requested the Treasury, the Fed and
the SEC to present full documentation of communications with the FSB, concerned that the United
States is “surrendering” to “an international old boys club that deliberates in secret” (Wallison, 2014).
This move was triggered by the potential designation of asset management companies as systemically
important, but it reflects widespread irritation among Congress members regarding the authority of the
Financial Stability Oversight Council (FSOC), a domestic regulatory body created by the Dodd-Frank Act,
and its connections to the government network. A recent Wall Street Journal article argues that “The
FSOC has consistently moved to implement the FSB’s decisions without telling Congress, or the public,
that it regards the FSB’s decisions as binding. There’s a reason for this lack of candor. Congress has never
endorsed the idea that FSB decisions are binding on U.S. agencies. […]The result would unravel the
separation of powers and the role of Congress in the U.S. constitutional system.” (Wallison & Gallagher,
2015).
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Disapproval of the authority of government networks is not confined to the United States. Even
in Canada, the intellectual birthplace of the G20 and home country of the FSB Chair, criticism of the FSB
grows louder (Richardson, 2009). David Dodge, a former Governor of the Bank of Canada states that
"Canadian authorities should resist pressure from the Basel Committee and the Financial Stability Board
to replace our highly successful pre-2008 supervisory process with costly detailed 'black letter'
regulation, regulation which is often not even appropriate for Canada." (Beltrame, 2014). Even members
of the European Parliament, a legislative body that is transnational in nature, started questioning the
authority of government networks when European banking regulation was found to be inconsistent with
Basel III standards. A comment by a European regulator captures the tension between government
networks and parliaments well: “It is all very nice that people hook up in G20, that is at least that these
are heads of states, fine but you have the FSB or other organizations which are regulators and then they
say, ‘Oh, we are going to do this.’ But you cannot just take this home and have it rubber stamped by our
parliament. I mean we all live in a democracy, right?” (EU Regulator 6, 2014).
Quality indicators of government networks
The rising tension between government networks and domestic legislative bodies calls for a
debate on the merits of transnational governance designs. Are legislators right in resisting the FSB in
particular and global networked governance in general? What are the advantages and shortcomings of
government networks in dealing with governance challenges of the 21
st
century? In addressing this
question, the remainder of this chapter turns away from description and analysis and adopts a more
normative perspective.
A good starting point to assess the merits and shortfalls of the FSB as a government network is
to subject it to a quality test in two dimensions. The first is effectiveness, that is the relationship
between stated policy goals and outcomes. This dissertation has presented a thorough analysis of FSB
effectiveness in implementing the G20 objectives of global financial reform. The second dimension
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contains questions of legitimacy, representation, and accountability. This section will review scholarship
and assess the performance of the FSB in both dimensions.
That there is a tradeoff between effectiveness and representation has been recognized by
scholars of domestic organizations in the 1960s, if not earlier. Merton (1966) distinguishes between
instrumental and group-maintaining functions and points out that the tension between the two is
especially high in democratic organizations. A drive towards more efficient practices threatens the
processes that ensure all constituents are represented, that is internal democracy. Conversely, group-
maintaining functions that are geared towards maintaining representativeness may render the
organization ineffectual. Merton (1966) states: “We note that some members develop so deep a passion
for democratic processes that they often forget the purposes which these processes were meant to
serve.” (p. 1060).
This dilemma of representation and effectiveness does not only apply to domestic organizations
and governments but also to international institutions. The legal structure of inter-governmental
organizations such as the Bretton Woods institutions was designed to achieve a compromise between
both goals. They are firmly embedded in international public law. Representation is ensured by the
ratification procedure: the organization and its agreements are effective only after ratification by a
certain number of member states (Harland, 2004; Sands & Klein, 2001; Shaw, 2008). Effectiveness in
turn is thought to follow from the fact that member states are legally bound by the agreements they
make.
Some global governance scholars regard the circumvention of such legal procedures as a
fundamental weakness of government networks both with regards to effectiveness and legitimacy. It is
worth subjecting these arguments to scrutiny by assessing FSB performance in both dimensions, starting
with effectiveness.
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Effectiveness
Binding government commitments in legal agreements is an unavoidable prerequisite for the
effective implementation of global policies in the eyes of many scholars. The “hard law traditionalists” as
Kirton (2013) calls them have a point. The institutional design of government networks may be suited to
facilitate member agreement on a certain focal point as stylized by coordination games (Fearon, 1998;
Lazer, 2005; H. V. Milner, 1997). However, as soon as redistributive issues arise (and they always do),
government networks have no power to punish free riders and deal with defection issues of the
Prisoners’ Dilemma kind (Abbott & Snidal, 2000; Joyce, 2014; Mosley, 2009; I. Ötker-Robe, 2014).
Davies (2014) applies this criticism to the FSB, calling it a “watchdog without teeth. It can neither
instruct the other regulators what to do (or not do) nor force countries to comply with new regulations.”
Even Paul Martin, intellectual author of the government network that provided the foundations for the
G20 summit series, called the FSB toothless (Greenwood, 2012). In a similar vein, the FSB’s predecessor
FSF was widely seen as merely a talk shop because of its lack of enforcement powers. When
reconstituting it as the FSB, G20 leaders had the opportunity to give it international legal standing. That
they chose not to do this is seen by some scholars as a sign that post-crisis reform failed to change the
status quo. Helleiner (2014b) argues: “The G20’s failure to depart from the soft-law nature of the pre-
crisis governance of international financial standards in a significant way meant that the challenges in
enforcing implementation and compliance remained. These challenges in fact intensified in the wake of
the crisis, making the failure to innovate in a more substantial way even more significant.” (p. 150).
As a response to the perceived shortcomings of government networks, hard law traditionalists
call for an international treaty to provide global financial governance with a legal foundation (Wright,
2012). Alexander, Dhumale, and Eatwell (2006) call for the “institutional and legal consolidation” of
regulatory standards and the establishment of a Global Financial Governance Council. Eichengreen
(2009) proposes the establishment of a World Financial Organization. The newest suggestion to date
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comes from Avgouleas (2012) who envisions a new governance system that combines existing
organizations such as the IMF, OECD and FSB with a new global resolution authority, all based on an
umbrella international treaty that also incorporates the goals of global development.
Not oblivious to such suggestions, G20 leaders tasked the FSB with making recommendations
for “strengthening the FSB’s capacity, resources and governance” at the 2011 Cannes summit (FSB
2012b). One option was to transform the Board into a classic intergovernmental organization. Yet the
Plenary arrived at a consensus that the FSB must remain a government network in order to operate
effectively. The decision was communicated to G20 leaders at the Los Cabos summit: “The FSB considers
a treaty-based inter-governmental organisation not to be an appropriate legal form at this juncture.”
(FSB 2012b: pt. 11). Instead, it currently has legal personality as a mere association under Swiss law.
The institutional proposals mentioned above are without a doubt the product of thorough
consideration by experts in the field. Nevertheless, I argue in this chapter that hard law traditionalists
not only provide unfeasible alternatives to government networks such as the FSB, they also
underestimate its power as an enforcement agent. First, the instruments of international public law are
unsuitable for a policy environment that is driven by fast change and uncertainty. Second, the review
procedures inherent in the design of the FSB can be more effective than legal obligation. Third, certain
institutional innovations in the reconstitution of the FSB strengthen its enforcement powers, giving it
more teeth than previous soft-law arrangements. And fourth, states are entangled in the global
financial system in such interdependent fashion that the mechanisms of issue linkage can be exploited
to bolster enforcement. Please let me elaborate.
The first reason why government networks represent a more suitable design for global financial
governance is that uncertainty and rapid evolution of this policy area puts a premium on speed and
flexibility. Jaime Caruana, general manager of the BIS, refers to this issue as the “regulatory uncertainty
principle” (Slater, 2014). The author states: “In a highly dynamic world, imperfect knowledge leaves
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regulatory design permanently in catch-up mode. […] As soon as a rule, simple or complex, becomes a
binding financial regulation, it will cause changes in financial institutions' risk management that will
make it less binding and less effective.” (Caruana, 2014, p. 2f). Financial corporations do not only have
the ability to work around financial regulation, they also have the incentive to do so. As Romer (2012)
put it in a paper that applies Myron’s Law to financial regulation: “The technology is evolving too quickly.
The scale of the markets is enormous and continues to grow. There may be no other setting in which
opportunism can be so lucrative.” (p. 123.).
Given the speedy operation of this feedback loop between regulators and the industry, the
policymaking procedures of traditional IGOs would render financial rulemaking a hopeless endeavor. At
the same time, the speed and flexibility needed for effective regulation insulates government networks
from external control, in particular that of member state parliaments. Paul Tucker, the Bank of England’s
Deputy Governor for Financial Stability, describes this tension in the following words: “Legislators in
many countries favour rules-based regulation in order to guard against the exercise of arbitrary power
by unelected regulators. But a static rulebook is the meat and drink of regulatory arbitrage. And the
more detailed the rules, the more rules-arbitrage is implicitly legitimized, because the rule-makers must
have said precisely what they meant and no more.” (Tucker, 2014, p. 9). This debate frames financial
regulation as a trade-off between arbitrage on the one hand and illegitimate rule by unaccountable
regulators on the other. Such a view would be unwarranted because legislative scrutiny is neither a
necessary nor sufficient condition for legitimacy, and because accountability can be achieved by other
means, as a later section shows.
The second argument against hard-law traditionalists builds on Raustiala’s (2005) conceptual
separation between form, substance, and structure of international agreements. The author notes that
legally binding agreements often lack substance because treaty members build in generous compliance
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cushions to protect themselves against legal challenges. Alternatively, substantive agreements can be
reached when legal form is replaced by a strong review structure.
In line with this prescription, the FSB has devised a Coordination Framework for Implementation
Monitoring (CFIM) in 2011. It assigns monitoring responsibilities between the internal implementation
monitoring network, the Standing Committee on Standards Implementation (SCSI), and external
standard-setting bodies that are FSB members. The framework establishes a two-stage information flow:
FSB member jurisdictions and standard-setting bodies are responsible to inform the SCSI on
implementation and to evaluate peer performance. The Standing Committee then provides its own
assessment of implementation progress and delivers it to the Plenary. This information sharing process
is restricted to selected officials in the FSB only. The Plenary discusses the SCSI assessment and approves
a selection of “key messages” that are then incorporated into G20 Implementation Progress Reports. It
is at this final stage that information about implementation becomes publicly available (FSB, 2011a).
This filtering process combines peer pressure within the government network at the early stages with
public pressure at the time of the G20 progress report publication.
The FSB has adopted this peer review procedure from the standard-setting bodies that are FSB
members. Their experience reveals that the power of naming and shaming can even overcome
legislative recalcitrance in some instances. An official at a standard-setting body recalls: “We called out
the outliers when there were people who were laggards and a little bit slower in adopting the rules. And I
think that process, I can tell you, it was very effective because there’d be a scramble, a legislative
scramble in the last couple of months in many countries to get their rules in place, because they knew
that we’d be publishing the results.” (International Regulator 5, 2014).
Some scholars contend that consensus rules in the Plenary enable laggards to exercise their
implicit veto power, preventing non-favorable results from being published. In addition, if FSB members
are guided by a deep-rooted norm of mutual deference, they would be unwilling to call out reform
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laggards (Helleiner, 2014b, p. 140ff). Even from a rationalist perspective it is conceivable that avoidance
of naming and shaming is a long-term “cooperation” strategy among states.
However, the FSB reform progress reports that this dissertation relies on extensively do not
support this conjecture. The empirical picture is consistent with the assessment of an international
regulator who states that: “There is plenty of calling a spade a spade about countries that have not
implemented things by the deadline. And yes, there were discussions with all those countries, and most
of them like any child with their homework had got their excuses for why, you know, that you should look
at it in a slightly different way, but that doesn’t mean that what they say the answer should be is what’s
reproduced in that table.” (International Regulator 6, 2014).
The candor of FSB peer reviews and progress reports contrasts with the prevalence of vague and
polished language at the G20. Even though the political headmasters of the FSB have intended to
employ peer review mechanisms with the Mutual Assessment Program and a so-called “accountability
report” (G20, 2013), efforts at naming and shaming fell flat under pressures to apply a diplomatic shine
to G20 documents. Future research is needed to investigate the underlying reasons for the stark
differences in peer review at the G20 and the FSB.
The third argument against hardening soft law arrangements in global financial governance
focuses on the specific institutional innovations that distinguish the FSB from its predecessor, the FSF.
Both generations of this government network have been created by state leaders, and both bring
together regulators, central bankers, and representatives of the executive branch of member countries,
usually finance ministry deputies. But the institutional connection between the political leadership of
member countries and the government network has been strengthened tremendously since the global
financial crisis. All FSB policy documents and reports mention the G20 and from 2012 onwards, they
start with an explicit reference to an item of a G20 declaration. At the same time the G20 reconfirms FSB
authority to pursue global regulatory reform at every leader’s summit.
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The tight institutional connection between government network and political leadership
increases the prospects of domestic implementation in two ways. First, members of the executive
branch are involved both in the negotiation of G20 commitments and in their FSB-coordinated
implementation. In this respect, the commonly used term “transnational regulatory networks” may be
misleading exactly because government networks are comprised not only of regulators. An EU official
explains the crucial difference: “If it is just regulatory standards or supervisory standards, that all
supervisors should be implementing, which are at a sub-legal or sub-parliamentary level. […] Then, this
can work out to the extent that the central bank is the supervisor, which they often are. But not
uniformly. As soon as you’re talking about anything that needs legal transposition: what’s a central
banker?” (EU Regulator 3, 2014). The double involvement of government officials in the G20 and the FSB
might thus make agreements harder to reach because domestic political realities reduce the inter-state
win-set (Odell, 2011; Putnam, 1988). But once an agreement is reached it is more likely to be
implemented than otherwise.
The second benefit of a close connection to political leadership is that it bolsters the peer review
process. Normally, the social pressure that is created by naming and shaming remains confined to the
group of officials in the government network (J. Braithwaite, 2011). The FSB however can escalate this
pressure to the highest political level, as Mark Carney explained shortly before assuming his role as FSB
Chair: “So we’re going to run formal audits, basically, of these things and one of my jobs is going to be to
go back to leaders if there’s an issue and call people out and say, you know: ‘We have a problem here.
You signed this communiqué in 2009 that meant that, and you’re not implementing it, and this has
repercussions.’” (Coyne, 2011).
A final institutional improvement from the FSF concerns membership. Global financial standards
were developed by a handful of developed countries and promoted by the equally selective FSF before
the global financial crisis. The leading economies made an effort to promote a widespread adoption of
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the 12 Key Standards that the FSF had compiled by instituting two types of country reviews, the Report
on the Observance of Standards and Codes (ROSC) and the Financial Sector Assessment Program (FSAP).
As Helleiner (2014) notes: “The creation of the ROSCs and FSAPs marked the first time that the Bretton
Woods institutions had been involved in the emerging international financial standards regime.” (p. 134).
However, an attempt by the G7 to make compliance with these standards a condition for IFI loans was
blocked by resistance from developing countries. Among the countries that resisted FSAP/ROSC or
blocked its publication were not only developing countries such as China and Indonesia but also the
United States.
This situation changed drastically in 2009 in two ways. The FSB and all standard-setting bodies
were expanded to include all G20 countries. In other words, all countries for which compliance with
global financial reform is expected were at the table when the reform package was developed.
Furthermore, a condition for FSB membership is to undergo regular FSAP/ROSC reviews, and both China
and the US are among the countries that have published the results of their reviews (D. W. Arner &
Taylor, 2009). Compliance review is thus not imposed upon the rest of the world by an exclusive club.
Instead, it takes place among members, none of which can shirk from their responsibilities. Moreover,
compliance review takes place at up to three distinct institutional levels: the standard-setting bodies,
the FSB, and the Bretton Woods institutions as part of their FSAP/ROSC.
The fourth criticism of soft-law government networks concerns the narrowness of the
negotiation space. Verdier (2009) argues that successful international negotiations make use of issue
linkages. Financial regulators in turn, the author states, have no trade-offs to offer. The empirical picture
however shows that even a relatively narrow field such as financial regulation offers space for issue
linkage. This is because G20 member states are involved in a variety of international commitments in
issue areas ranging from tax evasion and money laundering to relations with the Paris Club of sovereign
creditors. A country that fails to comply with a substantial portion of FSB commitments has reasons to
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fear not only opprobrium within the FSB but also in these other forums (Argentina Regulator 2, 2014).
Conversely, a stellar compliance record in the FSB may also be of advantage in debt negotiations and
other areas.
In sum, there are many reasons to believe that the critics of FSB reliance on soft law alone are
overly pessimistic. Traditional hard law approaches are too cumbersome to make effective global
financial regulation possible. The design of the FSB substitutes legal form with a strong review structure
to ensure compliance with global standards. It represents a significant institutional improvement from
the FSF, with wider membership and much tighter integration with political leadership in the G20. The
review process is driven by an acceptance of candid messages among members and in public. Moreover,
de facto interlinkages between the FSB and other institutions of global financial governance make it
hard for laggards to assume that non-compliance will only have narrow repercussions. All of the above
reasons give a government network like the FSB an advantage vis-à-vis traditional IGOs in moving
forward the global financial reform agenda. That government networks are less ineffective than IGOs
however does not mean they are effective. Even when the executive branch of member countries is a
supporter of regulatory reform, it faces difficulties in overcoming the challenges that legislation and
legislators pose.
Legitimacy
The quality indicator of government networks in comparison to other institutional designs that
is arguably even more important than effectiveness is legitimacy. The question of legitimacy of
international institutions has attracted more attention with the rise of globalization over the last
decades as these institutions take on an increasing range of responsibilities and policymaking authority
that affects citizens around the world. The perceived lack of legitimacy is particularly acute with regards
to the institutions of global economic governance. From the protests against the OECD’s multilateral
investment agreement to the outcry against IMF mismanagement of the Asian Financial Crisis and street
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rallies against the WTO in Seattle and elsewhere, citizens around the world have expressed their
conviction that the institutions of global economic governance have a negative impact on their lives
without providing them with any channel to make their voices heard (Marchetti, 2009). As the millions
of people whose savings and jobs were destroyed in recent financial crises can attest, mismanagement
of economic affairs can have repercussions for people’s livelihood that are much more immediate and
acute than say a comparable failure to manage the global environment. Given the high stakes of
international policymaking in this issue area, how do government networks compare to other
institutional designs in terms of legitimacy?
Whether international institutions of any design can carry democratic legitimacy is the subject
of much debate. The field can be meaningfully divided into three approaches (Bexell, Tallberg, & Uhlin,
2010). The first group of scholars argues that it is impossible to establish democratic legitimacy at the
supranational level (Dahl, 1999). The intricate polyarchic system of voting equality, effective
participation, enlightened understanding, control of the agenda, and inclusion that endows domestic
institutions with democratic legitimacy cannot be reproduced outside the confines of the nation-state.
In her work on government networks, Slaughter agrees with this outlook: “World government is both
infeasible and undesirable. The size and scope of such a government presents an unavoidable and
dangerous threat to individual liberty. Further, the diversity of the peoples to be governed makes it
almost impossible to conceive of a global demos. No form of democracy within the current global
repertoire seems capable of overcoming these obstacles.” (Slaughter, 2004, p. 8).
This recognition possibly influences state behavior. An empirical study on the rational design of
international institutions shows that treaties among democratic states are less likely to delegate
governance responsibilities to the supranational level than others. Koremenos (2008) interprets her
results as follows: “perhaps democracies worry more than nondemocracies about the democratic values
that international delegations might compromise” (p. 173).
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A second school of thought regards democratic legitimacy as both desirable and achievable for
international institutions if they undergo democratic reforms (Held, 1995). Advances in technology and
the recognition of fundamental interdependency on a global scale, scholars argue, provide the
foundations for the evolution of a cosmopolitan polity that engages with global institutions similar to
the way citizens do with their respective domestic institutions. Some even believe that democracies will
spread democratic values to other member states and thus enhance the legitimacy of global institutions
in a virtuous cycle. For example, Kirton (2013) believes that “Because open democracy has dominant
global appeal as the form of ‘right rule’ for the future, the G20 will become an increasingly legitimate
club.” (p. 19). Such ideas are likely to be dismissed as Western wishful thinking at best and universalistic
hegemonic overreach at worst by Russia, China, and Saudi Arabia, the non-democratic members of the
G20.
A third school of thought discards the idea of democratic legitimacy altogether. Keohane and
Nye (2003) contend that legitimacy and democracy should not be confounded. Taking the democratic
nation-state as the ideal type is not useful for assessing the degree of legitimacy of an international
institution. The authors further argue that even in democracies, officials are held accountable by other
means than electoral competition. That federal judges and central bankers for example are not subject
to electoral procedures does not decrease the legitimacy of their offices.
As an alternative to electoral procedures, accountability can be achieved through hierarchical,
reputational, legal, and market mechanisms. Of these four, the former two might be of particular
relevance for global governance institutions. Hierarchical accountability refers to the power of principals
to appoint and remove agents from office. The effectiveness of this kind of accountability depends on
the degree to which regulators are chosen by the executive or legislative branches of their respective
jurisdictions. But even if regulators enjoy independence from these political institutions, as central
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bankers do for example, they still subject their decisions to public scrutiny as a form of reputational
accountability.
Keohane and Nye (2003) add that accountability in what they term “policy networks” depends
also on the diffusion of power and the checks and balances among stakeholders. Yet the authors
acknowledge that “networks are by definition elitist” (p. 403), thus power tends to be highly unevenly
distributed both among states and among different sectors of society.
Hierarchical accountability in government networks minimizes slack between network agents
and state principals, but is clearly insufficient if the principal is subject to regulatory capture at the
domestic level. Reputational accountability in contrast can be a powerful mechanism at the global level
when affected parties across the world have the chance to scrutinize the regulatory decision-making
process.
In a subsequent publication, Buchanan and Keohane (2006) develop the idea of legitimacy for
international institutions further. The authors propose a “workable definition” of an institution as
legitimate when it is worthy of support even though it does not maximize members’ benefit and does
not live up to the highest normative standard (universal justice) (p. 12). Buchanan and Keohane start by
examining government support as a prerequisite for the legitimacy of an international institution, but
concede that this condition would not hold for undemocratic governments. The authors then propose
three substantive criteria for assessing legitimacy: minimal moral acceptability (that is no violation of
human rights), comparative benefit, and institutional integrity. Comparative benefit exists if an
international institution’s operations provide benefits to members that they could not otherwise obtain
– a variant of output legitimacy (Scharpf, 1999). The institutional integrity criterion is met when there is
no egregious disparity between an institution’s self-proclaimed goals and the procedures and outcomes
of its operations. In short, an international institution is legitimate if its existence makes member states
better off, and if its operations match its goals (Buchanan & Keohane, 2006).
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Low as the bar may seem, many international institutions would struggle to meet these
legitimacy criteria. This is not necessarily due to institutional performance but the uncertainty of the
global policy environment (J. R. Barth, Caprio Jr., & Levine, 2004; Best, 2010). For example, if the FSB’s
goal is to reduce the depth and likelihood of a global financial meltdown, will the institution be
considered illegitimate when the next global crisis hits? Also, when a global financial crisis exposes the
failure of governance institutions at all levels – from inter-governmental organizations and standard-
setting bodies to national legislatures and state leaders – to protect citizens, do all lose legitimacy in
comparable ways? Tying legitimacy to performance in a complex and uncertain global environment may
be a suboptimal way of assessing the quality of an international institution.
Instead, this chapter proposes two standards of procedural legitimacy: transparency and
inclusion of stakeholders. The transparency of an organization depends on the degree to which it makes
membership, organizational structure, inputs and outcomes of the policymaking process publicly
available. In this respect, the FSB started as one of the least transparent international institutions, as
opaque and secretive as the BIS that hosts and bankrolls it. An external audit of the FSB in 2011
concludes: “The FSB’s governance arrangements reflect, to a large extent, the central banking dimension
of its membership, which leaves considerable room for greater transparency and accountability.”
(Lombardi, 2011, p. 19). Since then, the FSB has made an effort to increase transparency by publishing
the minutes of meetings, comment letters, and speeches by the Chair. Nevertheless, the FSB still ranks
poorly in the transparency assessment of a global watchdog, scoring below financial institutions such as
the World Bank and the IMF (New Rules for Global Finance, 2013, 2014).
Government networks face the question of inclusion at an international and a domestic level:
which countries are members, and what stakeholders in member countries are involved?
The question of inclusion is at the heart of the dilemma between effectiveness and legitimacy.
As discussed in Chapter 5, global financial governance institutions have traditionally prized effectiveness
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and exclusion, espousing a minilateral approach by “bringing to the table the smallest possible number
of countries needed to have the largest possible impact on solving a particular problem” (Naím, 2009).
The selection criteria for membership in the clubs of financial governance however vary in important
ways. The FSF and many standard-setting bodies were comprised of major financial centers and
economies with similar levels of development. The G20 meetings of finance ministers and central bank
governors in turn were designed from its beginnings in 1999 to bring together systemically important
economies with wide regional representation (Helleiner, 2010; Kharas & Lombardi, 2012). With regards
to membership, the FSB is thus more of an heir of the G20 than of the FSF. Member countries of the FSB
represent 70% of the world population and 90% of world GDP. Neither the G20 nor the FSB however
provides the remaining G172 (Payne, 2010) with a seat at the table. In order to attenuate the tension
between outsiders and insiders and extend channels of deliberation to non-members, the FSB
established six regional consultative groups in 2011. In sum, the exclusive club of global financial
governance counts on a much wider and more diverse membership than before the global financial
crisis. That does not mean however that the FSB has abandoned a minilateral approach, or that it will
transform into a widely representative forum at any point in the future.
The second question of inclusion is more difficult to answer: which stakeholders within member
countries should have a voice in the FSB? Financial market regulators have traditionally considered
financial firms and investors as their constituency. However, as the global financial crisis made clear,
even citizens that have no involvement in financial markets suffer from the repercussions of a financial
meltdown. Furthermore, broadening the circle of stakeholders subjects public policies to increased
scrutiny. As Charnovitz (2010) asserts: “Transnational civil society and business should have an
opportunity to participate in dialogues with regulators so that the problems of government failure can
be exposed.” (p. 760). An assessment of legitimacy should thus take into account to what extent those
affected by the policies of an organization are included in policy deliberations.
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The original FSB charter contained a provision for “consultation with private sector authorities”,
but as a consequence of widespread criticism it was revised in June 2012 to provide for a wider
“structured process for public consultation on policy proposals” (Helleiner, 2013). According to this
procedure, FSB publishes rule proposals and invites public comment letters from interested parties. At
the end of the consultative period, comment letters are made public, and the agency takes comments
into consideration when finalizing the rule-making process. By using a process that is common among
domestic regulatory agencies, it is also adopting one of their sources of procedural legitimacy (Majone,
1997).
Scholars of global governance propose a standard of procedural legitimacy that goes beyond
mere consultation: deliberative equality. Slaughter (2004) argues that a basic principle for all legitimate
government networks is the inclusion of all relevant and affected parties on an equal footing. This ideal
is shared by many scholars of globalization who have studied the rise of transnational civil society
(Barnett & Finnemore, 1999; Berry & Gabay, 2009; Bexell et al., 2010; R. C. Carpenter & Jose, 2012;
Castells, 2008; Cerny, 2010; Finnemore & Sikkink, 1998; Fraser, 2007; Glasius, Lewis, & Seckinelgin, 2004;
Kaldor, 2003).
It is not clear however how deliberative equality can be attained. Baker (2009) argues that a
wide range of societal interests should be involved in financial regulatory deliberations: “Unfortunately,
‘transgovernmentalism’ is entirely incompatible with deliberative equality, and it is precisely the
transgovernmental characteristics and qualities of the GFA [global financial architecture] that have to be
reformed and challenged if we are to arrive at anything approximating deliberative equality.” (p. 196).
My argument in this chapter makes exactly the opposite claim. There is no such thing as
deliberative equality in global finance, and it would be wrong and dangerous to aspire to this ideal in the
design of any governance institution. For reasons that I will flesh out below, the deliberative field in
financial matters is so heavily tilted in favor of private special interest groups that the only way to
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achieve regulation in the long-term public interest is to insulate the policymaking process from societal
deliberation as much as possible.
The field of stakeholders in global finance is beset by structural inequalities in three dimensions
that expose the idea of deliberative equality as a dangerous illusion. The first structural inequality has
been identified half a century ago. Mancur Olson (1968) recognized that the distribution of costs and
benefits of a policy is a key driver of the logic of collective action. The cost of financial regulatory failure
may be acute enough to spur societal action in the wake of a crisis, but the benefits of financial stability
are too diffuse for civil society actors to sustain political mobilization. In contrast, the financial sector has
a clear and persistent incentive to water down financial regulation.
Even in the immediate aftermath of a financial crisis, the uneven distribution of costs and
benefits of financial regulation undermines any potential for deliberative equality. An activist from the
United States notes: “The overriding problem that we faced and that is currently the case is that
financial services unfortunately lives in the mud of enormous campaign contributions from the financial
sector and complexity, which allows a Senator to view banking as a fundraising opportunity for which
bad policy will not generally get him in trouble with his electorate. Nobody in Idaho is going to vote for
or against Senator Crapo based on his views on margin requirements for cross-border swaps trading.”
(US Civil Society Representative 2, 2014).
This situation is exacerbated by Aizenman’s (2009) “regulatory paradox”: assessing the benefits
of regulation relies on the counterfactual of “crisis avoided” whereas the cost of regulation is tangible
and measurable. Due to this fundamental information asymmetry, long periods of regulatory success
may actually contribute to the reduction of the perceived optimal degree of regulation. Moreover,
Mattli and Woods (2009) note that common interest regulation can only be achieved as the result of
extensive institutional supply in combination with broad societal demand for regulation. The unequal
distribution of costs and benefits in society and over time makes this outcome unlikely.
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The second structural inequality in the field of global finance lies in the access to information.
Sensible regulation in general and in finance in particular relies on high-quality data and sophisticated
methods to estimate the likely impact of a given policy. Both access to this data and the technical skills
to process it in meaningful ways couldn’t be more unevenly distributed. A bank lobbyist explains: “They
know that they don’t have the information. I mean they really, having been working in the European
Commission, where do you get your information about what is going on and what will work? Who else is
going to give it to you? If you talk to the Consumer Federations, those guys are chronically under-
resourced. The investors equally. You know I’ve got a lot of time for them but they, they really do not
have the resources. Who is going to give you the information? Ultimately the only people who have the
information, or who can tell you exactly what’s going on, are the banks.” (US Lobbyist 1, 2012). In all
areas of financial reform covered in this dissertation, the finance lobby has consistently used dynamic
stochastic general equilibrium models and sophisticated econometric methods to convince policymakers
that proposed regulation has a devastating impact on the industry, growth, and jobs. No civil society
organization in the field currently has sufficient technical expertise to counter these claims. In order to
address these stark inequalities in the deliberative field, the European Parliament even decided to
establish an advocacy group, Finance Watch, and support it with public funds. Yet the only groups that
have convincingly exposed the claims of the finance lobby as overly dramatic are regulators themselves,
and academics. As long as parliaments and civil society groups lack the technical sophistication to
undertake cost-benefit analyses and quantitative impact studies, their arguments are likely to lose out
against those of the private sector.
Whereas the first two structural sources of inequality exist both domestically and internationally,
the third one manifests in the capacity of cross-border organization. The recognition that financial
rulemaking increasingly takes place at a global level has triggered a structural transformation among
financial trade associations. The few lobby organizations that existed at the global level before, such as
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the IIF and ISDA, received stronger financial backing from their member firms, while previously domestic
organizations went global. When asked about the reasons for the establishment of a new global
umbrella organization, a bank lobbyist responds: “Everybody realized in 2008 and 2009 that what was
going on in the different jurisdictions ultimately related to one another. So it’s to make sure that what
we’re advocating for in the European marketplace is consistent with what we’re advocating for in the
Asian marketplace, and in the American marketplace.” (US Lobbyist 3, 2014). Civil society organizations
in contrast have failed to establish comparable cross-border organizational structures (Landolt &
Goldring, 2010). The arguments and policy goals of American and European civil society organizations
are sometimes inconsistent, not developed in coordinated fashion, and cross-border cooperation
attempts to date have been limited to information exchange and the occasional joint signing of position
papers. Asked about the reasons for this lack of cross-border coordination, an American activist admits:
“If we had more resources we would do a better job collaborating with our counterparts in Europe and
elsewhere, but there are enough brush-fires right now for us to put out, and we’re largely playing
defense.“ (US Civil Society Representative 2, 2012). A deeper inquiry into why financial advocacy groups
represent a patchwork rather than a network are beyond the scope of this work. In effect however, in
the deliberation of global standards, the financial lobby increasingly speaks with one voice, civil society
does not.
In sum, the field of policy deliberation in global finance is heavily tilted in favor of the private
sector. The finance industry faces concentrated costs and benefits that promote collective action. It can
rely on information asymmetries such as that between counterfactual benefits and tangible costs of
regulation, and it has a near-monopoly on firm data to support its arguments. In addition, the technical
expertise to turn this data into sophisticated policy arguments is largely absent outside the industry,
with the exception of regulators. Furthermore, the private sector is investing considerable resources to
respond to policy proposals with one global voice whereas civil society organizations still largely
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represent the jurisdiction where they are headquartered. The inequalities identified here are of
structural nature, they cannot be addressed with changes in leadership, motivation, or circumstances.
By ignoring them, proponents of deliberative equality run the risk of promoting a race where some
contenders use bicycles while others drive cars.
Given the fundamental inequalities among stakeholders, it may be more sensible to consider the
inclusion of any kind of advocacy group as an indicator of permeability to third parties (Broz & Hawes,
2006; Gould, 2006; D. G. Hawkins & Jacoby, 2006). Keohane and Nye (2003) argue that in the
development of technical standards where the public is “rationally ignorant”, the exclusion of outsiders
from the policy deliberation process does not make the organization unaccountable. When asked about
the difference between regulatory agencies at the national and international level, a bank lobbyist
responds: “The FSB to me is, I don’t want to say secretive, but it’s not exactly transparent. If you go on
the FSB website for example, there’s no detail, probably for a variety of factors they do it that way but it
doesn’t mean that we don't dialogue with the guys in FSB.” (US Lobbyist 3, 2014). From the point of view
of permeability and capture, the relative scarcity of access points for private special interest groups thus
can be considered a sign of legitimacy. A similar argument was made against tripartite governance
arrangements in the 1990s such as the UN Global Compact that brought together private interest groups
and NGOs. Global governance arrangements, critics say, should not consist of a self-selecting group of
corporate and civic actors that are driven by profit and passion, respectively. In this respect, government
networks such as the FSB enjoy greater legitimacy because they are able to “exercise authority at the
global level without centralized power but with government officials feeling a responsibility to multiple
constituencies rather than to private pressure groups” (Slaughter, 2004, p. 257).
Civil society organizations nevertheless have an important role to play as accountable-holders of
government networks. McCubbins et al. (1987) propose several measures to reduce slack in domestic
regulatory agencies. One of them, called “fire alarm”, relies on the mobilization of affected
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constituencies in the face of wrongdoing by the agency. Likewise, persistent monitoring by civil society
groups is one important channel to hold government networks such as the FSB accountable.
In sum, the legitimacy of government networks in general and the FSB in particular is harder to
assess than its effectiveness. As the preceding discussion shows, the indicators of legitimacy are in
dispute. For example, linking legitimacy to performance has benefits but can be problematic in an
uncertain policy environment. Furthermore, while some regard institutional openness to deliberation
among societal actors as an indicator of deliberative equality and thus legitimacy, others see it as a sign
of capture by special interest groups. This chapter highlights the importance of procedural legitimacy
and proposes two indicators: transparency and inclusion of stakeholders. In both categories, the FSB
occupies a non-stellar position, but it represents an improvement to previous financial governance
institutions. At an international level, systemically important countries from all regions are at the table,
irrespective of their level of development. Agenda-setting power is likely to unevenly distributed, but
not necessarily more unevenly than in the voting schemes of the Bretton Woods institutions. The
diversity of societal interests can be expected to be aggregated in the preferences of the regulators and
finance ministry officials that negotiate global standards at the FSB. In addition, interested parties can
take part in the public consultations that accompany the global rule-making process. And civil society
organizations can play an important role in triggering “fire alarms” when the agency violates its mandate.
At the same time, this chapter argues that given the massive structural inequalities that plague the
deliberative field in global finance, insulation from special interest groups is a strong feature of
networked governance in the FSB rather than a weakness. In short, the FSB can be regarded as
legitimate as other global financial governance institutions. That is, not much. Deliberative equality may
be a valid standard for procedural legitimacy in general, but it is impossible to attain in a system where
incentives and capabilities are as unevenly distributed as in global finance.
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Conclusion
The global financial crisis of 2007-9 and the Great Depression of the 1930s have a few things in
common. Both occurred at a time of unfettered global capital flows when policymakers regarded global
financial integration as a driver of prosperity. Both originated in the most advanced capital market, that
of the United States, and its negative effects spread around the world. In the aftermath of both financial
crises, politicians and regulators revised their attitudes vis-à-vis financial liberalization, and they created
new prudential agencies in order to guard against future financial meltdowns. But whereas the Great
Depression brought an era of globalization to a cataclysmic end, the policy response to the global
financial crisis was not retrenchment and return to the primacy of the nation-state. Instead, heads of the
leading nations promoted two new institutions to govern the global economy: the G20 and the FSB. As
the site for coordination of the G20-led financial regulatory reform agenda, the FSB is arguably the most
prominent government network to date.
This dissertation is among the first scholarly attempts to assess the performance of the FSB and
to draw inferences on the conditions of networked global governance in general. The analysis of global
financial regulatory reform shows that the different institutional pathways chosen by policymakers have
a major impact on reform progress. Legislators and legislation emerge as the primary obstacle to FSB-
coordinated reform. The recalcitrance of legislators becomes understandable when placing it in a
greater framework that exposes the tension between the vertical hierarchies of the nation-state and
horizontal transgovernmental networks. Legislators have seen their policymaking authority eroded with
the rise of the network society and the regulatory state. Government networks such as the FSB
represent an institutional design that enables state leaders to harness the benefits of delegation while
keeping agency costs low. It also furthers the goals of regulators, but it leaves legislators behind. The
territorial attachment and institutional myopia of national parliaments prevent legislators from
meaningfully engaging in government networks. The resulting turf battle over policymaking authority is
231

the main impediment to reform progress in global financial regulation, and likely an obstacle for the
operations of government networks in general.
This dissertation is among the first empirical studies of financial regulatory reform in the wake
of the global financial crisis. The reform process analyzed here has not come to an end, and in this
respect this study focuses on a moving target. Greater temporal distance is needed to provide a more
encompassing assessment of reform success and shortcomings in the future. Moreover, this study
focused only on the three major items on the G20 reform agenda. Other areas of financial reform may
develop along different institutional pathways and reveal other features of global financial governance.
There is also much work to be done in widening the thematic scope and comparing the operations of
global governance in the fields of trade, environmental regulation, and others.
The rise of transnational networks, first in business and now in governance, has been more
pronounced in the financial sphere than other issue areas. Although government networks of financial
regulation have their particularities, the tension between them and legislative bodies may emerge as a
common feature of networked governance. In finance as elsewhere, government networks will be
subjected to intense scrutiny regarding their effectiveness and legitimacy. This is a good thing. Whether
the power of public global networks can be geared towards the public good via sensible networked
governance, or whether they reproduce the polarizing, exclusive qualities of their private variety will
have a major impact on whether citizens around the world regard the forces of globalization as a threat
or as a blessing.

232

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Creator Knaack, Peter (author)

Core Title Examining global financial regulatory reform in the G20 and the FSB

School College of Letters, Arts and Sciences

Degree Doctor of Philosophy

Degree Program Political Science and International Relations

Publication Date 03/30/2016

Defense Date 10/29/2015

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Advisor Katada, Saori (committee chair), Aizenman, Joshua (committee member), Castells, Manuel (committee member)

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