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G-7 and the next 100 days

The meeting of the Group of Seven finance ministers and central bankers in Washington over the weekend acknowledged that the downside risks to the outlook persisted “in view of the ongoing weakness in US residential housing markets” and that the turmoil in global financial markets remained challenging and more protracted than they had anticipated.

But though the meeting was strong on analysis, it was weak on leadership and solutions and delivered little in respect of the work of the Financial Stability Forum (FSF) which had been asked last autumn to identify the underlying causes and weaknesses in the international financial system that contributed to the financial market turmoil.

The G7 have endorsed the subsequent report and committed to implementing its recommendations. The G7 said: “Rapid implementation of the FSF report will not only enhance the resilience of the global financial system for the longer term but should help to support confidence and improve the functioning of the markets”.

The G7 has identified the following recommendations for implementation within 100 days:

Firms should fully and promptly disclose their risk exposures, write–downs, and fair value estimates for complex and illiquid instruments. “We strongly encourage financial institutions to make robust risk disclosures in their upcoming mid-year reporting consistent with leading disclosure practices as set out in the FSF’s report”.

The International Accounting Standards Board (IASB) and other relevant standard setters should initiate urgent action to improve the accounting and disclosure standards for off-balance sheet entities and enhance its guidance on fair value accounting, particularly on valuing financial instruments in periods of stress.

Firms should strengthen their risk management practices, supported by supervisors’ oversight, including rigorous stress testing. Firms also should strengthen their capital positions as needed.

By July 2008, the Basel Committee should issue revised liquidity risk management guidelines and IOSCO should revise its code of conduct fundamentals for credit rating agencies.

The G7 has also endorsed the following FSF proposals for implementation by end-2008:

Strengthening prudential oversight of capital, liquidity, and risk management: The Basel II capital framework needs timely implementation. The Basel Committee should raise capital requirements for complex structured credit instruments and off-balance sheet vehicles, require additional stress testing, and enhance their monitoring.

Enhancing transparency and valuation: The Basel Committee should issue further guidance to enhance the supervisory assessment of banks’ valuation processes to strengthen disclosures for off-balance sheet entities, securitization exposures, and liquidity commitments.

Changing the role and uses of credit ratings: Investors need to improve their due diligence in the use of ratings. Credit rating agencies should take effective action (consistent with IOSCO’s revised code of conduct) to address the potential for conflicts of interest in their activities, clearly differentiate the ratings for structured products, improve their disclosure of rating methodologies, and assess the quality of information provided by originators, arrangers, and issuers of structured products.

Strengthening the authorities’ responsiveness to risk: Supervisors and central banks should further strengthen cooperation and exchange of information, including the assessment of financial stability risks. It is important that an “international college of supervisors” be established for each of the largest global financial institutions. Market authorities also should act cooperatively and swiftly to investigate and penalize fraud, market abuse, and manipulation.

Implementing robust arrangements for dealing with stress in the financial system: Central banks should be able to supply liquidity effectively during financial system stress, and authorities should review and where necessary strengthen their arrangements for dealing with weak and failing banks, domestically and cross-border.

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