They are here to fix the world

The most important financial conference ever to be held in Israel will take place in Tel Aviv.

Greg Tanzer 88 248 (photo credit: Courtesy)
Greg Tanzer 88 248
(photo credit: Courtesy)
The most important financial conference ever to be held in Israel will take place next week in Tel Aviv. Members of an organization most Israelis (and pretty much everyone else) have never heard of will gather to consider proposals on how to make global stock and bond markets function better, in the wake - perhaps in the midst - of the worst financial crisis in 80 years. Their decisions will, almost certainly, affect everyone with money invested in any stock market; if you have pension savings or an insurance plan, that includes you. IOSCO, the International Organization of Securities Commissions, is the umbrella organization for the regulators of securities markets in over 100 countries. As such, it is one of the key players in the effort underway to repair and, where necessary, rebuild the global financial system, after the hammering it took in 2007-08. Although the markets have rebounded strongly over the last three months - the rise in the US stock market has been the sharpest since 1933 - there is no pretence that "things are OK now" and the markets can get back to their pre-crash state. The damage inflicted during the 17-month slump from October 2007, when most major market indices made their record highs, until the low-point of early March 2009, is too severe to be glossed over. Even if prices recover, the revelations regarding how critical components of the financial system malfunctioned have generated a crisis of confidence that must be resolved, if the public is to be persuaded to keep its faith and its money in financial institutions and if similar disasters are to be avoided in the future. Those revelations, regarding investment and commercial banks, mortgage lenders, rating companies, underwriters and many other players in the securities markets, all beg the same basic question: where were the regulatory agencies that are supposed to oversee the markets and make sure that everyone is playing by the rules? It would seem that either the regulators were not doing their job in identifying and eliminating violations, or the rules were unsatisfactory to start with - in which case the regulators should have made better ones. This is the background of criticism, finger-pointing and ex-post blame-distribution, against which securities regulators from around the world are gathering in Tel Aviv for IOSCO's annual conference. When the Israel Securities Authority persuaded its global peers to have its 2009 confab in Tel Aviv, no one imagined in their wildest nightmares that the agenda would be dominated by recent market collapse and an unprecedented campaign targeting securities authorities for having been incompetent, misguided or simply asleep at the wheel when the vehicles they were supposed to be steering crashed. This state of affairs, which could euphemistically be decribed as "challenging," finds Greg Tanzer, who became IOSCO's secretary-general in November 2007, as laid-back and unflustered as you might expect from a 45-year-old Australian who describes himself as "a keen bushwalker." Asked in a phone interview from his office in the organization's Madrid headquarters whether the upcoming conference would move IOSCO in an evolutionary or revolutionary direction, his answer was "a bit of both". "We want to preserve the benefits of vibrant and efficient capital markets because they are needed by both investors and firms that raise money through the markets," Tanzer explained. He admitted, though, that that was "a lofty and ambitious goal", but nevertheless an essential one, if the global financial system is not to return to a saving and lending structure, wherein banks serve as the primary source of capital for businesses. At the same time, he is well aware of the arguments that markets were abused. "We agree that the structure and the system must improve, and therefore the focus must be on well-regulated markets." But not over-regulated, he stressed, because then the markets lose their vitality and effectiveness. "You can't take all the risk out of the financial system, because then there is no innovation. IOSCO wants to move to a system which builds in the risk and takes it more fully into account." In practice, what that means from Tanzer's and IOSCO's perspective, is extending the role and reach of regulatory agencies to cover areas previously left out. These were the areas in which the problems grew and developed and eventually brought down the whole system. "The key to our thinking is the need to focus on areas where there was 'light-touch' regulation," Tanzer noted. To the outsider this may seem innocent enough, but within the investment world there are code words for different opinions and attitudes that lie at the heart of the post-crisis post-mortem. "Light-touch regulation" was the buzz-word for the regulatory regime constructed in the UK via the establishment of the Financial Services Authority (FSA) in 1997. This "light touch" was what made London so attractive as a financial center, especially vis-à-vis the "heavier touch" of the American regulators in New York. Three years ago, "light-touch" encapsulated everything positive and desirable about the financial services sector; today, it is the regulatory equivalent of toxic waste. Thus, when Tanzer says IOSCO has to focus on "light touch" areas, he is staking out a very clear theoretical position with even clearer practical implications. "The crisis stemmed from sophisticated instruments being bought by professional investors," he said. But the assumption that these professional investors understood what they were doing and the risks they were taking proved false. Therefore, when I suggested that the guiding philosophy of securities authorities in recent decades - demanding full disclosure from issuers of securities would allow investors to identify and avoid excessive risk, let alone fraud - had been shown by the crash to be inadequate, he strongly disagreed. "Full disclosure didn't fail. The sophisticated instruments that caused the crisis were not subject to full disclosure rules, because they were sold directly to institutional investors, not to the general public." Interestingly, Tanzer explained the Madoff scandal in this context: "The major part of the fraud was perpetrated on sophisticated clients (such as hedge funds, P.L.), who were unregulated." While accepting that scandals such as that triggered by Madoff's mega-fraud typically impact public attitudes, he nevertheless rejected the popular view that the Securities and Exchange Commission, the US regulatory agency in charge of securities markets, should have exposed Madoff much earlier. Displaying considerable diplomatic dexterity, he simply noted that "you can't legislate against (someone engaged in deliberate) fraud, but regulators need to unearth it as early as possible." IOSCO is therefore working on proposals that will extend aspects of the normal regulatory apparatus to areas that have hitherto been unregulated. These include hedge funds, where Tanzer pointed out that the thinking had been that regulation was not necessary, because they did not engage in retail activity, but where "it is now accepted that greater transparency and disclosure is necessary." Similarly, previously unregulated products and markets, such as securitized and structured products, should come under regulatory purview. "Although the products based on sub-prime loans were bad, some structured products are fine," Tanzer said. IOSCO's approach for dealing with these kinds of products is to provide incentives for issuers and investors to take a long-term view, in other words, to prevent brokers simply packaging and selling off "toxic loans" whilst garnering a fat fee and having no involvement when the loans eventually go bad. Other items on the conference agenda, although discussion of them is unlikely to be completed in Tel Aviv and will continue in different IOSCO forums, include the need for central clearing houses to trade derivatives and other sophisticated (and hence dangerous) financial instruments; restrictions on short-selling that will demand tight settlement rules and fuller reporting of positions; and a survey of emerging markets and the impact the crisis has had on them. The final day-and-a-half of the five-day conference, includes a series of open sessions in which participants, together with several prominent guest speakers from Israel and around the world, will discuss various aspects of the crisis, the lessons to be learnt from it and, presumably, where we all go from here - hopefully, to a better-regulated and safer financial world.