Panel on The World Financial Crisis

From the Editor

The main focus of this highly insightful panel was identifying the nature and structure of regulatory frameworks that would be effective for averting or dealing with a financial crisis. Also discussed was an issue of specific relevance to lawyers: the complicity of the legal profession in the events leading up to the recent financial crisis and the role lawyers can play in averting a future crisis.



As a contextual background to this summary of the panel discussions, it is worthwhile to recall some basic facts of the financial crisis and the role played by complex financial instruments in the crisis. The crisis, which originated in the burst of the U.S. housing market bubble, had spread across the globe due to the purchase of U.S. securities by financial institutions outside the U.S. Subprime mortgage loans (a type of loan granted in the U.S. to individuals with poor credit history) had been bundled into a variety of financial instruments and sold to European banks and other financial institutions across the world. When subprime borrowers started defaulting on their mortgages, banks and investors that had purchased instruments backed by those mortgages lost a lot of money. Many of the affected buyers were unaware of the systemic risks involved in their purchase because of the complexity of the instruments involved. A significant proportion of the risky instruments had been sold by U.S. financial groups through subsidiaries located abroad.


The fact that institutions whose activities had precipitated the financial crisis also operated through subsidiaries located abroad meant that any system set up to regulate their activities (so as to prevent another crisis) would not be effective unless it applied across national borders. Also, the transnational dimensions of the crisis had led to a situation in which a variety of national authorities had to take action to contain its effects. This latter fact carried the risk of conflict between the measures taken by different national authorities to regulate the activities of  cross-border institutions. It was in this connection that Sean Hagan (General Counsel and Director of the Legal Department at the IMF) had in his presentation identified a lack of coordination of national responses as a factor leading to failures in effectively resolving the crisis. He therefore proposed the establishment of a framework for coordinating the regulation of cross- border banks.


The nature of this coordination framework, and the possible role of international law in its design, was one of the issues he dealt with in his presentation. He had identified as a possible role for international law, the establishment of an international treaty that would require countries to defer to the crisis resolution decisions of the country in whose territory the affected financial institution has its main activities. This idea, he had however discarded as not being feasible in the near future because it would demand a level of sacrifice of national sovereignty which States may not be willing to accept at present. He, therefore, proposed as a better alternative, “a pragmatic framework for enhanced coordination” which would be subscribed to by countries in a position to satisfy its elements. The proposed framework, which he considered to represent a significant step forward, would be evidenced by a non-binding understanding among participating national authorities. One of its elements is that subscribing countries would modify their laws so as to require their national authorities to coordinate their resolution efforts with their foreign counterparts (to the maximum extent consistent with the interests of creditors and domestic financial stability). Another element is that participating countries would agree to coordination procedures designed to ensure that resolution measures in the context of a crisis are taken as quickly as possible and can have cross border effect.


René Maatman (Financial Markets Authority of the Netherlands) had in his presentation dealt with the question of the most appropriate structure for financial regulation at both national and international levels. In this connection, he drew attention to the growing popularity of the “twin peaks model” (see Volcker report) used in the Netherlands and Australia. In contrast to the single universal regulator approach used in the UK, the twin peaks model requires a separation between the conduct of business supervisor and the credentials supervisor (the latter being, in the case of the Netherlands, the Dutch Central Bank).


The double role of lawyers as enablers and preventers of a financial crisis was discussed by Lee Buchheit (Cleary Gottleib Steen & Hamiliton LLP, New York). He had pointed out that one of the factors that precipitated the crisis was that because of the complexities of the financial instruments involved, many concerned parties lacked a full appreciation of the risks involved. For example, buyers did not know what they were buying, financial regulators could not warn of the dangers because they did not fully understand the products they were regulating, and even the people that created the products did not fully understand what they had created. In his view, lawyers bore some blame for this state of affairs because those complex financial instruments and the contracts for their sale had been drafted with the assistance of lawyers. He went on to identify several roles transactional lawyers can play in averting a future financial crisis. One is to serve as a common sense sounding board and critic for corporate clients in the process of designing financial instruments. Also lawyers charged with drafting contracts, disclosure statements and other documents relating to the sale of financial instruments should ensure that those documents are drafted with candour and in terms that can be clearly understood by the relevant parties.


Some members of the audience were of the view that more attention should have been paid to the role of the private sector – and not just governmental bodies - in maintaining a safe economic environment. As the crisis was, after all, the result of bad investment and risk-management practices of financial institutions, self-regulation by those institutions was, in their opinion, vital for preventing another crisis.


The panel agreed with this viewpoint. However Buchheit identified one factor that made self-regulation problematic today. Banks, he pointed out, would attach premium importance to self regulation, only if they knew serious consequences awaited them if they got things wrong. The motivation for self regulation, he noted, has been affected by the now prevalent understanding that some banks have to be bailed out if they get into trouble.


Many in the audience found this understanding to be problematic. As one of the conference participants emotively asserted, the international community has to get rid of the mindset that certain institutions are too big and too systemically important to fail. The participant was also of the view that the systemic problems of the crisis were being exacerbated by the policy of propping up failing banks, thus tampering with the normal operation of the market system. In his opinion, there would be no more systemic implications if badly performing banks were simply allowed to die off, leaving the healthy banks to continue operation.