Implementation of Financial Standards and Codes: Indian Perspective and Approach

Genesis of International Financial Standards and Codes

Transparency and Disclosure Practices

Transparency has come to be regarded as the golden rule for the orderly behaviour of the financial system. There are several reasons for this development. First, transparency backed by prudent supervision enhances the accountability of the financial system. This, in turn, builds in a check against undue risk-taking and reduces the probability of failures and systemic risk. In particular, it lessens the vulnerability of markets to sudden shifts in sentiment. Secondly, it fosters healthy competition in the financial system. Transparency of business operations ensures market discipline. Thirdly, transparency facilitates efficient investment decisions. For banks, it translates into allocative efficiency and a clear perception of the risk-return trade-off embedded in investment proposals.₁

In the aftermath of the East-Asian crises of 1997-98, it was realised that information available in the markets, prior to the crisis, did not reflect the underlying realities. Dissemination practices, reliability, timeliness, and quality of data/information also varied sharply from country to country. Hence, considerable attention is being devoted to developing uniform transparency codes and standards, and substantial progress has been made. The BIS has provided the primary momentum to the quest for international standards of transparency and is in the process of expanding its coverage of reporting information on international bank lending. The IMF has also developed voluntary standards of transparency and disclosure. At the macro level, there are the Special Data Dissemination Standards (SDDS)/General Data Dissemination Standards (GDDS). ₁

The IMF has also approved a Code of Good Practices on Fiscal Transparency and a Code of Good Practices on Transparency in Monetary and Financial Policies. The International Organisation of Securities Commission (IOSCO) is coordinating with other agencies, such as, the International Accounting Standards Committee, to develop proper accounting and disclosure rules for the securities market. A noteworthy feature of the exercise is that these efforts encompass the private sector also as many of the standards, e.g., accounting, auditing, bankruptcy, corporate governance, and securities market regulation require to be implemented at the corporate level. The OECD, the BIS, the World Bank and the European Bank for Reconstruction and Development are working on codes for corporate governance. The BIS�s Committee on Payments and Settlements is seeking best practices for payments and settlements. These international efforts indicate the critical importance assigned to transparency in the emerging international financial architecture.₁

While different specialised professioal bodies were gropping with the problems at the point of theiir respective domains, the task of consolidating an Compendium of 12 Standards inter-conected standards listing the various economic and financial standards that are internationally accepted as important for sound, stable and well functioning financial systems, was highlighted by The Financial Stability Forum (FSF) coordinating the efforts ofthe various professional bodies like IMF, BIS etc. Established by G-7 with the purpose of promoting international financial stability, improving functioning of markets and reducing systemic risk through enhanced information exchange and international cooperation in financial market supervision and surveillance. The FSF is a grouping of officials responsible for financial stability in key financial centers, international financial institutions, international supervisory and regulatory bodies and committees of central bank experts.

FSF was convened in April 1999 to promote international financial stability through information exchange and international co-operation in financial supervision and surveillance. The Forum brings together on a regular basis national authorities responsible for financial stability in significant international financial centres, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts. The FSF seeks to co-ordinate the efforts of these various bodies in order to promote international financial stability, improve the functioning of markets, and reduce systemic risk.

The FSF's mandate is:

• to assess vulnerabilities affecting the international financial system;

• to identify and oversee action needed to address these; and

• to improve co-ordination and information exchange among the various authorities responsible for financial stability. The FSF seeks to give momentum to a broad-based multilateral agenda for strengthening financial systems and the stability of international financial markets. The necessary changes are enacted by the relevant national and international financial authorities.

The FSF set up a Task Force (Chariman : Andrew Sheng) on Implementation of Standards relevant for a sound financial system presented its report in March 2000 and identified 12 key standards for a sound financial system viz., monetary and financial policy transparency, fiscal policy transparency, data dissemination, insolvency, corporate governance, accounting, auditing, payment and settlement, market integrity, banking supervision, securities regulation and insurance supervision. The key standards in these areas were prescribed by 10 standard setting bodies, viz., the IMF, World Bank, OECD, IASC, IFAC, CPSS, FATF, BCBS, IOSCO and IAIS. The Sheng Report also recognised that there has been good progress to-date in promulgating and assessing observance of international standards. The Fund-Bank experimental Reports on Observance of Standards and Codes (ROSC) provide framework for conducting these assessments, including by drawing on assessments conducted through the Fund-Bank Financial Sector Assessment Programme (FSAP).

The Compendium of Standards lists the various economic and financial standards that are internationally accepted as important for sound, stable and well functioning financial systems. The international community attaches much importance to the adoption and implementation of these standards because of their beneficial effects on the stability of financial systems both inside countries and globally.

The compendium is an initiative of the FSF and is a joint product of the various standard-setting bodies represented on the FSF. It is reviewed and updated periodically. The compendium highlights 12 key standards which the FSF has designated as deserving of priority implementation, taking account of country circumstances.

Standards set out what are widely accepted as good principles, practices, or guidelines in a given area. Standards may be classified by their scope:

• Sectoral: These cover the economic and institutional sectors such as the government and central bank, banking, securities, and insurance industries, and the corporate sector

• Functional: Within each sector, standards cover areas such as governance, accounting, disclosure and transparency, capital adequacy, regulation and supervision, information sharing, risk management, payment and settlement, business ethics, etc

From an implementation perspective, standards also differ in their specificity:

• Principle: These are fundamental tenets pertaining to a broad policy area. Principles are usually set out in a general way and therefore offer a degree of flexibility in implementation to suit country circumstances, e.g. the Basel Committee's Core Principles for Effective Banking Supervision, IOSCO's Objectives and Principles of Securities Regulation IAIS'sInsurance Supervisory Principles, and CPSS'sCore Principles for Systemically Important Payment Systems

• Practices: These are more specific and spell out the practical application of the principles within a more narrowly defined context, e.g. the Basel Committee'sSound Practices for Loan Accounting, IOSCO's Operational and Financial Risk Management Control Mechanisms for Over-the Counter Derivatives Activities of Regulated Securities Firms, and IAIS's Supervisory Standards on Licensing

• Methodologies/Guidelines: These provide detailed guidance on steps to be taken or requirements to be met and are specific enough to allow a relatively objective assessment of the degree of observance.

The development and implementation of internationally accepted economic, financial and statistical standards can help promote sound domestic financial systems and international financial stability. While a broad range of political, social, legal and institutional factors impinge on financial stability, the focus of the FSF is on economic and financial standards which are generally accepted by the international community as being objective and relatively free of national biases. The development, adoption, and successful implementation of international standards yields both national and international benefits. It helps to:

1. strengthen domestic financial systems by encouraging sound regulation and supervision, greater transparency, and more efficient and robust institutions, markets, and infrastructure; and

2. promote international financial stability by facilitating better-informed lending and investment decisions, improving market integrity, and reducing the risks of financial distress and contagion.

It is worth noting, however, that the implementation of standards in itself is not sufficient to ensure financial stability. Standards are not an end in themselves but a means for promoting sound financial systems and sustained economic growth. They need to be continually reviewed in order to remain relevant in the face of changing circumstances. The relative importance of different standards to individual economies depends on their financial structure and other domestic circumstances. Their implementation must fit into a country's overall strategy for economic and financial sector development, taking account of its stage of development, level of institutional capacity, and other domestic factors. Successful implementation of standards involves a process of interpretation, application, assessment, enforcement. It is critical that economies have in place an effective legal framework and infrastructure for enforcement.

1. Basel Committee on Banking Supervision (BCBS)
   The BCBS, established by the G10 Central Banks, provides a forum for regular co-operation among its member countries on banking supervisory matters. The BCBS formulates broad supervisory standards and guidelines and recommends statements of best practice in banking in the expectation that bank supervisory authorities will take steps to implement them.

2. Committee on the Global Financial System (CGFS):
   The CGFS, established by the G10 Central Banks, undertakes systematic short-term monitoring of global financial system conditions, longer-term analysis of the functioning of financial markets, and the articulation of policy recommendations aimed at improving market functioning and promoting stability. As part of its work on longer-term structural issues relating to financial markets, the CGFS has developed a list of general principles and more specific policy recommendations for the creation of deep and liquid government securities markets.

3. Committee on Payment and Settlement Systems (CPSS):
   The CPSS, established by the G10 Central Banks, provides a forum for regular co-operation among its member central banks on issues related to payment and settlement systems. It monitors and analyses developments in domestic payment, settlement and clearing systems as well as in cross-border and multi-currency netting schemes. It also provides a means of co-ordinating the oversight functions to be assumed by the G10 Central Banks with respect to these netting schemes. The CPSS formulates broad supervisory standards and guidelines and recommends statements of best practice in banking in the expectation that bank supervisory authorities will take steps to implement them. In addition to addressing general concerns regarding the efficiency and stability of payment, clearing, settlement and related arrangements, the Committee pays attention to the relationships between payment and settlement arrangements, central bank payment and settlement services and the major financial markets which are relevant for the conduct of monetary policy.

4. Financial Action Task Force on Money Laundering (FATF)
   The FATF, established by the G7 Summit in Paris in 1989, has set out a programme of forty Recommendations to combat money laundering. The Recommendations were updated in 1996 and again in February 2002 in the wake of the 11 September 2001 terrorist attacks against the U.S., when 8 Special Recommendations were added to the original forty. Comprising 26 member countries, FATF monitors members' progress in implementing measures to counter money laundering through a two-fold process of annual self-assessment and a more detailed mutual evaluation, reviews money laundering trends, techniques, and counter-measures and their implications for the forty Recommendations, and promotes the adoption and implementation of the FATF Recommendations by non-member countries.

5. International Association of Insurance Supervisors (IAIS)
   The IAIS, established in 1994, is a forum for co-operation among insurance regulators and supervisors from more than 100 jurisdictions. It is charged with developing internationally endorsed principles and standards that are fundamental to effective insurance regulation and supervision. After having developed the IAIS Core principles, Insurance Concordat and several other standards, much of the IAIS's recent work on standard setting has focused on developing standards in the areas of solvency, insurance concordat to cover cross-border service provision, asset risk management, group co-ordination of financial conglomerates, reinsurance, market conduct and electronic commerce.

6. International Accounting Standards Board (IASB)
   The International Accounting Standards Board is an independent, privately-funded accounting standard setter based in London, UK. Board members come from nine countries and have a variety of functional backgrounds. The Board is committed to developing, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require transparent and comparable information in general purpose financial statements. In addition, the Board cooperates with national accounting standard setters to achieve convergence in accounting standards around the world. The IASB is responsible for developing and approving International Accounting Standards (IAS). To-date, a total of 40 IAS have been promulgated by the IASB and its predecessor, the International Accounting Standards Committee (IASC).

7. International Auditing and Assurance Standards Board (IAASB)
   The International Auditing and Assurance Standards Board (IAASB) is a committee of the International Federation of Accountants (IFAC) that works to improve the uniformity of auditing practices and related services throughout the world by issuing pronouncements on a variety of audit and assurance functions and by promoting their acceptance. IAASB pronouncements are developed following a due process that includes input from the general public, IFAC member bodies and their members, and a Consultative Advisory Group that represents regulators, preparers, and users of financial statements.

8. International Monetary Fund (IMF)
   The IMF develops and monitors international standards in areas of direct operational relevance to its mandate to carry out surveillance over the international monetary system. In collaboration with other standard-setting bodies, it has developed international standards for data dissemination and transparency practices in fiscal, monetary and financial policies, and has contributed to the development of international standards for banking supervision. The IMF has prepared on an experimental basis several country reports on implementation of standards and codes of best practices.

9. International Organisation of Securities Commissions (IOSCO)
   IOSCO is an organisation for co-operation among national regulators of securities and futures markets. IOSCO develops and promotes standards of securities regulation in order to maintain efficient and sound markets. It draws on its international membership to establish standards for effective surveillance of international securities markets and provides mutual assistance to promote the integrity of markets by a rigorous application of the standards and effective enforcement against offences.

10. Organisation for Economic Cooperation and Development (OECD):
    The OECD aims to promote policies designed to achieve sustained economic growth and employment in its member countries. In the area of promoting efficient functioning of markets, the OECD encourages the convergence of policies, laws and regulations covering financial markets and enterprises.

11. Task Force on Securities Settlement Systems (CPSS-IOSCO )
    Building on the previous work, the CPSS and the Technical Committee of IOSCO set up this task force to jointly issue recommendations for securities settlement systems.

12. BCBS Transparency Group and IOSCO TC Working Party on the Regulation of Financial Intermediaries:
    The recommendations for public disclosure of trading and derivatives activities of banks and securities firms complement the two Committee's survey of trading and derivatives disclosures of banks and securities firms, which has been published annually since 1995. Both initiatives form part of a continued effort to encourage banks and securities firms to provide market participants with sufficient information to understand the risks inherent in their trading and derivatives activities.