Duncan Alford, Supervisory Colleges: the Global Financial Crisis and Improving International Supervisory Coordination

• Jurisdiction: United States,Federal
• Citation: Vol. 24 No. 1
• Publication year: 2010
• topic: Banking and Finance Law,Corporate / Commercial

SUPERVISORY COLLEGES: THE GLOBAL FINANCIAL CRISIS AND IMPROVING INTERNATIONAL SUPERVISORY COORDINATION

Duncan Alford^*

While the current financial crisis began in the United States, the crisis quickly spread globally, causing decreases in gross domestic product and employment levels around the world.¹The crisis has revealed numerous weaknesses in the supervision and regulation of global banks and financial institutions generally.²National governments and international bodies also recognized these weaknesses in the supervisory system of global financial institutions and have begun to take steps to improve the system with the hope of avoiding, or at least mitigating, future financial crises.³One such weakness has been the ineffective supervisory cooperation among national bank supervisors related to cross-border financial institutions.⁴As a result, several international governmental organizations, national governments, and commentators⁵have called for the use of colleges of supervisors to supervise global financial institutions, in particular, those systemically important financial institutions that have been the recipients of government financial support during the crisis.⁶As French President Nicholas Sarkozy and British Prime Minister Gordon Brown noted recently, "[b]etter regulation and supervision are the means by which the risk to the taxpayer can be reduced for the longer term."⁷

This Article explores one tool used to improve the international legal framework for financial supervision-the college of supervisors or supervisory colleges for systemically important financial institutions. These ad hoc groups are intended to improve the exchange of information among supervisors with the goal of ensuring safe and sound banking practices, reducing the possibility of governmental assistance to financial institutions, and building confidence generally in the international financial system.⁸The hope is that these colleges, which meet on a regular basis to discuss the supervision of a particular financial institution, will identify issues or problems early and can then address them quickly and reduce the risk of a bail out or bank failure.⁹

The G-20 and the European Union ("EU") have been particularly active in developing these colleges and codifying best practices for their operation. This Article explores their recent actions and suggests that the colleges are a step toward further global supervision of financial institutions with cross-border operations. However, colleges of supervisors are a limited, incomplete response to the inadequate coordination of supervision of global financial institutions. International supervisory coordination is necessarily hindered because each national supervisor will strive to minimize its use of taxpayer resources to cover any losses from bank failures. An international regime for the orderly winding up of insolvent banks is a necessary component of truly effective international supervisory coordination.

I. INAUSPICIOUS BEGINNINGS FOR COLLEGES OF SUPERVISORS-BANK OF

CREDIT AND COMMERCE INTERNATIONAL

Supervisory colleges were not first created as a result of the current financial crisis. Financial supervisors have previously formed these groups to monitor financial institutions with cross-border operations.¹⁰In the late 1980s, a college of supervisors, including supervisory authorities from the United

Kingdom, Luxembourg, and other European nations, supervised the Bank of Credit and Commerce International ("BCCI"), a bank with operations in several dozen countries.¹¹However, this college proved ineffective as the bank was ultimately liquidated because of internal fraudulent activities.¹²

In a coordinated action on July 5, 1991, regulators in eight nations closed all the BCCI branches located within their jurisdictions.¹³At the time BCCI had total assets of approximately $20 billion and was operating in sixty-nine countries, with the largest concentration of its deposits in the United Kingdom.¹⁴Due to the absence of any international law governing the closure of an international bank, local regulators acted under separate national laws.¹⁵

By July 6, 1991, BCCI offices in eighteen countries either were closed or their operations were restricted.¹⁶The closure of BCCI branches continued for several weeks, and by July 29, 1991, forty-four jurisdictions had closed BCCI offices located within their borders.¹⁷The immediate reason for the closure of BCCI was the Bank of England's receipt of a June 1991 report prepared by Price Waterhouse, the international accounting firm, which detailed massive fraud committed by BCCI's senior managers.¹⁸

Regulators in both the United States and England had been concerned about the safety and soundness of BCCI for years before the bank was finally closed.¹⁹In February 1990, Price Waterhouse, BCCI's auditor, refused to sign off on the BCCI financial statements for 1989 and subsequently reported to the BCCI board and the Bank of England its concerns of fraud at BCCI.²⁰In April

1990, the Bank of England permitted the government of Abu Dhabi to increase its investment in BCCI-in effect to bail out the bank.²¹Six months later, in October 1990, Price Waterhouse delivered to the BCCI board a follow-up to its April report, detailing the bank's massive loan problems.²²

To compensate for the lack of supervisory resources over BCCI, bank regulators from the Cayman Islands, France, Hong Kong, Luxembourg, Spain, Switzerland, the United Arab Emirates, and the United Kingdom created a college of supervisors in 1987 to coordinate their regulatory efforts over

BCCI.²³In the end, this scheme was an unworkable solution and allowed supervisors to shift responsibility for any BCCI transgression among themselves.²⁴No single supervisor had any incentive to supervise BCCI properly, and the supervisors did not cooperate adequately among themselves in sharing information on BCCI operations.²⁵In a 2004 speech, Callum McCarthy, then head of the Financial Services Authority ("FSA"), concluded that "in some cases the resources [of a supervisor] are simply not up to the task of acting as a home regulator for a large group[,]" and in the case of BCCI,

"the resources then available in Luxembourg[,]" the home regulator, were not sufficient.²⁶

Following the failure of BCCI in 1991, European bank regulators recognized the need to improve cooperation among supervisors of global banks.²⁷Ad hoc arrangements-colleges of supervisors-were created as the need arose to supervise banks with cross-border operations.²⁸A college of supervisors was created to exchange information related to Citigroup, Deutsche Bank, and HSBC.²⁹The Federal Reserve Bank of New York is the lead supervisor of Citigroup; the Federal Financial Supervisory Authority ("BaFin") in Germany takes the lead on Deutsche Bank; and the FSA in the United Kingdom is the lead supervisor of HSBC.³⁰Supervisory authorities from the United Kingdom, the United States, France, Canada, Hong Kong, and Switzerland meet regularly to share information on HSBC.³¹Every six months, the Federal Reserve, the FSA, and the Swiss Banking Commission meet to discuss the operations of UBS and Credit Suisse.³²

II. THE EUROPEAN UNION AND COLLEGES OF SUPERVISORS

Even before the current crisis, supervisory authorities were utilizing colleges as a tool to share prudential information on financial institutions with cross-border operations.³³The EU has been particularly active in utilizing colleges to supervise financial institutions operating in multiple member states.³⁴

The Committee of European Banking Supervisors ("CEBS")³⁵consists of the bank supervisory authorities of the EU member states and has the objective to "foster supervisory convergence across the Community."³⁶In furtherance of this objective, CEBS has been active in supporting the development of colleges of supervisors of cross-border banks within the EU.³⁷In December 2007,

CEBS issued two documents, Range of Practices on Supervisory Colleges and Home-Host Cooperation³⁸and Template for a Multilateral Cooperation Coordination Agreement on the Supervision of XY Group,³⁹that provided non- binding guidelines on the operation of colleges of supervisors.

The financial crisis has focused renewed attention on colleges of supervisors as one of several tools to reduce risk within the international financial system. CEBS updated both documents in January 2009 and provided more specific detail on the operation of the college of supervisors.⁴⁰In its Colleges of Supervisors-10 Common Principles,⁴¹CEBS provides that a college of supervisors shall supervise any cross-border insurance group, banking group, or financial conglomerate.⁴²The colleges-flexible, permanent fora for cooperation and coordination among financial supervisory authorities-shall have agreements in place describing the cooperation between the supervisors and the practical organization of the supervisory activities of the financial institution.⁴³For banking groups, the consolidating supervisor, as defined in the amended Capital Requirements Directive ("CRD"), shall initiate the cooperation process.⁴⁴The colleges shall also promote harmonization of supervisory approaches and coordinate all major supervisory decisions.⁴⁵In addition, the colleges shall plan and coordinate supervisory, on-site inspections and share the findings from such visits with other members of the college.⁴⁶

While not significantly different from the 2007 version, the 2009 Template for a Multilateral Cooperation Coordination Agreement removes some discretion given to the supervisor under the earlier agreement and requires supervisors to cooperate more fully with their peers in the supervision of cross- border banks.⁴⁷For instance, the new agreement adds a provision stating,

"Should the authorities in a College not reach an agreement, as foreseen by the CRD the matter may be referred for mediation to the Committee of European Banking Supervisors . . . ."⁴⁸In Section 7.2, which deals...