Tomorrow’sCapitalism
Towardsan
AccountableCapitalism
ByStephenDavis,JonLukomnikandDavidPitt-Watson
March2009
www.ippr.org/tomorrowscapitalism
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Tomorrow’sCapitalism|TowardsanAccountableCapitalism
Aboutippr
TheInstituteforPublicPolicyResearch(ippr)istheUK’sleadingprogressivethinktank,producing
cutting-edgeresearchandinnovativepolicyideasforajust,democraticandsustainableworld.Since
1988,wehavebeenattheforefrontofprogressivedebateandpolicymakingintheUK.Throughour
independentresearchandanalysiswedefinenewagendasforchangeandprovidepracticalsolutions
tochallengesacrossthefullrangeofpublicpolicyissues.
WithofficesinbothLondonandNewcastle,weensureouroutlookisasbroad-basedas
possible,whileourinternationalandmigrationteamsandclimatechangeprogrammeextend
ourpartnershipsandinfluencebeyondtheUK,givingusatrulyworld-classreputationfor
highqualityresearch.
ippr,30-32SouthamptonStreet,LondonWC2E7RA.Tel:+44(0)2074706100
E:[email protected]
ThispaperwasfirstpublishedinMarch2009.©ippr2009
‘Tomorrow’sCapitalism’
Tomorrow’sCapitalismisamajorprogrammeofworkpresentedbyipprinconjunctionwith
FriendsProvidentFoundation.Itaimstoexplorethefutureofourfinancialandeconomicsystem.
Formoredetailsandtoaccessotherpapersfromtheprogrammevisit
www.ippr.org/tomorrowscapitalism
Abouttheauthors
Davis,LukomnikandPitt-WatsonareauthorsofTheNewCapitalists:Howcitizeninvestorsare
reshapingthecorporateagenda(HarvardBusinessSchoolPress,2006).
StephenDavis isseniorfellowattheYaleSchoolofManagement’sMillsteinCenterforCorporate
GovernanceandPerformance.
JonLukomnikismanagingpartnerofSinclairCapitalandprogramdirectoroftheIRRCInstitute.
DavidPitt-Watson isasenioradvisertoHermesFundManagers.
Theviewsinthispaperarethoseoftheauthorsonlyanddonotnecessarilyrepresentthoseof
ipprorFriendsProvident.
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Tomorrow’sCapitalism|TowardsanAccountableCapitalism
Introduction
Thecreditcrisishasbeenasystemicfailure.Thoughthepressprimarilyblamesthebankersforour
problems,thefailurewasnotthatofonesinglesetofagents.
Inthispaper,wetrytosetoutsomeofwhatwentwrong,andhowwecandevelopaframeworkof
policyandinstitutionsneededtoensureavibrantandstablefinancialsysteminthefuture.This,we
believe,willrequirenewthinkingaboutthetypeofinstitutionsonwhichasuccessfulmodernfinancial
economydepends.Inparticular,wewillfocusontherelationshipbetweeneachoftheseinstitutions
andhowitispossibletogetthemtoworkinawaythatwillsupportopenandeffectivecapital
markets.
Ouraimisnottolayoutadetailedframeworkforbanksolvencyoraccountingregulationthoughwe
willtouchonmanyexamplesofreform.Rather,itistotrytoclarifytheprinciplesonwhichany
responsibleBrettonWoods-styleremakingofthemarketsystemwillrest,andhowthesemightbe
appliedtothebanksandotherinstitutionswherefinanceisraisedtokeeptheeconomygoing.
AswearguedinTheNewCapitalists (Davisetal2006)asuccessfuleconomyisnotjustaboutthe
tensionsbetweentwoseparatepoles:regulationormarket.Aneconomythatworkseffectivelyislikea
politicalsystemthatworkseffectively:ithaschecksandbalances,accountabilitiesandresponsibilities,
informationflowsandcultures.Ifwearetorepairourbrokenfinancialsystem,wewillonlydosoifwe
breakfreefrombipolarthinking.Ofcourseregulationisimportant.Buttherearefivecentralprinciples
onwhichasuccessfulfinancialsystemwilldepend.Thesearethat:
•Theentitiesinitareresponsiblefortheiractions.
•Theywillberesponsibleiftheyare accountable.
•Thosewhocallthemtoaccountwillneedrelevantinformation.
•Thatinformationmustbeindependentlyprepared.
•Andjustasahealthypoliticalsystemhingesonthescrutinyofvigilantcitizens,asuccessful
financialsystemwillneedtheoversightofvigilantmarketparticipants.
Whatwentwrong?
Beforeweofferamodelforabetterformofcapitalism,itisworthreviewingwhatwentwrongwith
thisoneandidentifyingwherethefiveprinciplesoutlinedabovewerelacking.
Readthepress,andyouwillfindalitanyofculprits.Theybeginwithbankerswhoareblamedfor
lendingmorethanwasappropriate,andwhowerecaughtflat-footedwhendepositorsaskedfortheir
cashtobereturned.Theircultureisviewedasbeinggreedyandshortterm.Regulatorsalsocomein
forcriticism.Howcometheydidnotseethiswasgoingtohappen?Afterall,theyknewwhatthe
banksweredoing.Whydidtheynotputastoptoit?
Whataboutallthoseeminentmenandwomenwhosatontheboardsofthebanks?Surelytheyknew
therisksthatwerebeingtaken?Whatabouttheaccountantswhodeclaredthesebankstobe
solvent?Andthecreditratingagencieswhotoldusthatthedebtwasinvestment-grade–fitfor
widowsandorphans–whenitlaterturnedouttobetoxic.Orthebanks’investors,whodidlittleto
stopthefree-for-all?
Highlightingalitanyofmiscreantsmissesthepoint.Itwasnotoneindividualorinstitutionthatwasto
blame:itwastheentiresystem.Eachofthe‘players’wasseekingtomaximizeitsowninterestsin
waysthatwereperfectlywithinthelaw.IftheywereaskedifthiswasOK,theywouldhavepointed
youtoAdamSmith,whofamouslyobservedinTheWealthofNations (1776)that‘itisnotfromthe
beneficenceofthebutcher,thebrewerandthebakerthatweexpectourdinner,butfromtheirregard
totheirownselfinterest’.Inasimilarvein,itwasthroughtheself-interestofthebank,orthe
mortgagebroker,orthecreditratingagent,ortheaccountant,thatweendedupwithourmortgages
andotherborrowings.Exceptthistime,thecollisionofalltheseself-interestsbroughtthesystemto
itsknees.
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Tomorrow’sCapitalism|TowardsanAccountableCapitalism
Let’splotwhathappened.
Attheheartoftheproblemwasthewaybanksthoughtaboutrisk.Theyworkedonthesimpletruth
thatifyoutakelotsofsmallrisks,youarelesslikelytoloseallyourmoneythanifyoutakeonebig
risk,andbanksbegantodiversifytheirrisk-takingactivities.Intherealmofmortgages,thiswentto
anextreme,asbanksandotherfinancialinstitutionsbegantoselloffpartsoftheirmortgageloans
andtobuyloansoriginatedbyothers.Soon,financialengineersrepackageddiversifiedpoolsof
mortgagesintostructuredproducts(knownas‘collateralizeddebtobligations’orCDOs),allowing
instantdiversificationwithasinglepurchase.
Whatdidthismeaninpractice?Intheolddays,abankmightholdlotsofmortgagesfrompeople
livinginaparticulartown.Thatwouldbequiterisky,becauseif,forexample,thelocalindustryfailed,
thebankwouldbeunderpressure.Soitneededtoholdlotsofreserves.Throughtheuseofthese
newlycreatedCDOs,bankscouldnowownapartshareinamyriadofmortgagesfromliterallyallover
theworld.Andbecausethatmeantbankshadlessriskintotal(theoretically),theywouldbeableto
lendmore.Lendtheydid,withavengeance.
Theresultwasahugeincreaseinthenumberofloansmadeusingthesamecapitalbaseandadecline
bothintheinterestrateschargedfortheloansandinthetoughnessoflendingstandards.Sofor
example,itwaspossibleforpurchaserstoborrowmorethanthevalueoftheirhouse.Thisinturn
forcedupassetprices,suchasthoseofhousesandcompanyshares.Homeownersandbuyersof
companiesfelttheywereonaone-waybet,sotheyborrowedandboughtmore.
Allthiswassanctionedbybankingregulatorsactinginaccordancewithinternationalagreementson
bankingsolvency,knownastheBasleagreements.Infact,anewregulation,BasleII,hadcomeinto
forcejustbeforethecrisisexploded.ItisironicthatNorthernRock,thefirstBritishbanktoneed
governmentfinance,wastellingitsshareownersonlyacoupleofmonthsbeforeittumbledthatit
wouldbeabletorepaymoneytothembecauseBasleIIregulationsmeantitwasovercapitalized!
Whydidwelackthevigilancetoquestionthesepractices?Whydidwenothearthewhistlesblowing
awarning?Forthetruthisthatmanyvoiceshadsuggestedamountingcrisis.
Perhapswesufferedfromwhatsocialpsychologistscallthe‘bystandereffect’:becausetherewereso
manybystanders,noonesawitastheirdutytocallintoquestiontheriskmodelsbeingused.Here’s
howTalebandTriana,expertsinriskmanagement,describethings:‘Almosteveryoneinrisk
managementknewthatquantitativemethodsdidnotwork.Yetamethodgroundedonthosesame
principlescontinuedtobewidelyused’(TalebandTriana2008).Orperhapsitwasthesirensongof
short-termprofitsthatblindedus.AsChuckPrince,thedeposedCEOofCiticorp,infamouslynoted:
‘Whenthemusicstops,intermsofliquidity,thingswillbecomplicated.Butaslongasthemusicis
playing,you’vegottogetupanddance.We’restilldancing’(Prince2007).Thiswasthemusical
chairsversionofcapitalism:makehaytodayandpraythatwhenthemusicstopssomeoneelseisleft
withoutachair,notyou.Weneverconsideredthattherewouldbenochairsleftforanyone.
Sothemusiccontinuedandthegamecontinued,evenasthechairswerebeingtakenaway.Those
issuingamortgage(‘originating’it,tousethejargon)solditontosomeoneelse.Thateliminatedthe
old-fashionedbankmanagerwhogaveyouamortgage,andwasresponsible formakingsureitgot
paidback,andaccountableifitwentwrong.Instead,themortgagebrokersoldontheloanto
someoneelse,whothenpackageditwithothersandbitsofitgotsoldaroundthesystem.Inthatway
everyonetookmanysmallbetsand,sotheythought,reducedtheirrisk.Infact,nooneknewwhat
risksthey,orthesystem,weretaking.Spreadingtheriskbecame,itself,arisk.Witheveryone
responsiblefortinybitsofthousandsofmortgages,noonewasresponsibleoraccountableforany
oneloan.
Enterthecreditratingagencies(CRAs).Theseareorganisationsthat‘rate’credit.Inotherwordsthey
predicthowlikelyaloanistodefault.Nowthisisaveryimportantrole.WhentheCRAssay
somethingisinvestment-grade,meaningunlikelytodefault,companiescanissuedebttoinvestors
widelyandthereforelessexpensively.Therewasonlyonesnag.TheCRAsgotitwrongonsubprime
mortgages.Ashomepricesfell,itturnedoutthattheCDOsthathadbeenfashionedoutofthem
werenotinvestment-gradeafterall.Thatwaswhattriggeredthecrashin2007.
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Tomorrow’sCapitalism|TowardsanAccountableCapitalism
SomemightarguethattheCRAsmadeanhonestmistake.However,thebusinessmodeloftheCRAs
isitselfsuspect,becausetheygetpaidbythosewhoareissuingdebt,notbythosewhoareinvesting
onthebasisoftheratings.So,ifitwantstogetpaid,aCRAhastheincentivetogivepositivecredit
ratings.This,too,wasobvious,andnotjustinhindsight.TheCRAshadalreadygotitwrongin2001
withEnronandWorldcom.In2006,wewrote:‘creditratingagenciesharborafundamentalconflict:
theyarepaidbythecompaniestheyrate,notbytheinvestorstheyaresupposedtoprotect’(Daviset
al2006:146).Thesameissuewasoneveryone’smindby2008.CertainlytheCRAswerenot
producingindependentinformation.
Theseproblemswerethencompoundedbythewayinwhichaccountantstreatedthenewsecurities
thatbanksweretrading.Inthepast,thebankwouldmakealoan,sayfor£100,000and,subjectto
someprovisionsfordefault,itwouldholdthatloanonitsbooks,at£100,000,untilitwasrepaid.But
nowpackagesofloanswerebeingtradedinthemarket.Accountantsinsistedthateachbundlebe
markedtothemarketprice,becausetheyfeltthatiswhatthosewhotradedbankshareswouldwant
toknowabout.Thatistrue.However,asthebasisfordeterminingthestrengthofabank,‘mark-tomarket’accountingisproblematic.Whenthemarketfortheseloansisstrong,thebankmakesa
profit,lendsmoreand,incidentally,paysitsstaffbigbonuses.However,ifthemarketforthoseloans
driesup,bankssuddenlylookinsolvent,eveniftheloansarecurrentinpayingtheirinterest,there
waslittlelikelihoodofadefaultandabankintendedonkeepingthatperformingloan.Putsimply,
accounting,wasprovidinginformationwhichmayhavebeenofinteresttothosebuyingandselling
bankshares,butitwasnotprovidingtherelevantinformation onwhichtojudgebankstability.
Inthisworldoflimitedresponsibilityandaccountability,theculturewasoneof‘deviltakethe
hindmost’–everymanforhimself.Incentivestructuresreflectedthatculture.Bonuseswerepaidon
year-endprofits,whereassetvalueswere‘marked-to-market’.Andforafewyearsthebonusesrolled
in.Buttherewaslittleregardforthelong-termriskstotheinstitutionsconcerned,andnonetothe
stabilityofthesystemasawhole.Tomany,thenotionof‘responsibleinvestment’wasananathema.
Thepublic,thepoliticianandthemedialookingonmayhavefeltthattherewassomethingwrong
withthequantumbeingpaidtoexecutives,buttheylackedtheinstitutionswithvigilanceandcloutto
raiseuncomfortablequestionsanddemandanswers.
Thenthecrisisbroke.Subprimeloansfellprecipitouslyinvalue,evenifthatparticularCDOwasstill
‘performing’,thatis,evenifitwaspayinginterestontime,andunlikelytodefault.Strongbanksnow
hadtomarkdowntheirvalue,astheaccountingrulessaid.Thebanksthenstartedtolookweak,so
depositorsbegantowithdrawfundsandputthemelsewhere.Governmentagenciesultimatelycame
totherescue,butwereconcernedthattheycouldnotbeseentosaveeverybank.Iftheyhad,they
wouldbecondoningthosewhoselendinghadbeenirresponsible.
SotheyallowedthecollapseofLehman.Thatspookedinvestors.Therewererunsonthebanks,as
depositorstooktheirmoneyout.IntheUK,therehadbeenarunonNorthernRockin2007;now
therewasarunontwoofitsmajorbanks:HBOSandRBS.Bankshadnowaytotrustthebalance
sheetsofotherfinancialinstitutionsorevenindustrialcompanies,andtheywantedtoconservetheir
owncash.Solendingbetweenbanksdriedup.Thisisthelifebloodofthefinancialsystem.Ifbanks
mightnotbeabletoraisecash,companiescouldnolongerassumetheyhadaccesstocashorcredit
andsocancelledinvestmentsandcutcosts.Therecessionwasuponus.
Whatwentwrong?Ashighlightedinthisdiscussion,itwasnotjustregulation,thoughitplayedits
part.Itwas,fundamentally,achronicandpervasivelackofresponsibility andaccountability.Itwasa
failuretoproducethe rightinformation,andalackof independencebythosewhodid.Anditwasa
failureamongmarketpartiestoexercisethevigilance necessaryforacomplexfinancialsystemto
work.
Therequirementsforaccountablecapitalism
InTheNewCapitalists,wearguedthatitwaspossibletobuilda‘civileconomy’;thattherewasa
burgeoningsetofinstitutionsthatcouldhelpembedaccountabilityintotheeconomicsysteminthe
samewaythatpoliticalinstitutionsgirddemocracyin‘civilsociety’.Inthatbook,wewereconcerned
withthewaythe‘equities’or‘shares’ofcompaniesweremanaged.Forthepast20yearswe,andthe
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restofthe‘responsibleinvestment’movement,hadfocusedlargely(thoughnotentirely)onequity,
notcredit.Inhundredsofinitiatives,nationalandglobal,voluntary,enterprisingandregulatory,
peoplehavebeentryingtocreatea‘civileconomy’toreplacetheuncivileconomyofthepast.
However,allcapitalmarkets,whetherequity,credit,currencyorwhatever,needtoconformtothefive
principleswespelledoutinTheNewCapitalists:accountability;responsibility;relevantinformation;
independentadjudication;andvigilantparticipants.Let’sbrieflyoutlinewhatwemeanforeach.
Accountability
Foreachplayerinthemarket,weneedtobeabletoanswersomesimplequestions.Inwhose
interestsdoyouwork?Towhomareyouaccountable?Whatalignmentsormisalignmentsofinterests
canaffectyourperformance?Eachplayerinthemarketmustfeaturegovernancetocompelalignment
betweenitsmissionanditsconstituency.Andlet’sbeblunt:ifitisnotsoconfigured,itmustbeseen
asapotentialthreattothestabilityofthecapitalmarket,andneedsparticularoversight.
Whenyoulookatcapitalmarkets,particularlythoseintheUSA,wherethecreditcrisisbegan,there
areglaringgapsinaccountability.Forexample:USpensionplangoverningboardsdonotinclude
representationfromretireesortheworkerscontributingtotheplan;thecreditratingagenciesarepaid
byissuers,nottheinvestorswhorelyontheratings;andtheboardsofmostinvestmentbanksinthe
USdidnotfeatureindependentchairmenwhocouldeffectivelyoverseetheCEOs.Intwocases–AIG
andWashingtonMutual–institutionalinvestorsactuallymountedpre-crashchallengestothatcrony
culture.Butdespitethefactthattheyweresupposedtocreate‘shareholdervalue’,directorsrallied
andrebuffedtheshareowners.
Responsibility
Accountabilityisthetoolthatenforcesresponsibility:eachplayershouldactivelyexerciseitsrightsto
optimisethelong-termvalueofitsassetsonbehalfofthoseforwhomitworks.Anexample:
shareownersshouldnotonlyhaverightstoreplacecorporateboardmembersattroubledcompanies,
theyshoulduse thoserights.
Biginvestors,particularlybigpensionfunds,havepooledoursavingsandbecomethefractional
owners,notonlyofmuchofthedebtthathasturnedtoxic,butofthecompaniesthatoriginatedthe
debt.Withsuchavastamountofvalueatstake,onemighthavethoughttheywouldhavefound
waystodefendtheirinterestsandholdboardsandmanagerstoaccount,andhenceprotectedthe
interestsoftheirsavers.Mostbarelytried.Why?
Institutionsmanagingtrillionsinsavingsfeaturelong-entrenchedhabitsthatsuppresstheirown
responsibilityandaccountabilitytoclients.USmutualfundsandUKunittrustshavelargelymorphed
intomachinesthatbuyandsellsecurities.TheaverageAmericanmutualfundturnsovermorethan
100percentofitssecuritieseveryyear,whichmeanstheyaretradersratherthanlong-terminvestors.
Theysufferfromthatpeculiardiseaseofsmartpeople–theyareallChuckPrince,thinkingthathe
canfindachairevenwhenthoseabouthimarefallingontothefloor.Sincetheyalwaysthinkthey
cangetoutofthewayofadisasteratthelastminutebytrading,theydonotworryabouttryingto
preventdisastersbybeingresponsibleownersorlenders.Worse,academicstudieshaverevealedthat
mutualfundsmayadjustinvestmenttacticsaswellasvotingtoattractmorecorporatebusinessrather
thantooptimisereturnsforinvestors.Mutualfundaccountabilityisdampenedfurtheraselectionsfor
theirownboardmembersarefewandfarbetween.
Relevantinformation
Disclosuresshouldnotmerelybevoluminous,butshapedforrealuseandaddresseddirectlytovalue.
Forexample,USregulatorssetdetailedrulescompaniesmustfollowforreleasingdataonexecutive
remuneration.Butprescriptionslargelymissthepointofwhatshareownersactuallyneedandhow
theyusecompensationreporting.
Moreconcerning,therearehugeareasofthefinancialmarketsthatareopaque.Lookatthe‘Credit
DefaultSwap’(CDS)marketplace.ACDSisessentiallyaninsurancepolicyonwhetheracompanywill
defaultonitsloan;itisabitlikealifeinsurancepolicyonaspecificcompany.Justlikealifeinsurance
policy,ithasausefulrole.However,mostpeoplewouldbequiteconcernediftheydiscoveredthat
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someonehadbeenbuyingalifeinsurancepolicyontheirlife,andtheydidnotknowwhoitwas.Yet
manyCDSareboughtandsoldwithnodisclosurewhatsoever.IfyouholdaCDSitisinyourinterest
forthecompanyconcernedtogobankrupt.Wasthatacontributoryfactortothecreditcrisis?Wejust
donotknow.
Thereisnotjustonesetofinformationneeded.Itisnotjustthatcurrentaccountingproceduresmay
beinadequate.Alotofheathasbeengeneratedbythedebateabout‘marktomarket’accounting.
Therelevancyofsuchanaccountingprincipledependsonthecircumstancesinwhichitisgoingtobe
applied,andthepurposeforwhichitisgoingtobeused.Certainlyitisverydangeroustousesuch
accountingforbankregulationbecauseitispro-cyclical;itrewardsthebankswhenthingsaregoing
wellbutputsasqueezeonthemwhenthingsgowrong.
Independentinformation
Thatmarketsmoveoninformationiswell-known;thatiswhythepastdecadeofreformshave
includedtheforcibledivorceofauditorsfromprovidingconsultingservicestothecompaniesthey
audit,andprohibitedstockanalystsfrombeingcompensatedforbyinvestmentbankingresults.
Marketsneedconflict-freeintermediariestoserveasareliablecheckoncorporateinformation.
Yetthereformshardlycoverthewaterfront.Asnoted,investors,notcorporations,shouldpayfor
creditreports.ButitisnotonlytheCRAsthatareopentoconflicts;similarpotentialconflictsmaybe
seenamongremunerationconsultants(temptedtobuildCEO-friendlypayoutsinhopesofgaining
otherbusiness);directorsearchfirms(waryofrecommendingfeistyboardcandidatesforfearoflosing
othersearchcontracts);andvariousdistributionchannelsthattakefeesfromassetmanagersbut
claimtobedoingduediligenceonthosesameassetmanagers.USSecuritiesandExchange
Commission(SEC)ChairwomanMarySchapirodeclaredinanOctober2008speechthatsuch
‘individualshaveallowedthepursuitofwealthtobecomemeresport,devoidofanyethicalmeaning
ormoralobligationtoothers’(Schapiro2008).WewroteinTheNewCapitalists thatifthepubliclost
faithintheintegrityoftheseagents,‘thecapitalmarketswouldseizeup’(op.cit.:123).Andthatis
exactlywhathappened.
Vigilance
Ownersofprivatesectorcorporations–betheyinstitutionalinvestorsor,morefrequentlytoday,
governments–needtocombineaccountabilitywithresponsibilityandinformationtodeployskilled
watchfulnessovercompanyboards.Ifownersfailtotakeupthatcharge,therestofusmustdepend
onregulatorstosupervisewellenoughtoensuremarketstability.Butwedonothaveenough
financialpolicetodothatunlessweturnsecuritiesmarketsintovirtualgarrisons,chokingthecapital
nimblenessnationsneedtostokeeconomicgrowth.
Today,thereisconsensusonwhatsortofvigilancelong-termshareownersshouldexercise.They
shouldmonitorand,wherewarranted,engagewithportfoliocompanyboardstobuildframeworks
forsustainableperformance.Butthatvigilancedoesnotcomenaturally.Entrenchedhabits
fosteredbyconflictsofinterestandahardycultureofpassivityhavesuppressedresponsible
behavior.Onestrikingexample:asthefinancialcrisishit,investmenthousesincludingDeutsche
Bank,CitiandJPMorganmovedearlytoslashtheircorporategovernanceanalyticalunits,which
arejustthesortof‘eyesandears’investorsrelyontopatrolthemarket.
Watchfulnesscan,however,benurturedbysmart,targetedpublicpolicies.TheAustralian
government,forinstance,isprovidingseedmoneyforaninvestoracademytoraisetrusteeand
fundoversightskills.Stepstoincreasetrusteeaccountabilitythroughmorethoroughreporting
requirementscanfurthercontribute.RulescanrequirethatjobdescriptionsforfundChief
InvestmentOfficersincludeskillsthatinvolvecorporategovernancemonitoring.Andcollective
fundgroupssuchastheUK’sNationalAssociationofPensionFundsandAssociationofBritish
Insurers,ortheUnitedStates’CouncilofInstitutionalInvestors,candomoretocoordinatejoint
investorengagement.Perhapsthemostpotentspurtovigilance,though,mightbetheriseof
grassrootsshareownermovementsusingWeb2.0socialnetworkingtoolstopressuriseinstitutional
investorsintocontinuousengagement.
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Theroleofregulation:horizontalvsvertical
Inthediscussionabove,wehaveoutlinedthesimplesetofprinciplesthatunderpinaresponsible
financialsystem,andgiveexamplesofclearfailureswherereformisneeded.However,movingto
anaccountable,sustainablecapitalismrequiresrethinkingthegovernanceofnotjustthebanksor
creditratingagenciesoranyotherentityinthefinancialsystem,butoftheoverallarchitecture
encompassingthem.
Eachmarketparticipantisalinkinmanychains.Forexample,themortgagechain,asnoted
previously,includesahomeownerwhoborrowstocreateamortgage(link1)fromamortgage
originatorsuchasabank(link2)whosellsthemortgagetoaninvestmentbankforpackaging
intoamortgagepool(link3)whichisratedbyacreditratingagency(link4)sothatitcanbesold
toapensionfundorotherinstitutionalinvestor(link5)andsoon.Thatisoversimplified,of
course;therecouldbeallmannerofintermediaries,butyougettheidea.
Theclichéthatachainisonlyasstrongasitsweakestlinkistrue.Butitisalsodangerous;itis
notthewholepicture.Chainscanfailnotbecausethereisaweaklink,butbecausethelinksdo
notworksmoothlywitheachother.Ifthelinksdonotworkwitheachother–iftheydonotfit
togetherwell,iftheyarerustedorfrozen–thenwhatyouhaveisnotachain,butmerelyaseries
ofellipticalpiecesofmetal.Thatiswhathappened.Therewasnotaweaklinkinthechain,yetit
failed.Borrowersgotwhattheywanted:cheapandplentifulcredit.Mortgageoriginatorsgotwhat
theywanted:lotsoffee-generatingorigination.Banksgotwhattheywanted:unprecedented
numbersofindividualmortgagestopackageandsell,reapingbillionsinfees.Thecreditratersgot
whattheywanted:alucrativenewproductareathatbecametheirsinglelargestprofitsource.And
institutionalinvestorsgotwhattheywanted:securitiesthatyieldedmorethanwasavailable
elsewhereintheinvestmentgradebondmarket.
Economistshaveatermforthistypeofsituationwhereineachindividualdecisionseemsrational
butthewholeiscrazy:a‘fallacyofcomposition’.Thelinkskeptonstrengtheningthemselves–
gorgingoncheapcredit,originatingmoreandmoremortgages,ratingmoreandmorestructured
products–evenwhilethechainitselfwasindangeroffreezingup.
Traditionalregulationtriestoensurethehealthofeachlink.Thetheorywasthatbyregulating
eachlinkseparately,thechainwillbestrong.Aswehaveseen,thatisafallacy.Inthistypeof
‘horizontal’regulation,aregulatorfocusesonaparticularlinkandissuesasetof‘thoushalt’and
‘thoushaltnot’commands,suchasbanksneedingtohavesomuchinreserve.Thehealthofthe
systemtakessecondplacetothehealthofeachspecificlink.
Horizontalregulationsuffersfromtwoinevitableforcesthatdegradeitseffectivenessovertime.
First,marketsevolvequickerthanregulatorscanregulate(forexample,creditdefaultswapswere
anon-entityafewyearsago).Second,suchcommand/controlregulationoftenresultsinthe
regulatedentitiesseekingtoavoidtheregulationssoastogainacompetitiveadvantageover
competitorssimilarlyregulated.So,forexample,wehaveseenthebanksusedevicesthatallow
themtolendmoreby‘gamingtheregulator’;therehasbeenextensiveuseofoff-balance-sheet
items,proprietaryriskcalculationmodels,andvariousderivativetransactionsthathavevitiatedthe
intentofbankreserverequirements.Andthatdoesnotevenincludethemostpervasivewayby
whichcredit-originatingentitiesavoidedhorizontalregulation:theysimplyrefusedtobe
recognisedasabank.Hencetheriseofthenon-bankfinancialinstitutioninthe1990sand2000s.
Weproposeanewconceptualisationofregulation.Regulationshouldenhancetherobustnessof
theinteraction between marketparticipants,aswellastherobustnessofanyparticularsetof
marketparticipants.Weshouldenablethevariousentitieswithinthesystemtobeaccountableto
eachotherandtoholdeachotherresponsible.Callitverticalregulation:wearelookingnotonly
tokeepthelinksstrong,buttoprovideoiltolubricatethelinkssothatthechainkeepsworking.
Sucharegulatoryphilosophyalsoimplicitlyrecognisesthepowerofthemarketplace,ratherthan
thepoweroftheregulators.Verticalregulationempowersthemarketparticipantsaswellasthe
regulators.
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Whatwouldverticalregulationdo?Itwouldlookateachlinkinthechainandensurethatitwas
responsibleandaccountable,withrequisiteindependentinformationandoversight.Soitwillhave
corollaries:
1.Enhancedisclosureacrossthesystem.Transparencyisaconditionnecessaryto
accountability.Hereareafew(necessarilytechnical)examplesofwhereitcouldbeused.
a.Mandatethatforafinancialinstrumenttobetradableortransferable,itmustbe
registered.Variousmarketshavesystemsforidentifyingtradeableinstruments,such
astheCUSIP(CommitteeonUniformSecurityIdentificationProcedures)numberin
theUSortheSEDOL(StockExchangeDailyOfficialList)identifierintheUKand
Ireland.Requiringthatanyfinancialinstrumenttoberegisteredasaconditionto
allowittobetradableortransferablewouldmeanitsbasiccharacteristicsareknown,
itistraceable,andthesizeofthemarketiscalculable.Thiswouldallowthe
developmentofnewinstruments,butassuremarketparticipantsandregulatorsare
awareofthesize,shapeandscopeofthembeforetheygrowtoasizethatcan
affectoverallfinancialstability.(Tokeepthisregulationmanageable,itcouldapply
onlytothosecreditinstrumentsofmorethanaminimalsize,sayUS$25million.)
b.Investors,speculatorsandtradersshouldhavetodisclosematerialpositionsina
companynomatterwhetherthosepositionsareheldinstock,options,andcontracts
fordifferencesorotherderivatives,andwhetherthosepositionsareshortorlong.
c.Askallsignificantinvestorstomakeastatementofinvestmentprincipleswhich
shouldincludeadisclosureonwhethertheyarewillingtomakeinvestmentsthat
maydodamagetothesystemortherealeconomyasawhole.That,ratherthan
traditionalregulationoraban,willbemoreeffectiveateliminatinginstabilitycaused
bythe‘shorting’ofshares.
2.Regulatepowerrelationshipsbetweenlinks,nottheoutcomes,ofthoserelationships.Inso
doing,givesomeamountofdeferencetothosewhosecapitalisatrisk.
a.Forexample,mandatingthatUScompaniesfeatureaUK-styleadvisoryshareowner
voteonpay,orallowingshareownerstonominatecorporatedirectorsmoreeasily,
changesthedynamicsandpowerrelationshipbetweenshareowners,executivesand
boardsofdirectors;itdoesnotmandateanyspecificoutcome.
b.Insistthatalltheagentsintheinvestmentchaindeclarehowtheyarepaid.That
includesfundmanagers,distributionchannels,financialengineers,information
providers,raters,andsoon.Allowagenciestodevelopwhichwillhelpconsumers
understandwhethertheremunerationisappropriate,andlikelytoleadtheagentto
workintheprinciple’sbestinterest
3.Focusonthefunctionalpurposeofeachentity,notthelegalstatus.Ifmarketparticipants
are‘gamingtheregulator’,blowthewhistle.
a.Forexample,therequirementsaroundtheissuanceofacreditinstrument–the
extensionofcredit,and,therefore,thecreationofcounterpartyrisk–shouldbethe
sameifyouwereabank,insurancecompany,hedgefundornon-bankfinancial
institution.
b.Ifanassetis‘offbalancesheet’,butismanagedasthoughitwere‘onbalance
sheet,’itshouldbetreatedinthesameway.Dittoforbankingassetsthatareheld
onthebankingbookandthetradingbook.
4.Aligninterests.
a.Thisisbasic,butremembertoaligninterestsacrosstimeframesaswellaswithin
andbetweenentities.Forexample,makeallexecutivecompensationagreementsfor
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Tomorrow’sCapitalism|TowardsanAccountableCapitalism
executiveofficersofpubliccompaniessubjecttoclaw-backstoallowrecoupingof
paymentintheeventoflaterrestatementsorfinancialdistress,afterthepayperiod
haspassed.
5.Donotallowintermediariestoaffectaccountabilitybetweenotherentitiesiftheyhave
nothingatrisk.
a.Forexample,intheUS,brokersoftenvoteproxiesonbehalfofretailshareowners;
theseso-called‘brokernon-votes’areusuallycastblindlyformanagementwithlittle
thoughtandlessexpertise.
6.Whereknownmisalignmentsofinterestpersist,thereisathreattothesystem.Itwillnot
bepossibletoeliminateallconflictsofinterest,butwheretheyexist,theyshouldbean
urgentareaforreform.
a.Corporate-sponsoredretirementsavingsschemesintheUSarenearlyallcontrolled
bytheissuingcompany;memberstypicallyhavenosayindefiningthenatureofthe
planorchoicesavailable.Thiscananddoesproducefundsthatshunactive
engagementwithportfoliocompanies,evenwheresuchstrategiesmightalignwith
theinterestsofbeneficiaries.Onekeyregulatoryantidotewouldrequireeachsuch
schemetofeaturemember-selectedtrusteesalongsideissuerrepresentativesinan
oversightboardchairedbyanindependentoutsider.Similarreformshavealready
beeninstalledintheUKandAustralia.Fundsaroundtheworldshouldalsohaveto
disclosefulsomeannualreportstomembersandregulatorsontheirengagement
resources,policiesandrecords.
b.Anotherexample:creditratings,bylaw,affectwhichinstrumentsvarious
institutionalinvestorsmaybuy.Yetthecreditratingagenciesarepaidbytheissuers
ofthedebt,notthepurchasers.Aswenotedin2006,andastheworld
unfortunatelydiscoveredin2007and2008,thiscreatesanincentiveforratings
inflation.Itistimefornewbusinessmodelsforratings,suchasagenciescollectively
ownedbyfunds.
7.Alwaysthinkabouttheotherlinksinthechain,whetherthisbeinrelationtomarket
participants,orinrelationtoregulatoryactivityitself.
a.Thereisalwaysthedifficultyinanymarketsystemthatparticipantswillsuffer‘the
tragedyofthecommons’.So,forexample,theywillinvestinsecuritiesthatcould
yieldthemahighreturn,butcauseasystemicproblem,becausetheyknowothers
willnot.Suchmarketparticipantsshouldbeidentifiedandexposed.Theircase
shouldbetakentothosetowhomtheyareaccountable.Thisrequiresa
knowledgeableandvigilantfinancialpress,aswellasinformedmarketparticipants.
b.Mostregulatorswillonlybesuccessfuliftheycoordinatewithotherpartsofthe
regulatorysystem.So,inBritain,thefailureoftheFinancialServicesAuthorityto
recognisethattheBankofEnglandwasnotmindedtoactaslenderoflastresortto
overstretchedbankshascontributedtotheinstabilityofthesystem.HadtheFSA
understoodthis,perhapsitwouldhavebeenmoreconservativeinpolicingthe
banks’liquidity.Focusneedstobeputonhowthelinksinthechainofregulation
willworkunderstress.
Wewillleavethe‘toomuch’or‘toolittle’regulationargumenttoothers,thoughwesuspectthat
combiningverticalregulationwithhorizontalregulationshouldleadtoamoreresilientandselfcorrectingfinancialsystem,evenwhileallowingtheeliminationofsomeentity-levelcommandand-controlrules.Ideally,verticalregulationwillenhancetherobustnessoftheinteractions
betweenmarketparticipants,ratherthantherobustnessofanyparticularsetofmarket
participants.Regulationshouldstrengthenthegame,notdeterminethewinners.
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Tomorrow’sCapitalism|TowardsanAccountableCapitalism
Beyondregulation:vigilanceinthecapitalmarkets
Regulationalone,however,isnotsufficient.Thinkofitthisway:regulationisthesocietal
codificationoftherulesofthegame.Asinsports,manyrulesaresubjecttointerpretation;was
thecontactincidentalorseriousenoughtobecalledaviolation?Outsideenforcementagencies
areoftenthewrongentitiestointerpretsubtleties,foranumberofreasons,nottheleastofwhich
isthatregulatorsoftenhavebinaryoptions–somethingisorisnotallowed.Moreover,eventhe
bestrefereesintheworldcannotcreateworld-classlevelsofplay.Thatisonlycausedbythe
participants.
Bygivingtoolstomarketparticipantstoenablethemtobevigilant,weseektoenablethemto
craftreactionsthatareproportional,quick,andfitforpurpose.Thatshouldincrease
accountability,whichshouldincreaseresponsibility,whichshouldsparkdemandformore
accountabilitytools,andsoon,inavirtuouscircle.
Clearlythosetoolsaremorethanregulation,asimportantasthatis.Limitingthediscussionto
regulationwouldbeakintosayingtheonlythingthatmattersincivilsocietyarelaws,policeand
courts,whileignoringafreepress,acultureofcitizenaction,religiousinstitutions,theroleof
technologyandahostofotherinfluences.So,too,anaccountablecapitalismhingesonthe
participationofmultiplecivileconomyinstitutions.
Market-basedsolutionscanbeinfluencesforaccountablecapitalism.CEFEX,theCenterfor
FiduciaryExcellence,hascreatedacertificationprogrammetopromotebestpracticeinthe
investmentmanagementindustry.1 Morethan50independentfirmshavereceivedcertificationsin
thetwoyearssinceitwasestablished.HermesEquityOwnershipServices(EOS),andGovernance
forOwners,anindependentfirm,havecreatedagenciesthatpoolinstitutionalinvestorresources
soastoefficientlyengagewithmanagersofcorporations.
Non-governmentalorganisationscanplayarole,astheydointhepoliticalarena.TheAspen
Institutehascreatedanetworkofbusinessschooleducatorsaroundsustainabilityandcultural
issues,withthegoalofencouragingvalues-basededucation.Inourownexperience,theUK’s
RoyalSocietyofArtsispromotingnewinstitutionsandcitizenawarenessofinvestmentchoices;
theIRRCInstitute(InvestorResponsibilityResearchCenterInstituteforCorporateResponsibility)
issponsoringresearchandtheYaleSchoolofManagement’sMillsteinCenterfosterseffective,
responsiblemarketinstitutions.2
Leadershipmatters.WarrenBuffetthaspublicisedtheneedforresponsiblebusinessleadership
focusedmoreoncreatingsustainablewealthandlessonshort-termget-rich-quickefforts.
1.JonLukomnik
servesontheCEFEX
advisoryboard.
2.DavidPitt-Watson
isanadvisertothe
RSA;JonLukomnik
isprogramme
directoroftheIRRC
Institute;Stephen
Davisisseniorfellow
attheMillstein
Center.
Industrygroupscanbepositivedriversofchange.TheInternationalCorporateGovernance
Networkhashistoricallydrawnitsstrengthfrominstitutionalinvestorsandhasrepresentedthem,
callinguponcorporationstoactresponsibly.ButmorerecentlytheICGNhasputincreasing
resourcesbehindmakingsurethatitsmembersthemselvesactresponsibly,bothtothosetowhich
theyareaccountable(theindividualswhosesavingsthoseinstitutionsinvest)andtothosethey
wouldseektoholdaccountable(publiccorporations),culminatinginitsissuanceofaformal
‘StatementofPrinciplesonInstitutionalShareholderResponsibilities’.Theseeffortsatpromoting
responsibleinvestmentneedtobeextendedfromthemanagementofsharestothemanagement
ofallsecurities.
Meanwhile,theEthisphereInstituteandtheBusinessEthicsLeadershipAllianceareexploring
ethicalbusinessstandardsfromacorporateperspective;thecoalitionincludessuchglobal
heavyweightsasGeneralElectric,AccentureandPepsico.Putsimply,theethicsofbusinessare
fundamentaltoitssuccess.If,whenthecrisisisover,wehaveahighlyregulatedfinancialsystem
wheremarketparticipantsfailtorecogniseanybroaderresponsibilitiesfortheiractions,wewill
stifleinnovation,andwhatinnovationthereiswillbedirectedatsubvertingtheregulationwe
havepassed.Wewilljusthavedrawnthecontoursforthenextcrisis.
Allthese,andnumerousotherefforts,promisetohavemoreimpactmorequicklyandmore
appropriatelyscaledthanwillregulation,nomatterhowwellcrafted.
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Tomorrow’sCapitalism|TowardsanAccountableCapitalism
Dealingwiththeglobaldimension
Onefinaldimensiontosolvingthecreditcrisisneedstobementioned.Inourglobalisedeconomy,
banksoperate,andsecuritiesaretraded,aroundtheglobe.AlargeAmericanorBritishcompanymay
wellbefinancedbyabankfromJapan,orapensionfundfromtheNetherlands.Banksreceivecapital
fromsovereignwealthfundsinAsiaandtheGulf.BritishdepositorshadtheirmoneyinIcelandic
banks.GermanbankswerehurtbyUSsub-primeexposure.Frenchinstitutionsplacedbillionswith
BernardMadoff.Soifanewaccountablecapitalismistoarise,itmustdosoonaglobalbasis.Ifit
doesnot,institutionsbasedinonecountrycouldcontinuethedestructiveshort-termisttacticof
buildingupasinglelinkinonecountry,evenifitdamagesallothers.Thatispreciselywhatthe
Icelandicbanksdid,andwhytheywereabletoofferhigherinterestratestotheirdepositorsthanwere
theirdomesticcompetitors.Aswehaveseen,thattacticworksforsometime,butthenleaves
everyone–notjusttheproximate,causalentity–withamesstocleanup.
However,therearetwohurdlestocreatinganyinternationalframework:institutionalandregulatory.
Atthepresenttimewehavenointernationalinstitutionsthatare‘fitforpurpose’.Eachofthe
internationalregulatorssuffersfromamyopicfocusonitsparticularlinkinthechain,ratherthan
havingapanoramicvisionofthewholesystem.ThemainregulatorsincludetheBaselCommitteefor
Banks,InternationalOrganizationofSecuritiesCommissions(IOSCO)onsecurities,theInternational
AssociationofInsuranceSupervisors(IAIS)forinsurance,theInternationalForumofIndependent
AuditRegulators(IFIAR)foraudit.Evenwithinthesebroadareasthereareotherindependentbodies.
TheInternationalAccountingStandardsBoard(IASB),forexample,isresponsibleforglobalreporting
standards.Noglobalregulatorclaimsjurisdictionovercreditratingagencies,oroverinstitutional
investorsactingasfiduciariesforothers.
Thereisonebodychargedwithcoordinatingallthesebodies:theFinancialStabilityForum(FSF).Its
goalisto‘promoteinternationalfinancialstability,improvethefunctioningoffinancialmarkets,and
reducethetendencyforfinancialshockstopropagatefromcountrytocountry’.Ithasbeenaround
forabouttenyears,andasrecenteventshaveshown,hasbeenaboutassuccessfulastheLeagueof
Nationswas,andforsimilarreasons.First,itisunrepresentative.ItoffersseatstothefourEuropean
membersoftheG7,plustheUSandJapan.TheBRICnations(Brazil,Russia,IndiaandChina)arenot
thereatall.Second,theforumhasnoexecutivepowers.
ButjustastheLeagueofNationswasrebornastheUnitedNationsin1945,sotheFinancialStability
Forumneedsanewlifewithapropermandate.Realistically,thatmandatecannotbetobecomethe
newunifiedglobalregulator.Thatisbothimpractical,andpoliticallyimpossible.Aroundtheworld,
regulatorystructures,eventhenatureofthelaw,differ.Onesizewillfitnoone,neithersubstantively
norpolitically.
Inanycase,thefundamentalmessageofthispaperisthatregulationalonewillnotbeenough.
Indeed,ifanything,theattempttocreateglobalregulationswasoneofthefactorsthatcontributed
tothecreditcrisis.ThenegotiationsforBasleIIended,notwithfinancialstabilityforbanks,butwitha
settlementthatwasnegotiatedasalowestcommondenominator.Andforallthelegitimate
enthusiasmforinternationalaccountingstandards,itisdifficulttoconcludethattheprincipleof
‘decisionusefulness’whichunderpinsthem,andfocusesontheneedsofstockmarkettraders,was
helpfulinencouragingcautiousbehaviourbybanks.
Butwhataninternationalbodycandoistoagreetoprinciples.TheOrganisationforEconomic
CooperationandDevelopmenttookthatapproachinitswidely-praisedcorporategovernanceefforts,
andthosehavebeenwidelyadopted.Aprinciples-basedinternationalentitycouldberigorous,notin
writingregulations,butininvestigatingwhetherthoseprinciplesareappliedineverycountry.
Herearethesimpleprincipleswehaveoutlinedinthispaper.EventheG20couldsurelyagreethat:
•Allactorsinthefinancialsystemhaveclearresponsibilityforthetaskstheyundertake
•Theyareinturnaccountable,andthosetowhomtheyareaccountablearequalifiedandtake
theirresponsibilityseriously
•Thosewhomakethemaccountableareprovidedwithrelevantinformation
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Tomorrow’sCapitalism|TowardsanAccountableCapitalism
•Informationisprovidedbyindependentagents
•Allbanksandotherfinancialinstitutionshavebeen‘stresstested’,notonlyforsolvency,but
alsoforliquidity
•Civilsociety,regulatoryinstitutions,andcentralbankingauthoritiesareempoweredinaway
thatcangivepracticalmeaningtotheabove.
Wehavearguedthatsuchprincipleshavecorollaries:apreferencefortransparencyinalltransactions;
clearlinesofauthorityforeveryone;coordinationamongregulators;anendtoopaquetradingin
derivatives;andaconcernaboutOTC(over-the-counter)markets.
Theyimplynewinstitutions;alenderoflastresortforsmallercountries,perhapswithanexpanded
rolefortheIMF.
Theyraisequestions:overtheincentivestocreditratingagencies;overtheadoptionof‘decision
usefulness’asthecriteriaforaccountingstandards…evenovertheriskmetricsthatbanksand
regulatorswereusing.
Perhaps,then,itistimeforamodernised,BrettonWoods-stylearchitecturetorepurposetheFinancial
StabilityForumasageneratorofprinciplesforaccountablecapitalism.Foritstrikesusthatany
inspectorchargedwithjudgingwhetherthefinancialmarketsoftheworldin2006hadmetthose
principleswouldhaveconcludedthatmanydidnot.Andperhaps,hadtherebeensomesuchan
inspectorate,backedbythecloutandauthorityoftheG20groupofnations,totenaciouslyensure
thattheseprincipleswereapplied,theirresponsibleandunaccountablebehaviourthatwasallowedto
thriveuntil2007wouldhavebeenputincheck.
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Tomorrow’sCapitalism|TowardsanAccountableCapitalism
References
DavisS,LukomnikJandPitt-WatsonD(2006)TheNewCapitalists:HowCitizenInvestorsAre
ReshapingtheCorporateAgenda,HarvardBusinessSchoolPress
PrinceC(2007)CommentsmadebyChuckPrinceininterviewwiththeFinancialTimes,9July,
availableatwww.ft.com/cms/s/0/5cefc794-2e7d-11dc-821c0000779fd2ac.html?nclick_check=1
SchapiroM(2008)RemarksbyMaryL.Schapiro,ChiefExecutiveOfficer,FINRA,Ethicsand
LeadershipLecture,‘TheRoadAheadinRegulation’,DominicanUniversity,October14,available
atwww.finra.org/Newsroom/Speeches/Schapiro/P117298
TalebNNandTrianaP(2008)‘Bystanderstothisfinancialcrimeweremany’,FinancialTimes,
7December
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Tomorrow’sCapitalism|TowardsanAccountableCapitalism
Appendix:Summaryofprinciplesandselectedreforms
mentionedinarticle
Althoughithasnotbeentheaimofthepapertoofferacomprehensivesetofproposalsforreform,
thistableisillustrativeoftheprinciplesofreform,andofthesortofmeasureswhicheachprinciple
mightsuggest.
Principle
Exampleofreform
Overview
•Fiveprinciplesagreedasbasisforfuturereform
•FinancialStabilityForumreconstitutedasan‘inspectorate’ratherthan
tryingtobeglobalregulator.
•Allregulatorstobechargedwith‘vertical’responsibility.(Believetheir
actionstobeconsistentwithsystemicstability)
Accountability
•GovernanceofFSFandotherinternationalinstitutionsrepresentativeofthe
globalfinancialcommunity
•Allfiduciariesexercisegovernancepowersonbehalfofprinciples
•No‘hidden’votes
•Informationavailableonissueswhereconflictlikelytoarise(e.g.
remunerationandstructures)
•Votingonissueswhereconflictlikelytoarise(e.g.sayonpay)
Responsibility
•Alllicensedfiduciariesaskedtohavestatementofinvestmentprinciples,
including‘donoharm’clause
•Regulationtobebasedonfunction,notlegalform(e.g.off-balance-sheet
finance)
•Clawbackonpaypermittedforfailurewhichcomestolightatalaterperiod
•Investmentfundboardstorepresentbeneficiaries
•ReconstitutegovernanceofCreditRatingAgenciestorepresentusers
Relevanceof
information
•Riskframeworksforregulationareexplicitandpublic
•Alltradableinstrumentstoberegistered
•Allpositionswhichmightgiveinfluence,includingderivativepositions,tobe
declared
•Accountingandothermeasuresrelevantforregulatorypurposes
•Informationavailableonaccountability/responsibilityissuesabove
Independenceof
information
•AskinvestmentmanagerstodeclareCEFEXorsimilarcertification
•GovernanceofCRAs(seeabove)
Marketvigilance
•Establishsystematic‘nameandshame’,aspartofhardandsoftregulation
•Promoteindustrybodiesandotherspreparedtocoordinatefiduciaries
and/orgivechallenge(e.g.RSAintheUK,InternationalCorporate
GovernanceNetworkglobally)
•Regulaterelationships,toachievesystemicgoals