Wednesday, September 24, 2008

Can Soft Law Lead to Hard Financial Regulations?

President Nicolas Sarkozy of France called for a summit meeting to develop greater international regulations of financial markets at the recent opening of the United Nations General Assembly. This was done in response to financial turmoil in the United States stock & credit markets that has affected the global economy.

Will there actually be a summit?


Will the summit achieve any lasting international regulation?

Not a snowball's chance in the heart of the sun.

What are the issues?

Can comprehensive international regulation of the financial market exist? Yes, but history teaches us that it will be ineffective without universal participation.

International law works on states - in part - because they choose to be bound by international law.

A nation that refuses to sign a treaty is not bound by that treaty.

And the United States has refused to sign a lot of multilateral treaties. We've also failed to ratify even more.

With the U.S. holding regulatory control over the NYSE and its affiliated indexes, not having the U.S. as a signor is likely to have very little effect in the short term.

What is the controlling international law?

Stock exchanges tend to be regulated in two fashions, domestic regulation and domestic regulation that applies to corporations.

But stock exchanges also impose their own regulations on their listed members - even though the stock exchange is a private corporation.

What this means, is that stock exchanges help create a body of practice - given legal effect - even though the stock exchanges have no legislative abilities.

They cannot create real laws that are legally binding in a court. But they can create practices through contracts with their members that are so widespread they might as well be law.

In the practice of international law, these widespread types of self-regulation are called Soft Law.

Soft law is a controversial concept. Some legal scholars argue that soft law does not even exist. Many cite that lack of binding commitment or enforcement mechanisms mean that soft law cannot exist, except as a theory.

However, when state actors fail to take action, sometimes all we are left with is soft law.

It has been seen in areas relating to such as human rights law and environmental law that soft law can make a difference in the actions of non-state actors.

An example of soft law would be the Fair Trade Coffee initiative. There are few laws governing the purchase of coffee. The Fair Trade Coffee initiative has set standards followed by individuals and multinational corporations alike.

Soft law has the potential to affect the world.

What does this mean to the reader?

If the U.S. plays to type and refuses to sign any multilateral treaty with new obligations and financial regulations, soft law may the world's only method for creating new regulations and preventing future financial meltdowns.

Chances are pretty good that the U.S. will not sign such a treaty. Our track record says we will refuse.

So, it will be up to the stock exchanges and the countries regulating their own stock exchanges to impose regulations that might save the U.S. financial sector in the future.

Oddly, this may work through a survival-of-the-fittest model among companies.

For example, say the Toronto Stock Exchange required new types of reporting from its listed members. Companies that met this reporting standard would be considered a better investment. Their transparency would reduce the risks associated with the stock.

Those companies that are considered better would raise more capital, and potentially acquire companies that do not meet the new reporting standards.

To survive, companies would have to meet the new reporting standard or risk being acquired or driven out of business.

In this age of international business competition, even companies not listed on the Toronto Stock Exchange would have to compete with these new reporting requirements - even though they are not required.

Non-binding regulations, that affect actors around the world, that's soft law.

And it may be the only way to regulate future financial stability.