The Network seeks to focus research and debate on the underlying causes of financial market instability and on development of fundamental reforms. To that end, we set forth the following principles to guide our participation in the reform process:
I. The Economic and Social Purpose of Markets is to Create Long-Term, Sustainable Value, which Requires the Efficient Allocation of Capital towards that Goal
This is the primary goal against which market practices and regulatory approaches should be justified. Too much financial market activity over recent years has had too little real economic and social benefit. Greater attention needs to be paid to how sustainable, long-term value is created, and market and regulatory reforms directed towards creating such value.
II. Sustainable Value Creation Requires that Hidden Risks and Rewards be Identified and Valued
Companies’ ability to create both negative and positive externalities is rarely accounted for in the marketplace. All too often, companies offload hidden costs onto society, while capturing benefits for their private gain. Similarly, companies that invest in the creation of long-term value for society are rarely rewarded. Better recognition and valuation of intangibles is a necessary prerequisite to sustainable value creation. Capital cannot be efficiently allocated without assessing all risks, costs and benefits, including those items not currently reflected on balance sheets.
III. Balance Between Short-Term and Long-Term Views is Needed
Numerous tax, legal, accounting, regulatory, social and compensation incentives pressure financial market participants to focus on short-term gains, often at the expense of greater future value creation. These pressures need to be better understood so that regulatory and governance reforms reward long-term, sustainable value creation.
IV. Market Participants Must Take Responsibility for Their Actions
A shift in business models throughout the financial services industry has led to widespread offloading of financial risks away from those who create them, while compensation systems do not account for the systemic risks thus created. Market and regulatory mechanisms are needed that encourage originators to ‘eat some of their own cooking’. These mechanisms should not absolve other market participants, such as investors and intermediaries, from the responsibility of understanding the risks they choose to accept.
V. Governance at All Financial Institutions Should be Improved
Better governance and risk management practices are needed throughout the industry. Independent directors have proven to be ineffective. Narrow interpretations of fiduciary duty have encouraged institutional investors to blindly mimic each other, accept risks they did not understand and resist governance improvements. Governance issues like these exacerbate financial crises and undermine the efficient allocation of capital and therefore need immediate and determined attention.
VI. Better Alignment of Financial Interests is Needed to Reduce Agency Costs
Conflicts of interest, asymmetric access to information and misaligned financial interests are rife throughout the financial services industry. This has encouraged profiteering by agents and intermediaries at the expense of investors and society. This problem is of particular concern when it has resulted in mismatches between portfolio investments and plan liabilities for the long-term security of pension beneficiaries. Measures to better align the short-term activities of financial companies with the longer-term interests of their customers are necessary.
VII. A Coordinated Global Approach is Needed to Better Protect the Financial Markets
In an increasingly global marketplace, oversight bodies must evaluate aggregated cross-border risks to protect market stability. However, market participants should not be forced to rely on a single market regulator. The presence of alternative enforcement mechanisms is necessary to limit damage when a previously effective regulator becomes neutralised. In addition, global institutional investors should play a bigger role. Their cross-border and long-term focus on meeting liabilities gives them a unique perspective which should inform regulatory decisions. They also have an incentive to help maintain international standards of quality and protect against regulatory capture.
Hat tip: Peter C