A robust framework

The foundation for this unprecedented half century of growth was, in fact, laid in the waning days of the Second World War: the 1944 Bretton Woods agreement regarding international monetary management, the foundation of the International Monetary Fund (IMF) in 1945 and, in the immediate post-war period, the 1947 General Agreement on Trade and Tariffs (GATT). Together, they stabilized exchange rates and brought down many trade barriers, bolstering international commerce between industrialized countries.

In parallel, moves were made to deregulate national financial markets, particularly following the collapse in 1977 of the currency exchange rates set by the Bretton Woods agreement. Since then, according to Bank for International Settlements (BIS) statistics, daily trading volumes on the foreign exchange markets have skyrocketed from just a few million to 1.2 trillion US dollars a day. Deregulation, combined with development of information and communication technology, helped financial specialists create a long list of innovative products – from credit cards to derivatives, completely changing the character of the global financial system in a few decades.

Of all the innovations, derivatives are the newest, with global traded volumes in them rising more than tenfold between 1990 and 2000. BIS statistics, for example, show the combined value of all outstanding over-the-counter (OTC) derivative contracts being USD 370 trillion at the end of June 2006. Derivatives, or contracts to buy or sell an asset for a certain price at a predetermined point in the future, have allowed the industry to redistribute risk and hedge against losses, increasing the stability of the global economic and financial framework significantly.

On the other hand, these massive market volumes, along with the role hedge funds play in today's markets, have alerted central banks, regulators and international financial organizations to new types of potential risk. The use of credit derivatives, for example, to hed­ge a bank's loans, could potentially lead the industry as a whole to become lax when lending, setting the stage for ­future defaults. With this and other ­issues in mind, the IMF has called upon financial market regulators to monitor risk management in the financial sector and draw up new rules where necessary.

Regrettably, the global liberalization of the financial system has also produced new types of criminal activity. Careful monitoring and regulation of the financial markets is crucial to ensure their stability over the long term. But how much regulation should there be and how much freedom should markets keep? The questions themselves are not new. On one hand, the global economic boom of recent decades would not have been possible without liberalized markets. On the other, the globalization of capital markets and the ­global fight against criminal and terrorist activities has meant that regulations in the financial sector have become more and more complex and difficult to implement.

The financial industry, aware of this, has taken a number of preventive steps on its own. The Wolfsberg Principles, for example, are a collection of global guidelines designed to combat money laundering, drafted and signed by a group of the world's leading banks. These oblige the banks involved to be able to identify their clients around the globe at any time and to define a joint international standard through the exchange of internal money laundering guidelines. A second example is the increased cooperation between the financial sector and the US authorities following the September 11 terrorist attacks.

A few months ago, the Institute of International Finance (IIF), an association composed of managers of the world's major financial institutions, called for a strategic dialog on efficient regulation.

Both these initiatives clearly show that the international financial industry, ­taking public interest as well as its own into account, is working to ensure that market-oriented solutions are being sought to resolve the challenges ­currently being faced.