International Economic Situation
London, January 29, 2008
The global economy has experienced a period of stable and sustained growth. However, recent financial turbulence has increased the risks for 2008. The fundamentals of the European economies remain strong with employment still rising. They are thus well placed to face the challenges presented by heightened global uncertainty. As the leaders of the major European economies we remain committed to cooperating closely to maintain economic stability, and to strengthening and deepening economic reform. At this time of global uncertainty we need to signal our commitment to an open global economy. An ambitious and balanced agreement on the Doha Round, to which we are committed, is essential to this.
Financial markets globally have suffered a prolonged period of turbulence triggered by the sub-prime crisis in the United States which spilled over into other financial markets. Prompt and coordinated action has helped to ease the immediate problems, though there is no room for complacency.
In view of this we remain fully supportive of the call for action in the joint declaration of 19 October. We look forward to discussing the outcome of the work currently under way in the Financial Stability Forum, and to discussing at the Spring European Council Ecofin’s work to examine the causes and proper response to recent financial market turbulence. vIn developing a longer-term response we should be guided by three principles:
First, primary responsibility for managing risk is and must remain with individual financial institutions and investors.
Second, this needs to be backed up by strengthened national regulatory and supervisory frameworks.
Third, regulatory authorities in different countries need to cooperate and exchange information effectively in the EU and internationally to prevent and manage crises and contagion.
More immediately, however, we must rebuild confidence and increase the transparency of financial markets, institutions, and the instruments they trade by: improving the quality of the information available to investors on structured products, including in relation to their valuation; enhancing the understanding and management of risk; and avoiding possible conflicts of interest.
To this end we call for:
improvements in the information content of credit ratings to increase investors’ understanding of the risks associated with structured products, and for action to address potential conflicts of interest for rating agencies. While preferring market-led solutions, such as the amendment of the IOSCO code of conduct, if market participants prove unable or unwilling to rapidly address these issues we stand ready to consider regulatory alternatives;
improvements in the understanding of banks’ and other financial institutions’ exposure to off-balance sheet vehicles. We call upon the major audit firms and supervisors to deliver clear and consistent guidance on valuation and disclosure of such risks; and
prompt and full disclosure of losses of banks and other financial institutions that would help reduce uncertainty and improve confidence in financial markets;
improvements in EU early warning on financial stability through regular reporting from the Level 3 committees (CEBS [Committee of European Banking Supervisors], CEIOPS [Committee of European Insurance and Occupational Pensions Supervisors] and CESR [Committee of European Securities Regulators]);
market participants, the FSF and the EU to act rapidly to ensure adequate transparency and disclosure about how structured products are valued, that uncertainties around those valuations are clear and that risks are well managed.
Recent events have also shown that we need to improve management of liquidity risk. The Basel Committee of Banking Supervisors should bring forward standards on improving the international management of liquidity risk. Additionally, we need to improve dialogue between supervisors and firms about risk management and stress testing.
Market-orientated solutions are crucial to achieving the necessary improvements in business operations and in interactions between market participants. We therefore welcome the voluntary best practice standards presented by the London-formed Hedge Fund Working Group on 23 January 2008 in the context of the Financial Stability Forum’s five recommendations on hedge funds.
International and EU cooperation
It is also important to ensure the work already under way in the Financial Stability Forum and the EU to improve crisis prevention and management is concluded and implemented as soon as possible. This should include:
measures to foster the effectiveness of EU networks of financial supervisors and to ensure strong and effective supervision of cross border groups;
common principles for international financial crisis management;
a common analytical framework for the assessment of the systemic implications of a potential crisis;
common practical guidelines for crisis management, including improved information exchange; and
closer cooperation between countries with particularly important links at firm or capital market level.
Reform of the international institutions
The recent market turmoil has also highlighted the need for reform to ensure that global institutions can meet the challenges of the 21st century. We need a better early-warning system for the global economy and we need to ensure that its warnings have the force and authority to ensure that they are acted upon. To this end:
in the short term the IMF and Financial Stability Forum need to report at the next IMF meetings on the threats to the global economy from financial sector developments. This will improve transparency about risks in the financial sector and how markets and regulators are responding. The IMF and FSF should also present as soon as possible proposals on how they will further enhance their cooperation.
in the longer term we should consider how to strengthen and clarify the IMF’s responsibility to oversee macro financial stability./.