Integrating Socio-Economic Integrating Socio-Economic Rights into the Regulatory Rights into the Regulatory

Architecture of the Financial Architecture of the Financial SystemSystem

Mary Dowell-Jones, Ph.D.Mary Dowell-Jones, Ph.D.Research FellowResearch Fellow

Institute for Human Rights and BusinessInstitute for Human Rights and Business

Overview:

1. Overview of the Financial Crisis

2. Limits of Human Rights Engagement with Finance

3. The Crisis – A Network of Interlocking Causal Factors

4. Potential for a Human Rights Response?

5. Moving Forward – A Strategy for Integrating ESR into the Regulatory Architecture

1. Overview of Financial Crisis:

1. Most Critical Banking Crisis Since the Great Depression

Estimated losses of $3.4 trillion Largest bankruptcy in history – Lehman’s $660 billion + hedge

funds, insurers Government orchestrated rescues including AIG ($177 billion),

Citigroup ($326 billion), Bear Sterns, Northern Rock Unprecedented Government bailouts – roughly $6.6 trillion

across major economies

Global financial system only survived thanks to Government intervention

Human Rights Impacts

Major impacts of global recession on ESR: ‘Global Jobs Crisis’ (ILO):

1. 21 million more unemployed in OECD2. Over 600,000 a month lost jobs in USA in Q1 20093. 20 million migrant workers unemployed in China4. Thousands of jobs lost in export industries after sharp

contraction in world trade post-Lehman’s

‘An Emergency for Development’ (World Bank)1. Fall in remittances/loss of migrant worker jobs2. Fall in State revenue/State spending for ESCR3. Rise in poverty – 53 million more people estimated to be

living on less than $1.25 a day (World Bank)

Human Rights Impacts (cont)

Impacts in developed economies:1. Rise in personal/corporate bankruptcies2. Rise in foreclosures/loss of homes3. Massive losses on pension funds4. Rise in food insecurity (USA)5. Sharp drop in government revenue/tax takes

Long term:1. Explosion of government debt – likely sharp spending cuts2. Impaired bank balance sheets – era of sluggish lending/growth3. Threats from inflation/new asset bubbles4. Health/education impacts of reduced incomes for very poor

2. Limits of Human Rights Engagement with Finance Human rights engagement has been issue-specific:

Corruption/Transparency e.g. EITI, Wolfsberg Principles Project Finance e.g. Equator Principles Ethical Investing e.g. UNPRI, UNEPFI Divestment Campaigns e.g. Burma

Even Ruggie Consultation seemed limited: Financial Companies “at least one step removed from the

human rights impacts of the business activities that they enable with their funds”

Limits of HR Engagement:

Focus on defined areas where impacts are visible and easily mapped to financial activity e.g. project loan

Focus on familiar human rights territory where HR issues are well understood e.g. funding mining projects that impinge upon rights of indigenous people/ companies with bad labour rights

Based on prevailing ‘legal’ approaches to socio-economic rights i.e. where direct causality/responsibility is required between act/actor and victim/violation

BUT this approach does not fit the complexity and interconnectivity of 21st century finance. These initiatives do not offer a template that can be extrapolated to address the crisis. Because:

Causality is too diffuse, underlying issues too technical. Way beyond the scope of existing approaches to ESCR

3. The Crisis – A Network of Interlocking Causal Factors Global financial system is now a huge influence on

economic conditions and socio-economic rights Hugely complex & profoundly interconnected ‘Financialisation’ of world economic space over last 20

years: World Stock Market cap. now $55 trillion Daily FX trading in US alone = $660 billion up 44% in 3 years Derivatives exposures $1000 trillion+ In contrast – world GDP now $60 trillion Credit Default Swaps – estimated $60 trillion in 2007

3. The Crisis – Causal Factors:

Mutually Reinforcing Financial Factors:1. Securitisation/explosion of credit derivatives ($1.4 trillion of US

subprime mortgages)2. Rise of the shadow banking system/off balance sheet vehicles3. Over-reliance on credit ratings ‘outsourcing risk’4. Global search for yield5. Fundamental failings of risk management6. Leverage/under-capitalisation of banking system7. Moral hazard + lack of understanding of dynamics of 21st

century finance

System-wide abdication of responsibility

The Crisis – Causal Factors:

Compounded by Macroeconomic Factors:1. Low interest rate environment2. Arrival of China into world trading system,

suppressing CPI3. Build up of enormous FX reserves in Asia + their

recycling into treasuries – de facto currency pegs4. Huge trade deficits/surpluses – Asia produced, the

West consumed5. Massive build up of debt in Western economies –

personal (consumption), corporate (LBOs), financial (leverage) government (war financing)

4. Potential for a Human Rights Response? There are significant underlying problems with SE rights

themselves: A legal instrument with economic foundations BUT Has been approached as a legal project, e.g. efforts to delineate

layers and typologies of obligation Macroeconomic issues have been downplayed except as issues

to argue against Focus on economic neutrality crystalised economic

decontextualisation of ICESCR

Result: No foundation of technical macroeconomic/financial content of ESCR to work from.

Potential HR Response?

Result:1. Debate among HR lawyers has tended to focus on

critique of failings of ‘neoliberalism’2. Discussions of type of State we need3. Proposals to simply insert a HR clause into Basel II

Capital Adequacy Accord4. Lack of engagement with technical financial detail or

visibility of HRs in regulatory reform debates5. Limits of due diligence

Potential for a HR Response?

Is the Crisis a Human Rights Issue? Does it Make Financial Regulation a human rights issue? Yes: crisis has had a devastating impact on human

rights worldwide, as have previous crises. State obligations & Ruggie Framework

No: Answer isn’t so obvious. Regulatory issues are highly technical and arguably well beyond the scope of existing notions of human rights. No clear template for integration.

5. Moving Forward – A Strategy for Integrating ESR into the Regulatory Architecture:

Centered on complex international accord Basel I & II Purpose: to ensure a sound and stable financial system Does not mandate or monitor social outcomes of market

processes. Why? Heavily quantitative/mathematical models Probability theory/statistics Assumes efficient, self-correcting markets.

Risk Management:

Fundamental to financial regulation & the way the financial markets work Centered on probability estimates for loss

distribution Works on the assumption that by averaging

market data you can predict future losses Uses ‘normal’ market i.e. strips out tail risk Failed abysmally to warn of crisis

Failings:

Highly pro-cyclical Drove markets higher by reducing risk numbers

Strips out reference to socio-economic context Only looks at market data, very narrow basis of analysis

Embeds complacency about actual risk Appears highly sophisticated, but very limited picture of markets

Produced an under-capitalised financial system that was critically vulnerable to systemic problems Compounded by fact that most financial actors were using the

same regulatory-required techniques A key lever of interconnectivity

Produces a one-way market

Potential for Integrating Human Rights and Risk Management Broadening notions of risk to include ESR factors What form could this take?

Move beyond formulaic mathematical models that do not reference market context i.e. human factors

Are inherently reductive of social processes How? Build work that demonstrates that socio-economic rights

and the goods they represent are central to value, risk and pricing. Currently largely ignored.

Return to qualitative, more contextual understanding of markets, beyond mathematical thinking

Build human factors into finance

E.g. Subprime mortgage boom Over $1.4 trillion in mortgage origination between 2005-7 Huge change in fundamentals of underlying market Risk management methods ignored this by focusing on VaR or

credit ratings – historic loss figures No effort in banking system to look at details of what mortgages

were being sold to who and whether they were affordable Huge disconnect between social reality and financial vision

Enormous human rights consequences & enormous financial losses

Emerging Markets

Huge structural poverty/human rights issues ignored by financial thinking

Tendency of investors to overestimate growth prospects by ignoring institutional, legal, political, historic, social factors. Focus instead on rising stock markets/macro indicators.

Inequalities in fact often cemented by economic growth captured by elites, rather than addressing it. Econ/financial models assume the opposite.

Tendency of EM to large boom and bust cycles. Pay more attention to the unique socio-economic, institutional &

historic characteristics of each country.

Risk needs to be informed by broad assessment of HR reality. HRs benefited by better risk management.

Commodities

Development of commodities as an investable asset class Huge pressure on human rights from affordability of basics like food,

fuel and heating oil No visibility of that reality in financial analysis, or of financial factors

in HRs analysis – even SR on right to food focused on supply constraints and renewable fuels

But major driving factor has been use of commodity futures for investment/returns

Risk management would merely look at averaging historic price data and volatility to assess potential for loss. Would not investigate ‘structural’ reality of the human impact of prices.

Enormous pressure on HRs. No risk-based constraint.

Conclusion

Financial crisis has opened up debate on HR and financial system

No quick fix for failing financial system, nor for human rights

BUT risk management weaknesses offer significant opportunity

Just a starting point. Need to develop much more clarity prior to regulatory incorporation of HR standards

Workability essential

Institute for Human Rights and Business

www.institutehrb.org

Financial Crisis and Human Rights report: Available on website late March/April