Eight years have passed since the most recent global financial crisis although its long-term effects linger in the form of low growth rates, weak labour markets and high levels of public and private indebtedness in many countries.  History suggests that we will experience more crises which will increasingly exhibit international dimensions with the internationalization of financial markets. Thus, we must confront the central question of whether there is an optimal regulatory structure that countries should implement, given that members of the G-20 have individually committed to regulating systemic risk in their respective domestic economies.

Financial crises come in many shapes and sizes. In a recent widely acclaimed survey of eight centuries of financial crises around the globe, Reinhart and Rogoff (2009) helpfully categorize them as including sovereign defaults, banking crises, exchange rate crises and finally crises marked by bouts of very high inflation that constitute the de facto equivalent of outright default on public or private sector debt. These are not watertight categories, of course – what may begin as one type of crisis can quickly transform into a different class of crisis both within and across countries.

Historically, many countries have implemented sectoral or institution-based regulation, e.g. maintaining a separation between banking as a deposit-taking endeavour and securities trading, but this loosely coordinated framework failed to reflect the dramatic growth of financial transactions that cross-sectoral boundaries.

An alternative to sectoral regulation is to regulate financial markets according to certain regulatory objectives specified in applicable legislation. This approach identifies three basic regulatory objectives that the regulatory architecture must address: macroeconomic stability typically associated with central banks in terms of implementing monetary policy and acting as lender of last resort in maintaining liquidity in the financial system; microprudential regulation which focuses on the financial stability of individual financial institutions; and conduct of business regulation designed to protect consumers of financial services and investors in financial institutions.

We favour this model as it benefits from specialization and coordination advantages. The model, sometimes called “twin peaks” regulation, divides responsibility according to regulatory objective (though “twin peaks” is something of a misnomer, as the model identifies three not two basic regulatory objectives). Australia’s regulatory structure is a strong case in point consisting of the Australian Prudential Regulatory Authority, the Australian Securities and Investment Commission, and the Reserve Bank of Australia, with a committee of the heads of these agencies playing a coordinating role.

This “objectives-based” model is superior to the sectoral approach: distinct regulatory objectives require distinct regulatory strategies. For example, business conduct regulation of market participants can be adversarial, while prudential regulation is often cooperative, solutions-oriented, and based on repeated interactions between regulators and market participants. It seems clearly preferable to an integrated approach, exemplified by the now disbanded UK Financial Services Authority, in which a single entity is tasked with the regulation of financial markets (including banking and insurance, microprudential regulation, and business conduct). Unlike the integrated approach, an objectives-based model is less prone to one priority giving way to another (e.g., consumer protection prioritized over the soundness of financial institutions, or the converse) and introduces some checks and balances in the regulatory regime.

Canada’s financial system does not exhibit either the twin peaks or integrated structure but sits somewhere in between. Separate agencies regulate banking, insurance, and securities activities which has meant that monitoring systemic risk historically has required coordination among the Bank of Canada, the federal prudential regulator (OSFI) and provincial and territorial securities regulators. Multiple securities regulators impede centralized decision- making during financial crises, something that the proposed cooperative capital markets regulator would alleviate.

But we must remember that the question of regulating systemic risk is not just a domestic question. At the international level, cross-border contagion requires a coordinated response among international standard-setters which also have historically reflected an institutional or sectoral structure. Facing an international economic downturn during the crisis, the G20 accelerated policy reforms, effectively directing changes to regulatory standards through organizations such as the Basel Committee on Banking Supervision, while the new Financial Stability Board seeks to play a co-ordinating role internationally across financial sectors.

The voluntary and informal nature of these international arrangements presents an additional problem in monitoring and enforcement. An expanded use of soft law, including memoranda of understanding, among countries is necessary to bind them to a system of monitoring and managing systemic risk.

How would MOUs be useful? A loose network of international institutions is responsible for various aspects of financial oversight.  The G20 and Financial Stability Board determine policy direction, for example, but neither can coordinate the implementation of these standards across countries. We argue that countries should voluntarily enter into MOUs with each other to bind themselves to both monitoring and coordinating on systemic risk issues. Regarding OTC derivatives, for example, countries would seek a commitment at the national level from each member country to reach agreement about trade repositories and/or central counterparty clearing (with assistance no doubt from domestic regulators where needed). At present, countries are pursuing individual initiatives in this area that are not necessarily harmonized with each other.

The question that would then arise is which body, if any, would play an enforcement role if countries violate their obligations under an MOU? Three options present themselves. The first alternative is for individual countries to decide whether there will be domestic enforcement in case of violations of global standards. This option is a “path of least resistance” of sorts and would not likely result in effective coordination among countries in the long-term, given countries’ willingness to defect in cases where it is in their own self-interest to do so. Countries may walk a grey line by choosing to “cherry pick” from the international rules or under-enforce them.

A second alternative would be to create a new governing body to play a coordinating and enforcement role not simply in the area of prudential supervision and enforcement but in all areas of financial regulation as specified in the MOU or treaty. Along these lines, Eichengreen (2010) calls for the creation of an international financial regulator –structured in the same general manner as the World Trade Organization – to establish and enforce principles upon member states. Kern and Dhumale (2006) propose a global financial governance council to be established under a multinational treaty. Treaty signatories would agree to meet standards developed by delegated standard-setting institutions such as Basel, IOSCO, etc. – which would largely be left unchanged. The signatories could opt out of standards in certain cases, such as when they would undermine domestic financial stability. The council would be comprised of any willing state, thus moving out of the G20 “agenda setting” model. Supervision (i.e., monitoring and compliance) would remain with domestic authorities. This proposal does not include enforcement as one of the roles of the international body. But we believe that some type of enforcement, including mandatory peer reviews that compel or incentivize countries and their financial institutions to follow international standards, is necessary in the international arena, relying principally on reputation costs and higher costs of “capital” to undue initial commitments and subsequent compliance (a form of signalling effect).

Whether or not it is charged with enforcement powers, the creation of a new international body would entail significant costs that may not be outweighed by the benefits of the new organization. While countries gain some status in taking membership in such organizations, they are likely to be reticent in implementing the policy recommendations of these organizations holus bolus. They may not, therefore, yield to attempts by the organization to enforce its rules and standards by applying sanctions and settling disputes through adjudication. IOSCO is a clear example of an international organization that has numerous members and sets standards that members aim to follow. Yet IOSCO (which has members from over 100 different countries that regulate more than 90 percent of the world's securities markets) has no remit to undertake enforcement actions against its members for failing to implement its recommendations. Its membership may decline if it attempted to do so.

A final alternative is to utilize existing international organizations, such as the IMF, the FSB or IOSCO, to manage systemic risk. Under this alternative, countries would comply with obligations under an MOU or treaty into which they enter voluntarily. The costs of setting up an oversight program would be less than under the second alternative because countries would be using a current organization in which they are members, including its infrastructure and bureaucracy. Countries would agree to coordinate their oversight efforts and share information regarding relevant NSR issues that come to their respective attention. Essentially, they would agree to alter the mandate of the existing organization and to abide by its standards and ex post reviews, including peer review assessments by other countries.

Along these lines, Garciano and Lastra (2012) seek to make the IMF a global sheriff. They argue for a shift towards a hierarchical structure modeled after the WTO, with similar dispute settlement and enforcement powers. This proposal is potentially effective as it builds on the backbone of a relatively successful global organization that provides a framework for countries’ conduct in negotiating and formalizing trade agreements as well as a formal dispute resolution process. Indeed, the WTO Financial Services Agreement may be appealing as a model to follow in the international realm of financial institution regulation. The main difficulty with this model, however, is that the dispute resolution process can take years to complete and may be impractical in financial markets that can move significantly and quickly on the basis of just one piece of information. It is impractical to expect that a WTO-type process can be transplanted to regulating systemic risk in the financial services sector.

We should not be blind to the fact that global financial reform is extraordinarily difficult to affect for various political, legal, and economic reasons. There is a certain path dependence that constrains major shifts in the institutional landscape from both a standard-setting and an enforcement perspective. Path dependence is driven by a series of self-reinforcing mechanisms that inhibit the adoption of different institutional arrangements.

However, major economic shocks provide a window for overhauls in a country’s institutional architecture. The 2008 financial crisis led the UK government to shift from an integrated structure to an objectives-based form of regulation. The US eliminated a federal agency (the Office of Thrift Supervision) and established the Financial Stability Oversight Council and the Consumer Financial Protection Bureau as part of their Dodd-Frank Act reforms, although the U.S. regulatory system remains remarkably diffused among a host of federal and state agencies.

Similarly, the 2008 crisis has also presented an opportunity for Canada to re-examine and improve its financial system, and to move towards a more fine-tuned objectives-based model. This model would consist of a single securities regulator, a prudential authority and the central bank.  Whether a new model of financial regulation is more robust than its predecessors must await stress testing in the next potential global financial crisis, which sooner or later we are bound to confront.

Anita Anand and Michael Trebilcock are co-authors of a chapter in the recently published book entitled Systemic Risk, Institutional Design and the Regulation of Financial Markets, Anita Anand, ed. (Oxford, 2016).


Barry Eichengreen, ‘International Financial Regulation After the Crisis’ (2010) Daedalus 107.

 Luis Garciano and Rosa M. Lastra, ‘Towards a new architecture for financial stability: seven principles’, in Thomas Cottier, John H. Jackson, and Rosa M. Lastra (eds.), International Law in Financial Regulation and Monetary Affairs (OUP 2012).

 Alexander Kern and Rahul Dhumale, Global Governance of Financial Systems (OUP 2006).

 Carmen Reinhart and Kenneth Rogoff, This Time Is Different: Eight Centuries of Financial Folly (Princeton University Press, 2009).