the real g2: americans, europeans, and their role in the g20

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AbstractGlobal economic governance is in the process ofmaking a quantum leap. Hopes regarding the G20process as the new global nucleus of political andeconomic governance are strong. But the realityof international financial market diplomacy is aharsh one. Reaching consensus among the G20participants on financial market governance hasproved a challenging task. This article argues thatthe United States and the European Union are theproblem – and its solution.Recent disagreements over capital and liquidityrequirements, the organization of over-thecounter(OTC) derivatives markets, the treatmentof alternative investments, and the handling ofsystemically important financial institutions areonly a few examples of the low point transatlanticfinancial market diplomacy has reached. At thesame time, only the United States and the EUcan provide the impetus the G20 process needs.This requires that they first and foremost arriveat joint policy positions between themselves. Inpractice, this necessitates concrete cooperation onthe scheduling, design, and details of regulation.This would optimally include ex ante bilateralconsultations on all new policy measures as well asa close coordination of policy positions discussedin the G20. In the final analysis, however, thecredibility of Americans and Europeans will dependin the long run on their ability to achieve a moreintegrated financial market at the transatlantic level.These are very ambitious objectives, but theirbenefits would be substantial and real. The UnitedStates and the EU should intensify their policycooperation and encourage their G20 partners tostrive for more effective global coordination offinancial market policies.The Real G2: Americans, Europeans,and their Role in the G201

IntroductionGlobal economic governance is in the processof making a quantum leap. Hopes regardingthe G20 process as the new global nucleus ofpolitical and economic governance are strong. Infinancial market matters, this high-level processis supported by international organizations, suchas the International Monetary Fund (IMF), theFinancial Stability Board (FSB), or the InternationalOrganization of Securities Commissions(IOSCO), whose work holds out the prospect ofan internationally coordinated approach to the keyregulatory challenges in the world’s increasinglyintertwined financial markets.Expectations are high, and the urgency of closerinternational cooperation after the financial crisis ishigher still. But the reality of international financialmarket diplomacy is a harsh one. Two years afterthe first G20 meeting at the principal level inWashington in November 2008, optimism aboutthe scope for global solutions has given way tosober realism. Reaching consensus among the G20participants on financial market governance – beit on grand design or specific detail – has proved achallenging task, even at a time when the memoryof the financial crisis and the perceived “[need for]reforms in the world’s financial systems” 1 is stillfresh.The United States and the European Union arethe problem – and its solution. While the globaleconomy is undergoing tectonic changes, andits future is widely expected to be shaped by theUnited States and China – often referred to as theG2 – this article argues that it is the United Statesand the EU who need to provide the impetus theG20 process needs. Only they can drive globalfinancial market reform. Otherwise, the visionof establishing the G20 as an effective forum forinternational economic policy coordination mayfail.The G20 as a Forum of InternationalFinancial Market Policy CoordinationIf successful, the G20 may enter history books asone of the most important institutional innovationsin post-cold war global politics. While the initialcrisis reaction held out the prospect of a new eraof international high-level cooperation, however, anumber of political challenges have surfaced sinceits inception, rooted in the design of the processbut also in the diverging interests among the majorparticipants.The rationale of the G20 process was spelledout clearly at the first high-level meeting inNovember 2008, and has been greeted by manypolitical, academic, and business commentatorsas an important, if not overdue, step. Twoimportant objectives can be identified. One is theintensification of policy cooperation. In the areaof financial market policy, the G20 participantsdecided to “[...] enhance [...] cooperation andwork together to [...] achieve needed reforms inthe world’s financial systems.” In particular, theG20 recognized that “[...] financial markets areglobal in scope [and] intensified internationalcooperation among regulators and strengtheningof international standards [...] and their consistentimplementation is necessary to protect againstadverse cross-border, regional, and globaldevelopments affecting international financialstability.” 2Second, it was agreed to open up the high-leveldialogue and enhance the circle of decision-makersto include key emerging economies. Extending theTwo years afterthe first G20meeting optimismhas given way tosober realism. TheU.S. and the EUare the problem— and its solution.1G20 Meeting, November 15, 2008, final communiqué:“Washington Declaration – Summit on financial markets andthe world economy.”2G20 Meeting, November 15, 2008, final communiqué:“Washington Declaration – Summit on financial markets andthe world economy.”The Real G2: Americans, Europeans,and their Role in the G203

Joint action onfinancial marketreform will leadto superior policyoutcomes. It’ssuccess hinges onthe U.S. and theEU solving theirbilateral issuesand forging aheadwith internationalcooperation.forum of policy coordination from the traditionaladvanced nations of the G7 to the 20 mostimportant economies promised a more effectivehandling of the 2008 financial crisis and a moresustainable policy framework for navigating thepost-crisis environment. It did this by inviting fastdevelopingnations such as China, India, and Brazil,which enjoy a growing share in global trade andoutput and increasing stakes in global productionand asset ownership, as well as formidable financialreserves. Including key emerging economies inglobal economic policy coordination has beenpraised widely as a major leap forward for globalgovernance.The potential benefits of closer cooperation amonga larger number of key players are substantial.In financial market policy, a joint approach toregulation and supervision promises a more levelplaying field in terms of regulation and a lowerrisk of regulatory arbitrage by market participants.By establishing high-quality rules across the G20,the overall level of financial market oversightcould be raised substantially. Closer cooperationamong supervisory authorities may contribute toa more effective handling of cross-border risksfor international capital flows and transnationaloperations of financial firms. In other words, jointaction may result in superior policy outcomes,as the logic of what theorists refer to as collectiveaction also applies to financial market diplomacy. 3But so do the problems associated with collectiveaction. Thus, the likelihood of reaching agreementamong the participants in the policy processdeclines with their number and with a risingheterogeneity of their interests. The transitionfrom G7 to the G20 has added to both. In addition,the chances of finding joint solutions rise with3Masson (2009) provides a comprehensive theoretical analysisof the dynamics behind international cooperation in financialmarket regulation.the expected costs of failure to do so, 4 and theunexpectedly quick economic recovery afterthe crisis in many parts of the world has clearlydiminished the sense of urgency perceived in thecontext of financial market reform. Cooperationmay get further aggravated by the multitude ofnegotiating bodies involved, especially if theirmembership varies as is the case between the G20,the IMF, the FSB, IOSCO or the Basel Committee. 5Finally, the question of the right scope of theG20 remains a latent issue. Depending on theperspective they have, critics have claimed that theGroup may be either too large or too small, andthat the range of political issues on the G20 agendawas too extensive or too limited. 6Theory, however, tells us another important storyabout international negotiations: Their successcritically hinges on group dynamics – atomistic,self-interested countries are less likely to reachagreement than a limited number of oligopolisticplayers, and the likelihood of joint solutions vitallydepends on one or more large countries forgingahead with international cooperation. 7This brings us to the United States and the EU. Iftheory — let alone historical experience — is rightabout the central importance of a small number ofkey drivers in intergovernmental processes, thenthe United States and the EU intuitively qualifyas important promoters of joint G20 solutions.Judging by their economic and financial weight,they should indeed be the driving force behindglobal policy coordination, especially in the area offinancial market regulation.4Masson (2009), pp. 18-19.5Weber (2007), p. 103 and Bradlow (2010).6Bradlow (2010), p. 12.7Masson (2009), p. 17.4Transatlantic Academy

The United States and the EU:Global Centres of Finance and RegulationThe still central role of America and Europe inglobal finance is impressive. In banking, well overtwo-thirds of global assets remain concentratedin financial centres in the United States and theEU. Together, they capture more than threequartersof the global revenue pool of investmentbanking services. On stock exchanges, the shareof the United States and the EU in global marketcapitalization remains dominant at more than 50percent of the total, and the 78 percent share inglobal equity trading attests to their strong positionas the key equity trading centres worldwide. Inaddition, more than 70 percent of all private andpublic debt securities and almost 80 percent of allinterest-rate derivatives outstanding are registeredin the traditional financial centres in the UnitedStates and the EU. Finally, foreign exchange trading,too, remains highly concentrated in transatlanticmarkets, capturing a combined 50 percent share inglobal trading.The financial crisis, despite its impact inparticular on the United States and the EU, hasnot immediately led to a critical change in thetectonics among the major financial centresaround the globe. The traditional financial centresin the United States and the European Unionhave managed to retain their strong position andcontinue to provide around three-quarters of globalfinancial services, albeit at least temporarily loweroverall levels of market activity in many marketsegments. 8The solid share of transatlantic financial markets,however, cannot belie the fact that the historicposition of the traditional financial centres inEurope and the United States is increasingly8For a more detailed analysis of the role of U.S. and EU financialmarkets in the world economy see Kern (2008), also TABD(2010).Decline of Traditional Stock MarketsSources: World Federation of Exchanges; own calculationsSources: World Federation of Exchanges; own calculationsbeing challenged by emerging competitors.Equity markets are an illustrative and in largeparts representative example: Today’s 50 percenttransatlantic share in global stock marketcapitalization has declined substantially from its78 percent peak in 2001, while its share in stocktrading has fallen from 86 percent to just over 70percent in the same period. Strikingly, the growthof stock markets in the BRIC countries amountedto more than 40 percent per year, while the EU andTraditionalfinancial centresin the UnitedStates and theEU have retainedstrong position.But this cannotbelie the factthat they areincreasinglychallengedby emergingcompetitors.The Real G2: Americans, Europeans,and their Role in the G205

The G20 processhas arrived ata low point. Itseems difficultfor the UnitedStates and the EUto reach beyondthe minimumconsensus.U.S. markets actually contracted (see graphs page5). 9 China alone can be expected to raise its sharein global financial markets by the end of the currentdecade to 13 percent in banking, 5 percent in debtsecurities, and 16 percent in stocks. 10These long-term dynamics in financial marketsmake a very strong case for including key emergingeconomies in financial market reform at the globallevel. The still-dominant U.S. and EU shares inglobal finance, however, also illustrate that theUnited States and Europe are in a unique positionto promote global financial reform, a position thatfor the time being remains unattainable for anyother economy around the negotiating table.Transatlantic Financial MarketDiplomacy at a Low PointBeing the most important financial marketsworldwide is one thing. Pursuing joint interests,however, may be a completely different matter. Inprinciple, the United States and the EU may havediverging, possibly competing interests when itcomes to financial market policy, and they coulduse their economic and political weight as abasis for pursuing these interests in a G20 settingconcurrently.In fact, two years into the G20 process, transatlanticcooperation on financial market policy appearsto have reached a low point. On the one hand,some credit can be given to the United States andthe EU, as well as to the other nations representedin the G20. Arriving at a joint agenda for policydevelopment and on broad policy directions9All figures based on own calculations and data from Bank forInternational Settlements, International Financial Services,Transatlantic Business Dialogue, World Federation ofExchanges.10China’s share in the global total is expected to rise from 9percent to 13 percent in banking, from 2 percent to 5 percentin debt securities, and from 6 percent to 16 percent in stockmarkets (Kern 2009).especially in the area of financial market reformmarks an important political achievement that canhardly be overestimated.On the other hand, however, it has been difficultfor U.S. and EU policymakers to reach beyondthe minimum consensus on agenda items andbroad policy directions. Importantly, they differsubstantially in their approaches to the G20 agendaand its implementation at home. While the UnitedStates chose a single-package strategy that hasalready resulted in the Dodd-Frank Act, coveringall major areas of financial reform. The EU, on theother hand, follows a menu-type strategy of morethan 25 individual measures for final adoption inthe course of 2011. As a consequence, the politicalprocesses have remained largely out of sync.Apart from procedural questions, Americans andEuropeans also disagree on a number of substantiveissues. These include topics such as the U.S. VolckerRule, a proposal not directly contained in the G20agenda. While the EU is not planning comparablemeasures, there is widespread concern that itsimplementation may have negative extraterritorialeffects. Similarly, there is, reflecting on earlierexperiences, concern that the United States maynot succeed in implementing the recent versionof the Basel Accord on bank capital, despite itsendorsement at the November 2010 Seoul Summit.Americans, in turn, are ill at ease with the EUrules on alternative investments as adopted in theAlternative Investment Fund Managers Directive(AIFM) and are critical of the treatment of thirdcountryfunds under the new regime. Furthertransatlantic deviations can be found in theapproaches to additional bank taxes and levies, aswell as to short selling. 1111For details on the differing policy positions between theUnited States and the EU, see Atlantic Council (2010).6Transatlantic Academy

However, the rift between the United States andthe EU actually goes beyond crisis-related financialreform and has pushed earlier initiatives fromthe political agenda. Thus, the initial enthusiasmover a new era of dialogue at political and agencylevel, which was embodied by the U.S.-EUFinancial Market Regulatory Dialogue (FMRD)started in 2004 and the Transatlantic EconomicCouncil established in 2007, has disappeared, andpolicymakers appear to find it difficult to maintainnecessary communication. Even more ambitiousprojects, including the 2008 plan of taking concretesteps towards a more integrated U.S.-EU financialmarket by harmonizing and mutually recognizingsecurities market rules across the Atlantic, 12 are nolonger deemed realistic undertakings.The result of these rifts is regrettable. Lack ofcooperation across the Atlantic has preventedboth sides – and the other participants in the G20process – from arriving at more ambitious, betteraligned, and more synchronised policy responses tothe financial crisis.Joint Interest in More Stableand Efficient MarketsBut are American and European interests sodifferent after all? The economic evidence suggeststhat there is a strong rationale for a much closeralignment of activities and measures. In fact,financial markets on both sides are not only verylarge and sophisticated, they are also closelyintertwined and have reached a level of integrationunparalleled by other large economies. The tradingof securities between U.S. and EU investors servesas an instructive example where American andEuropean stocks and bonds make up well overone-third of foreign securities holdings in bothdirections, and where the growth rates of theseTransatlantic Securities Transactions andSavings PotentialSources: U.S. Treasury; own calculationsSources: U.S. Treasury; own calculationsbilateral shares have – interrupted by the crisis –been double-digit over the past decade (see graphabove). 13Clearly, securities transactions between the UnitedStates and the EU and other forms of capitalflows such as credit and direct investments havebenefitted investors on both sides over the pastyears. Growing transatlantic financial interactionThe economicevidence suggeststhat there is astrong rationalefor a much closeralignment ofactivities andmeasures onfinancial marketreform betweenthe United Statesand Europe.12U.S. SEC and EU Commission, Joint Statement on MutualRecognition, February 1, 2008.13For detailed calculations, see Kern (2010a) and (2008).The Real G2: Americans, Europeans,and their Role in the G207

The way theUnited Statesand the EU areimplementingthe G20 financialmarket reformagenda isleading to evenwider regulatorydiscrepanciesthan beforethe crisis.has also raised the degree of interconnectedness– i.e. the level of market integration – betweenthe two economic areas. As a result, there isan increasingly strong rationale for enhancingcooperation on financial regulation and oversight,as was acknowledged by the U.S. administrationand the EU Commission when they issued theirJoint Statement in 2008.If anything, this rationale has been reinforced bythe financial crisis, which highlighted the growingrisks of financial contagion given the level ofcross-border capital flows already achieved. 14The implementation of the G20 agenda, however,gives rise to the concern that the regulatorydiscrepancies between the U.S. and the EU may,in fact, widen further. This is likely to aggravate,rather than facilitate, the oversight of increasinglyinternationalized financial markets between theUnited States and the EU as well as beyond. Notto mention the fact that substantial cost savingsfor corporate and retail clients from a moreintegrated financial market will be lost. In case ofan integration of U.S.-EU securities markets alone,such savings would be non-trivial and may amountto US$50 billion per year or more (see graph onpage 7). 15Looking Ahead – The Role of theUnited States and Europe in the G20In financial markets, the United States and the EUare the real G2. They carry a responsibility that goesfar beyond that of their partners in the G20: Theyremain the largest and most advanced financialmarkets worldwide. They look back at the mostextensive experience in financial market regulationand supervision – not least owing to their role asthe epicenters of the most severe financial crises14TABD (2010).15For a quantification of the potential benefits of transatlanticsecurities market integration, see Steil (2002) and Kern(2010a).in history. And they continue to be the centre ofinternational financing and financial innovation. Atthe same time, the benefits of achieving bilaterallyand globally coordinated reforms are evident.As a result, it seems advisable that the UnitedStates and the EU should be credible promotersand forceful drivers of financial market policycoordination in the G20. Reaching joint policypositions will, in practice, require concretecooperation on the scheduling, design, and detailsof regulation. This would optimally include exante bilateral consultations on all new policymeasures in the area of financial market regulationof national, bilateral, or international dimensions,as well as a close coordination of policy positionsdiscussed in international forums, especially inthe G20 and the bodies entrusted with supportingglobal financial reform.Finally, the credibility of Americans and Europeansas promoters of free capital flows and as keyinnovators in the global economy will dependin the long run on their ability to be good rolemodels and achieve a more integrated financialmarket at the transatlantic level. This would requiresystematic work on resolving existing bilateralregulatory barriers on the basis of their existingJoint Statement, i.e. towards a harmonised andmutually recognized regulatory system. In otherwords, they will at some point need to embark onthe journey towards a single transatlantic financialmarket.These are very ambitious objectives, and theymay run counter to the zeitgeist that prevails inthe political environment after the economic andfinancial crisis. But the benefits of internationallyconsistent financial reform are substantial andreal, and no other two economies know thisbetter than those of the United States and the EU,whose prosperity is founded on the openness ofmarkets, the free flow of goods and investments,8Transatlantic Academy

and effective governance. The United States andthe EU should intensify their policy cooperationand encourage their G20 partners to strive for moreeffective global coordination of financial marketpolicies.BibliographyAtlantic Council (2010), “The danger of divergence– transatlantic cooperation on financial reform,”Atlantic Council, Washington.Bradlow, Daniel David (2010), “AssessingInternational Financial Reform,” in:International Law, Economic Globalization andDeveloping Countries, J. Faundez, C. Tan, eds.,Edward Elgar Press, 2010; American University,WCL Research Paper No. 09-29.Steil, Benn (2002), “Building a TransatlanticSecurities Market,” Council on ForeignRelations.Transatlantic Business Dialogue (2010), “EU-U.S.financial markets – need for cooperation indifficult times,” Transatlantic Business Dialogue,Brussels and Washington.Weber, Rolf and Arner, Douglas W. (2007), “Towarda New Design for International FinancialRegulation,” University of Pennsylvania Journalof International Economic Law, Vol. 29, pp. 391-453, 2007.International Financial Services (2010),“International Financial Markets in the U.K.,”International Financial Services London.Kern, Steffen (2008), “EU-U.S. financial marketintegration – work in progress,” Deutsche BankResearch, Frankfurt.Kern, Steffen (2010a), “Benefits of U.S.-EUfinancial market integration,” presentation forCESR Mutual Recognition Task Force, Paris,January 18.Kern, Steffen (2010b), “U.S. financial marketreform – the economics of the Dodd-Frank Act,”Deutsche Bank Research, Frankfurt.Kern, Steffen et al. (2009), “China’s financialmarkets – a future global force?,” Deutsche BankResearch, Frankfurt am Main.Masson, Paul R. and Pattison, John C. (2009),“Financial Regulatory Reform: Using Models ofCooperation to Evaluate Current Prospects forInternational Agreement,” Mimeo.The Real G2: Americans, Europeans,and their Role in the G209

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