Yesterday, the leaders of the G-20 countries met in Washington, D.C. to address the serious challenges facing the world markets. At the conclusion of yesterdays’s meeting, the leaders released a Declaration of the Summit on Financial Markets and the World Economy. The White House also issued a Fact Sheet summarizing the conclusions reached at the summit. In anticipation of yesterday’s summit, the G-20 Finance Ministers and Central Bank Governors had discussed the global financial crisis during the G-20 annual meeting in Sao Paolo last week, while the Heads of State of the European Union announced their agreement on a set of principles and proposed actions to address the global financial crisis.

According to the White House Fact Sheet, the G-20 leaders at yesterday’s financial summit achieved the following key objectives:

(1) reaching a common understanding of the root causes of the global crisis;
(2) reviewing actions countries have taken and will take to address the current crisis and strengthen growth;
(3) agreeing on common principles for reforming global financial markets;
(4) launching an action plan to implement these principles and directing financial ministers to develop further specific recommendations that will be reviewed at a subsequent summit; and
(5) reaffirming their commitment to free market principles.

The Declaration is careful not to assign blame for the financial crisis to any single government or its policies, but does state that the G-20 leaders identified various “root causes” of the current crisis, including market participants seeking “higher yields without “adequate appreciation of the risks” and failing to “exercise proper due diligence,” together with “weak underwriting standards, unsound risk management practices, increasingly complex financial products, and consequent excessive leverage.” At the same time the leaders acknowledged that policy-makers, regulators and supervisors “did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions.” The leaders also identified “inconsistent and insufficiently coordinated macroeconomic policies” and “inadequate structural reforms” as contributing to “excesses” and ultimately leading to “severe market disruption.”

After citing various efforts that have already been taken to stimulate and stabilize world markets, the G-20 leaders agreed on various immediate actions to be taken to restore growth and support emerging economies, including stabilizing the financial system, providing monetary support, using appropriate fiscal measures to stimulate domestic demand, providing liquidity to thaw credit markets, and ensuring that the IMF, World Bank and multilateral development banks have sufficient resources to assist developing countries affected by the crisis, and to provide trade and infrastructure financing.

The G-20 leaders also agreed on a set of common principles to guide reform of the financial markets, and identified both immediate and longer-term actions that could be taken to achieve these principles. The common principles and general actions to be taken to achieve these principles are summarized below:

  • Strengthen transparency and accountability by “enhancing required disclosure on complex financial products and ensuring complete and accurate disclosure by firms of their financial condition” and aligning compensation and other incentives to “avoid excessive risk-taking.”
  • Enhance sound regulation by ensuring, among other initiatives, oversight of “all financial markets, products, and participants as appropriate to their circumstances” and “strong oversight of credit rating agencies, consistent with the agreed and strengthened international code of conduct.”
  • Promote integrity in financial markets by “bolstering investor and consumer protection, avoiding conflicts of interest, preventing illegal market manipulation, fraudulent activities and abuse,” protecting against use of the financial system to support terrorism, drug trafficking, or other illegal activities, and promoting information sharing between jurisdictions.
  • Reinforce international cooperation by making national laws and regulations more consistent and encouraging regulators to “enhance their coordination and cooperation across all segments of financial markets” and “strengthen cooperation on crisis prevention, management, and resolution.”
  • Reform international financial institutions (notably the IMF, World Bank and Financial Stability Forum) by modernizing their governance and membership to encompass “greater voice and representation” by emerging market economies and developing countries, and, in the case of the IMF, collaborating with an expanded Financial Stability Forum to “better identify vulnerabilities, anticipate potential stresses, and act swiftly to play a key role in crisis response.”

The G-20 leaders approved a comprehensive Action Plan that encompasses the specific actions that should be taken prior to March 31, 2009, to ensure compliance with the common principles, which include:

  • enhancing guidance from the global accounting standards setting organizations (mainly FASB and the IASB, which are already in the midst of hosting a series of roundtables and forming a high-level advisory group to consider financial reporting issues arising from the global economic crisis) on the valuation of securities, including addressing weaknesses in accounting and disclosure standards for off-balance sheet vehicles and complex financial instruments, and enhancing the governance of the IASB, “including by undertaking a review of its membership, in particular in order to ensure transparency, accountability, and an appropriate relationship between this independent body and the relevant authorities”;
  • developing regulatory recommendations of how to “mitigate pro-cyclicality” by reviewing the impact of “valuation and leverage, bank capital, executive compensation and provisioning practices” on cyclical trends;
  • ensuring that credit rating agencies, about which a comprehensive regulatory proposal has already been proposed by the European Commission and for which the SEC will be holding an open meeting this Wednesday, “meet the highest standards of the international organization of securities regulators” and “avoid conflicts of interest, provide greater disclosure to investors and issuers, and differentiate ratings for complex products”;
  • ensuring that financial institutions maintain adequate capital, and setting out “strengthened capital requirements for banks’ structured credit and securitization activities”;
  • accelerating efforts, by “building on the imminent launch of central counterparty services for credit default swaps (CDS) in some countries,” to reduce the “systemic risks of CDS and over-the-counter (OTC) derivatives transactions, and insisting that “market participants support exchange traded or electronic platforms for CDS contracts”;
  • developing enhanced guidance to strengthen banks’ risk management practices, and ensuring that financial firms “reexamine internal controls” and implement policies to improve risk management, including management of liquidity risk and the “measurement of risk concentrations and large counterparty risk positions across products and geographies”;
  • establishing processes whereby national financial supervisory authorities review business conduct rules, collaborate and share information about “domestic and cross-border threats to market stability,” and form “supervisory colleges” that meet with major global banks to discuss each “firm’s activities and assessment of the risk it faces”; and
  • expanding the Financial Stability Forum (FSF) to include broader membership of emerging economies, and strengthening collaboration between the IMF and the FSF.

The G-20 leaders also agreed that the following long-term actions that should be taken:

  • collaboration by global accounting standards bodies (mainly FASB and the IASB, whose oversight bodies recently cautioned the G-20 countries to refrain from political interference in the accounting standards-setting process at the summit) in creating a “single high-quality global standard,” ensuring the consistent application and enforcement of accounting standards, and ensuring the inclusion of complete and accurate information in financial institutions’ financial statements;
  • commitment by all G-20 members to undergo a Financial Sector Assessment Program (FSAP) report to assess the regulatory system of each country and its compatibility with the changing globalized financial system, and the provision of report by appropriate regulatory authorities regarding the “differentiated nature of regulation in the banking, securities and insurance sectors”;
  • harmonization of the definition of capital to “achieve consistent measures of capital and capital adequacy”;
  • registration of credit rating agencies providing public ratings;
  • developing “consistent approaches for liquidity supervision of, and central bank liquidity operations for, cross-border banks”;
  • monitoring of “substantial changes in asset prices and their implications for the macroeconomy and the financial system”;
  • implementing measures that “protect the global financial system from uncooperative and non-transparent jurisdictions that pose risks of illicit financial activity”;
  • collaboration by tax authorities to “promote tax information exchange”;
  • collection of progress status information of the convergence of regulatory practices in accounting standards, auditing and deposit insurance; and
  • comprehensive reform of the Bretton Woods institutions (IMF and World Bank) to “adequately reflect changing economic weights in the world economy.”

The G-20 finance ministers were also tasked with making specific recommendations on the following topics:

  • mitigation against pro-cyclicality in regulatory policy; 
  • alignment of global accounting standards, particularly for complex financial products; 
  • strengthening and improvement of the infrastructure for OTC derivatives markets; 
  • determination of how compensation practices correlate to incentives for risk taking and innovation; 
  • review of the mandates, governance and resource requirements of the international financial systems; and
  • defining the scope of “systemically important institutions” and determining their appropriate regulation and oversight.

The G-20 leaders expressed their commitment to an open global economy, by agreeing to refrain from imposing new trade or investment barriers for the next 12 months, to strive to reach agreement on the modalities that will lead to a successful outcome of the Doha Round of World Trade Organization negotiations, and to reaffirm assistance for developing economies.

Finally, the G-20 leaders agreed to meet again prior to April 30, 2009 to review and discuss the implementation of the principles and decisions agreed upon yesterday.