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Financial regulation should be reviewed to better reflect the role of highly leveraged institutions, namely private equity, hedge funds and special purpose vehicles, and of derivatives markets in general, Trichet said.
The unpreparedness of the private sector for a market correction results from the view that regulation should not stifle financial innovation and that markets knew best and regulate themselves adequately, ECB President Jean-Claude Trichet said speaking at the conference "Nouveau Monde, Nouveau Capitalisme” in Paris. The turmoil has shown how complacent and misleading this attitude was, he underlined.
Looking ahead, we should correct the substantial flaws in the financial system that have now become evident, Trichet said. But our basic aim should be to improve very significantly the resilience of the financial system, he said criticizing that the apparent fragility of the financial sector is not acceptable.
The shortcomings in areas such as short-termism, pro-cyclicality, and transparency were instrumental in creating the conditions for the crisis and deserve change, in particular:
Ø to create more balanced and forward-looking incentive frameworks for management compensation and more effective internal risk measurement and control systems that take into account not only near-term profitability but also sustainability and durable financial strength.
Ø to re-examine all aspects of the current regulatory framework, including fair value accounting and leverage, capital requirements and provisioning regimes. New mechanisms such as additional capital and liquidity buffers should be introduced.
Ø to increase investor information and financial education including enhanced risk disclosure, particularly in institutions and markets that are currently unregulated.
We need a paradigm change in the global economy based upon the notion of medium and long-term sustainability and the resilience to shocks, Trichet said.
Also, the long-term sustainability and resilience of public macro policies and the associated progressive but resolute elimination of large domestic and external imbalances is a fundamental factor that has to be taken into account, he underlined.