Two-way street from Lobbyville: The Institute of International Finance in financial regulatory processes

The influence of private lobbies in policymaking is dependent on the two-directional interaction between policymakers and lobbyists. Analyses starting from this premise offer better insights into regulatory processes and point to opportunities for change
 

The possible divergence of market regulations has been a sticking point in the negotiations on the future relationship between the European Union and the United Kingdom. Financial regulation is especially significant in this respect as it has always played a prominent and multifaceted role in the UK’s relation to the EU. One might expect that Brexit will have important consequences for financial regulation in the UK and in the EU, putting the spotlight on financial regulatory processes.

A wealth of research has demonstrated substantial financial sector influence on regulatory processes, from the domestic policymaking processes that unleashed the financial sector in London, New York, and Tokyo in the 1980s to the attempts to regulate the resulting global financial system in the 2000s. This private sector influence raises important questions about the democratic legitimacy of contemporary financial regulations.

To better answer these questions, we should not just analyse the lobby of interest groups, but also the ‘demand side’ of public policymakers. I argue that there is a recursive dynamic between public officials and private interests. Taking better account of public officials opening the doors to lobbyist offers enhances insight into the regulatory process and exposes new pressure points to increase the democratic legitimacy of regulation. I will illustrate these points with examples from my research into the Institute of International Finance (forthcoming in Business & Politics), a key interest group of globally active financial institutions.

Let the right one in

Interest groups are often assumed to be established by market participants to lobby politicians and regulators on their behalf. However, this commonly held view neglects the role of public officials asking private sector representatives to provide input into policymaking processes (‘reverse lobbying’). This recursive relationship is reflected in the emergence of the Institute of International Finance (IIF). Instead of resulting from private sector interests, the idea to establish the IIF emerged at a think-tank conference and was enthusiastically embraced by public policymakers. To promote the establishment of the IIF, the IMF, OECD, and World Bank agreed to provide access to their hitherto confidential internal data, providing an important incentive for banks to become member of this new interest group.

This recursive dynamic is not unique to the IIF. Baker and Wigan (2017) demonstrate how in the aftermath of the Great Financial Crisis of 2008, TheCityUK was set-up in a collaborative effort of private sector and HM Treasury officials. This interest group for London’s financial sector was directly plugged into HM Treasury strategy groups, providing it with an important channel of policy influence.

The demand of public policymakers for private sector input continued to play a role in the evolution of these interest groups. International organizations saw potential in the IIF as a focal point for dialogue between the international banking community and global policymakers. During the negotiations on bank capital adequacy standards (the so-called Basel Capital Accords) the IIF was invited to organize informal private sector input. The IIF even restructured its organization to respond as best as possible to the requests of policymakers.

Interest groups thus do not just emerge because of private sector interests, but also because of demand from public officials. Similarly, their influence on public policymaking processes is in part a consequence of public officials inviting them in. Importantly, as the examples above show, this implies in effect giving privileged access to a specific segment of the private sector over others (e.g., international active banks over regional cooperative banks).

Let the right one govern

The influence of interest groups is further enhanced when they are enabled to take up self-regulatory roles. Again, the IIF provides an illustrative example. In the early 2000s, a high-profile IMF proposal to regulate sovereign debt crises through a ‘bankruptcy court for states’ faltered in the face of opposition from the private sector, the US, and major emerging markets. To mend fences with the private sector, the Banque de France proposed the development of a code of conduct for private creditors and emerging markets instead. This would at least establish some form of governance for sovereign debt crisis resolution.

The development of this code of conduct was delegated by the G20 to a working group of major emerging markets and private sector representatives, led by the Banque de France and the IIF. The BdF subsequently left the group, enabling the IIF to take a leadership role in the governance of sovereign debt crisis – a role it enthusiastically embraced. The resulting ‘Principles for Stable Capital Flows and Fair Debt Restructuring’ were mostly aimed at emerging market behaviour, but included some constraints for private creditors as well. In other words, the IIF now governs the dynamic of crisis resolution in the market for sovereign lending (opening an interesting second recursive relation from market actors to interest group).

Presenting its Principles as the international standard for sovereign debt restructurings, the IIF managed to extend its involvement from emerging markets to the Eurozone crisis. The Institute successfully argued against ‘involuntary’ private sector involvement in the crisis, while at the same time pressuring its membership to participate in the deal former IIF Managing Director Dallara had negotiated with Greece. Despite the significant haircuts which were imposed, one might still wonder: what would have been the outcome if an independent sovereign bankruptcy court had ruled instead of a negotiation with such a significant place for private interests?

Lessons?

The development of the role of the IIF in global financial regulatory processes holds a number of important lessons for both academics and practitioners. The academic analysis of interest groups should move beyond the unidirectional view of lobbying to an understanding of the recursive relations between interest groups, public policymaking processes, and changes in market structures. Only then will we get the full picture of private interests in democratic processes.

The fact that private interest groups get put into their influential position by public policymakers is also of practical relevance for those who want to address the power of the banking lobby and those who strive for more progressive and environmentally sustainable financial regulations. Building coalitions of think tanks, politicians, and financial professionals seems a more promising way to replace traditional banking lobbyist than to push to end the lobby access altogether. The demand of the public sector is apparently there, it is up to the progressive movement to find a suitable supply for that demand as an alternative to the current private interest groups.

Above all, sustained public and academic scrutiny of financial regulatory processes across levels of analysis is needed to enhance democratic legitimacy. The significant adverse socioeconomic impacts of financial crises warrant keeping a critical eye on the governance of the sector.