Theoretical Foundation of States Regulatory Response to the Financial Crisis - Assignment Example

International financial crisis has existed since early 1930s, its impacts escalating far beyond its original point and affecting several states in the globe, thus spilling negative consequences from financial systems to the real economy. The cruelty of international financial crisis has exposed key weaknesses in the global architecture for practical financial regulation, constructed from the mid 1970s. Responses have been made with policymakers coming up with ambitious creativity to reform global standards and reinforce the financial regulatory structure. In this context, the perspectives applied include changes across some sectors of international finance and the international regulatory response from the point of key powers financially in US, Asia, and Europe. The first theoretical concept or theme set by States to regulate financial crisis has been global regulatory coordination, which first took place within the banking section in the mid 1970s by creating a committee of public banking supervisors that was referred to as Basel Committee on Banking Supervision (BSBS). Following the formalizing of the division of duties in the international bank supervision, the BSBS defined minimum capital levels for intercontinental banks in 1988 and updated from 1998-2004. This coordination then extended to security markets and other related sectors like credit ranking agencies through the International Organization of Securities Commissions (IOSCO) initiated in 1983 and to insurance markets through International Association of Insurance Supervisors (IAIS). Central banks that were members of the Basel Committee created the Committee on Payment and Settlement Systems (CPSS) that provided some central principles for steadily significant payments systems and joined with IOSCO for central counterparts and securities settlements systems. In response to the financial crisis in 1990s, financial regulation perimeter expanded more to comprise auditing standards, accounting, and corporate governance. Economic theory suggests that the existence of a helping hand that complements or substitutes market mechanisms is justified by market failure. States expect banks to finance long-term loans by use of short-term deposits, thus acting as a lender of last resort. Interbank market has also helped in regulating financial crises since it is a source of credit risk obtained from loan operations with no guarantees within financial institutions. Small investors are protected and the generalization of deposit insurance is guaranteed. Liquidification of deposits in a common bank for many states is aimed at opening of deposits in other financial institutions. Another theme in the response is the conveying to private market actors to regulate and supervise financial markets. This is manifested through the legitimization and endorsement of standards drafted by private actors, including auditing and accounting standards. An additional manifestation was that regulators were to shift part of the duty for observing markets into the control of private investors by requesting public and private actors to disclose much information concerning their regular activities. This market discipline was elevated by Basel II agreements capital supervisions and requirements. The conformity also allowed large banks to utilize their risk management strategies and information to determine the quantity of reserve capital to be saved for credit risk. It also assigned credit rating organizations an official duty in credit risk assessment for all kinds of banks. Generally, a paradigm shift in terms of prudential policies resulted in States increasing attempts to work with, instead of against market forces. Apart from expanding international financial regulation perimeter, State leaders tried to reinforce their institutional basis by establishing joint supervisory colleges for all key cross-border monetary institutions. The Financial Stability Board (FSB) was assigned the task of collaborating with IMF in carrying out early warning practices as well as supporting and setting guidelines to the supervisory colleges. FSB was also required to undertake cooperative strategic evaluations of the policy development task of the global standard setting bodies to make sure that their work is coordinated, timely, addressing gaps, and focused on priorities. The bodies required to set bodies were to report their work to FSB in order to provide a wider accountability framework regarding their activities. Global financial crisis has highlighted issues concerning credit default swamps, especially their reliability, transparency, and their settlement and price setting mechanisms. Several countries have agreed on high standard principles intended to sustain the development of correctly regulated structures to eliminate standardized credit default swaps markets. Hedge funds have also been suggested as a response to financial crisis. Reforming hedge funds involves revisiting regulations to classify areas of improvement. States have agreed on six regulatory principles intended to address market stability and introducing transparency in operational management over market participants. 2. Analyze the fundamental reasons behind the failure of independent directors in preventing the current financial crisis. It is widely perceived that the current financial crisis emanates from an insufficient accessibility of regulations and the presumed solution is taking the existing regulations and distributing them without leaving gaps across jurisdictions and institutions. The notable efforts to prevent financial crisis are aimed at alleviating the invariably enormous costs on the society and excessive costs on the private sector that are beyond their individual financial institutions. Nevertheless, presumption of the statement as the only remedy presents several mistakes. This is based on the fact at the center of the crisis lies highly regulated firms or company’s with sophisticated jurisdictions. These include institutions such as the Royal Bank of Scotland, UBS, Northern Rock, and Fortis. It is argued that financial crisis would occur in presence or absence of mortgage fraud, conflicts of interest, and tax secrecy. In regards to independent directors, there exist several forces behind their failure to curb the menace of financial crisis Failure of independent directors in preventing the current financial crisis is attributable to corporate governance failure. A surge in interests of principles is experienced because of severe social costs in terms of distress and unemployment that usually emerge. Despite efforts imparted in prevention of future risks of indifferent governance, the financial pages of business press progresses in reporting instances of corporate governance shortcomings in practices. This is seen as a drawback to the several corporations and governments efforts in provision of an enabling environment for the corporate governance. This is because failure to notice the current governance debacles by independent directors exemplifies their inability to control the current financial crisis. In addition, this is attributable to poor governance, which despite portraying a formidable huddle to surmount; it is also at the forefront of economic development issues. In regards to this exposition, there exists a dilemma on whether companies may seem to comply with the predefined corporate governance rules without abiding by the spirit and principles of good governance. Independent directors fail to curb the current financial crisis because of lack of skills, tools, and corporate governance analytical principles inherent in management. Acquisition of these principles enables them to differentiate between companies that superficially or cosmetically comply with the corporate governance rules and those that portray genuine commitment. Therefore, independent directors lack the knowledge on insufficiency of traditional financial criteria in attracting investors. In essence, they fail to demonstrate a consistent conduct with the principles of good governance. Preferably, independent directors should genuinely adopt, embrace, and adhere to the predefined principles of corporation. As a result, a multitude of benefits are derived such as lower cost and availability of capital, ability to attract business partners and top talents, better financial performance, more transparency, and greater competitiveness. The inability to control the current financial crisis is based on forces of convergence that are instigated by globalization of firms or companies. Independent directors are disadvantaged in controlling companies that have range of service provision, worldwide production, added-value chain, customers, and markets that rely on international sources of finance. Failure to meet these conditions leads to financial crisis. This is exemplified by difference in legal procedures, standards in legal processes, stock market differences, and ownership structure. Moreover, failure to curb the present financial crisis by independent directors is ascribed to their strategic decisions to retain wide exposures to super senior tranches of collateral debt obligations that exceed the company’s understanding of risks entailed in such strategic decisions. Similarly, independent directors fail to implement appropriate procedures to mitigate or control risks. In addition, these discrepancies in management of the current financial crisis are based on the limited control over and understanding of the firms’ potential balance sheet growth and liquidity needs. Independent directors fail to effect proper prices, which expose the firm to risks of off-balance sheet vehicle, which calls for external funding thus resulting into expensive and difficult methods of soliciting funds. Therefore, failure to understand and control over potential balance sheet growth and liquidity needs promotes the occurrence of financial crisis in most firms. In order to control such discrepancies, there is need for the independent directors to implement a comprehensive and co-ordinated approach to assess a firm’s wide risk exposures. This is best achieved through sharing of both qualitative and quantitative information across the company and embracing dialogue across the management team. The approach is effective because it portrays more adaptive risk measurements systems and processes that could quickly change the underlying assumptions such as valuations to reflect the current financial position of a firm. 3. Takeover defenses can impose some ethical challenges. Discuss In recent years, there has been increased rash of mergers and takeovers of many companies. Those who carry out this transaction have neglected several ethical practices. On one hand, it has to do with the rights of the employees affected by takeovers. On the other hand, there is the issue of roles of shareholders during the transaction. There are ethical challenges associated with forcible acquisition of companies in that such moves by some company’s leads to loss of many jobs. In business, takeover is used to imply that the company has been by another company whose shares are listed on stock exchange. Takeovers has serious financial consequences to a company when the target company’s board approves a defense or shows its intention to do so by incorporating its defense strategies to the corporate charter after the company is aware of the impending takeover. In order to identify ethical implications involved in takeovers, the purchaser is not in a position to make an attempt to purchase or buy stock. Instead, the buyers try to persuade the shareholders to vote out the immediate board of directors. By taking this step, they proceed to support the party that is in favor of the takeover. This creates proxy fights within the management of the company which plunge the current management to ask for change in the ownership of the company, which they make sure is done by the help of other shareholders. These disagreements or proxy wars are common because it surpasses the company’s defenses that help in preventing takeovers. During takeover process, the firm does not honor the rights of employees at work place, which in turn leads to disrespect of employees rights at the same time endangering its own claims to those rights. In addition, it is failure on the part of the company because it is not in a position to cater for the needs of its employees that it hired. The people are responsible adults whom it is supposed to act morally by respecting them. Most of these defenses are evaded or sidestepped by changing the standpoint of the people who posses or own the stock. In most cases, when takeover news breaks out, employees at all levels are usually neglected since they are last to know about the transaction. In any takeover, whether there will be financial successful or not, there is great deal of employee stress because in the corporation to be transacted, but the employee in the merger company too may have worries which originate from ambiguity, secrecy and uncertainty surrounding the merger. In this scenario, no employee is sure of his or her job in the newly formed firm or company created out of takeover. In most takeovers, the top management conducts the negotiations and what is acquired is kept secret to avoid stock fluctuations, competing offers, and other changes that occur on market. In many takeover situations, preoccupation with the process of takeover is aligned in a manner that even employee interests are forgotten or even neglected. The mergers usually consider economic concerns over other demands. In addition, questions arise concerning the ethical property of the transaction actions by these companies. Some of these actions have to do with methods or tactics used when trying to acquire a company or when trying to avoid being merged. In addition, when the takeover or merging is successful, there is much information to suggest that employees stress is threatened by such behaviors, which translates into lowered productivity, loss of trust in board of directors, occupation with self-preservation. Moreover, to some extend resignation of humble or good people who, fearing their future lack of job looks for an alternative means and most likely more secure jobs. In simple terms, absence of respect on employee’s rights translates into loss of loyalty, trust, responsibility, and commitment. This transaction results in serious ethical challenge in that the rights of the employees are neglected in favor of top management. Regarding the responsibility of shareholder or top management as it relates to takeover process, the fiduciary role of mergers are viewed very seriously since they are the ones who stands to lose or benefit in such transaction. Board of directors or shareholders will apply coercion or force because they have the right to maximize the price of their shares since they are the real owners of the company. Individual shareholders have a moral obligation to ensure that the top management is looking after their interests. In order to create an ethical organization, the management must come up with mechanism to take up interest of employees for its own success. Since, if morale is weak or bad and trust undermined, the aftermath is loss of efficiency and low productivity. The shareholders responsibility should have strong moral obligation especially in takeover defenses of companies. Work Cited Goodhart, Charles. The Regulatory Response to Financial Crisis. New York: Edward Elgar Publishing, 2010. Print. Read More