paper series

The Real G2:

Americans, Europeans,
and their Role in the G20

Steffen Kern
Helmut Schmidt Fellow, Transatlantic Academy
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 The Real G2:
Americans, Europeans,
and their Role in the G20

Transatlantic Academy Paper Series

February 2011

Steffen Kern*
Helmut Schmidt Fellow, Transatlantic Academy

*Steffen Kern is the Transatlantic Academy’s 2011 Helmut Schmidt Fellow, and Director for International Financial Market
Policy at Deutsche Bank.
Abstract
Global economic governance is in the process of
making a quantum leap. Hopes regarding the G20
process as the new global nucleus of political and
economic governance are strong. But the reality
of international financial market diplomacy is a
harsh one. Reaching consensus among the G20
participants on financial market governance has
proved a challenging task. This article argues that
the United States and the European Union are the
problem – and its solution.
Recent disagreements over capital and liquidity
requirements, the organization of over-the-
counter (OTC) derivatives markets, the treatment
of alternative investments, and the handling of
systemically important financial institutions are
only a few examples of the low point transatlantic
financial market diplomacy has reached. At the
same time, only the United States and the EU
can provide the impetus the G20 process needs.
This requires that they first and foremost arrive
at joint policy positions between themselves. In
practice, this necessitates concrete cooperation on
the scheduling, design, and details of regulation.
This would optimally include ex ante bilateral
consultations on all new policy measures as well as
a close coordination of policy positions discussed
in the G20. In the final analysis, however, the
credibility of Americans and Europeans will depend
in the long run on their ability to achieve a more
integrated financial market at the transatlantic level.
These are very ambitious objectives, but their
benefits would be substantial and real. The United
States and the EU should intensify their policy
cooperation and encourage their G20 partners to
strive for more effective global coordination of
financial market policies.
The Real G2: Americans, Europeans, 1
and their Role in the G20
Introduction
Global economic governance is in the process
of making a quantum leap. Hopes regarding
the G20 process as the new global nucleus of
political and economic governance are strong. In
financial market matters, this high-level process
is supported by international organizations, such
as the International Monetary Fund (IMF), the
Financial Stability Board (FSB), or the International
Organization of Securities Commissions
(IOSCO), whose work holds out the prospect of
an internationally coordinated approach to the key
regulatory challenges in the world’s increasingly
intertwined financial markets.
Expectations are high, and the urgency of closer
international cooperation after the financial crisis is
higher still. But the reality of international financial
market diplomacy is a harsh one. Two years after
the first G20 meeting at the principal level in
Washington in November 2008, optimism about
the scope for global solutions has given way to
sober realism. Reaching consensus among the G20
participants on financial market governance – be
it on grand design or specific detail – has proved a
challenging task, even at a time when the memory
of the financial crisis and the perceived “[need for]
reforms in the world’s financial systems”1 is still
fresh.
The United States and the European Union are
the problem – and its solution. While the global
economy is undergoing tectonic changes, and
its future is widely expected to be shaped by the
United States and China – often referred to as the
G2 – this article argues that it is the United States
and the EU who need to provide the impetus the
G20 process needs. Only they can drive global
financial market reform. Otherwise, the vision
1
 G20 Meeting, November 15, 2008, final communiqué:
“Washington Declaration – Summit on financial markets and
the world economy.”
of establishing the G20 as an effective forum for
international economic policy coordination may
fail.
The G20 as a Forum of International
Financial Market Policy Coordination
If successful, the G20 may enter history books as
one of the most important institutional innovations Two years after
in post-cold war global politics. While the initial the first G20
crisis reaction held out the prospect of a new era meeting optimism
of international high-level cooperation, however, a has given way to
number of political challenges have surfaced since sober realism. The
its inception, rooted in the design of the process U.S. and the EU
but also in the diverging interests among the major are the problem
participants. — and its solution.
The rationale of the G20 process was spelled
out clearly at the first high-level meeting in
November 2008, and has been greeted by many
political, academic, and business commentators
as an important, if not overdue, step. Two
important objectives can be identified. One is the
intensification of policy cooperation. In the area
of financial market policy, the G20 participants
decided to “[...] enhance [...] cooperation and
work together to [...] achieve needed reforms in
the world’s financial systems.” In particular, the
G20 recognized that “[...] financial markets are
global in scope [and] intensified international
cooperation among regulators and strengthening
of international standards [...] and their consistent
implementation is necessary to protect against
adverse cross-border, regional, and global
developments affecting international financial
stability.”2
Second, it was agreed to open up the high-level
dialogue and enhance the circle of decision-makers
to include key emerging economies. Extending the
2
 G20 Meeting, November 15, 2008, final communiqué:
“Washington Declaration – Summit on financial markets and
the world economy.”
The Real G2: Americans, Europeans, 3
and their Role in the G20
 forum of policy coordination from the traditional
advanced nations of the G7 to the 20 most
important economies promised a more effective
handling of the 2008 financial crisis and a more
sustainable policy framework for navigating the
post-crisis environment. It did this by inviting fast-
developing nations such as China, India, and Brazil,
Joint action on which enjoy a growing share in global trade and
financial market output and increasing stakes in global production
reform will lead and asset ownership, as well as formidable financial
to superior policy reserves. Including key emerging economies in
outcomes. It’s global economic policy coordination has been
success hinges on praised widely as a major leap forward for global
governance.
the U.S. and the
EU solving their The potential benefits of closer cooperation among
bilateral issues a larger number of key players are substantial.
and forging ahead In financial market policy, a joint approach to
with international regulation and supervision promises a more level
cooperation. playing field in terms of regulation and a lower
risk of regulatory arbitrage by market participants.
By establishing high-quality rules across the G20,
the overall level of financial market oversight
could be raised substantially. Closer cooperation
among supervisory authorities may contribute to
a more effective handling of cross-border risks
for international capital flows and transnational
operations of financial firms. In other words, joint
action may result in superior policy outcomes,
as the logic of what theorists refer to as collective
action also applies to financial market diplomacy.3
But so do the problems associated with collective
action. Thus, the likelihood of reaching agreement
among the participants in the policy process
declines with their number and with a rising
heterogeneity of their interests. The transition
from G7 to the G20 has added to both. In addition,
the chances of finding joint solutions rise with
3
 Masson (2009) provides a comprehensive theoretical analysis
of the dynamics behind international cooperation in financial
market regulation.
4 Transatlantic Academy
the expected costs of failure to do so,4 and the
unexpectedly quick economic recovery after
the crisis in many parts of the world has clearly
diminished the sense of urgency perceived in the
context of financial market reform. Cooperation
may get further aggravated by the multitude of
negotiating bodies involved, especially if their
membership varies as is the case between the G20,
the IMF, the FSB, IOSCO or the Basel Committee.5
Finally, the question of the right scope of the
G20 remains a latent issue. Depending on the
perspective they have, critics have claimed that the
Group may be either too large or too small, and
that the range of political issues on the G20 agenda
was too extensive or too limited.6
Theory, however, tells us another important story
about international negotiations: Their success
critically hinges on group dynamics – atomistic,
self-interested countries are less likely to reach
agreement than a limited number of oligopolistic
players, and the likelihood of joint solutions vitally
depends on one or more large countries forging
ahead with international cooperation.7
This brings us to the United States and the EU. If
theory — let alone historical experience — is right
about the central importance of a small number of
key drivers in intergovernmental processes, then
the United States and the EU intuitively qualify
as important promoters of joint G20 solutions.
Judging by their economic and financial weight,
they should indeed be the driving force behind
global policy coordination, especially in the area of
financial market regulation.
4
 Masson (2009), pp. 18-19.
5
 Weber (2007), p. 103 and Bradlow (2010).
6
 Bradlow (2010), p. 12.
7
 Masson (2009), p. 17.
The United States and the EU: Decline of Traditional Stock Markets
Global Centres of Finance and Regulation

The still central role of America and Europe in

global finance is impressive. In banking, well over
two-thirds of global assets remain concentrated
in financial centres in the United States and the
EU. Together, they capture more than three-
Traditional
quarters of the global revenue pool of investment
financial centres
banking services. On stock exchanges, the share
of the United States and the EU in global market
in the United
capitalization remains dominant at more than 50 States and the
percent of the total, and the 78 percent share in EU have retained
global equity trading attests to their strong position strong position.
as the key equity trading centres worldwide. In But this cannot
addition, more than 70 percent of all private and belie the fact
public debt securities and almost 80 percent of all that they are
Sources: World Federation of Exchanges; own calculations
interest-rate derivatives outstanding are registered increasingly
in the traditional financial centres in the United challenged
States and the EU. Finally, foreign exchange trading, by emerging
too, remains highly concentrated in transatlantic competitors.
markets, capturing a combined 50 percent share in
global trading.

The financial crisis, despite its impact in

particular on the United States and the EU, has
not immediately led to a critical change in the
tectonics among the major financial centres
around the globe. The traditional financial centres
in the United States and the European Union
have managed to retain their strong position and
continue to provide around three-quarters of global Sources: World Federation of Exchanges; own calculations
financial services, albeit at least temporarily lower
overall levels of market activity in many market being challenged by emerging competitors.
segments.8 Equity markets are an illustrative and in large
parts representative example: Today’s 50 percent
The solid share of transatlantic financial markets, transatlantic share in global stock market
however, cannot belie the fact that the historic capitalization has declined substantially from its
position of the traditional financial centres in 78 percent peak in 2001, while its share in stock
Europe and the United States is increasingly trading has fallen from 86 percent to just over 70
percent in the same period. Strikingly, the growth
8
 For a more detailed analysis of the role of U.S. and EU financial of stock markets in the BRIC countries amounted
markets in the world economy see Kern (2008), also TABD to more than 40 percent per year, while the EU and
(2010).

The Real G2: Americans, Europeans, 5

and their Role in the G20
 U.S. markets actually contracted (see graphs page
5).9 China alone can be expected to raise its share
in global financial markets by the end of the current
decade to 13 percent in banking, 5 percent in debt
securities, and 16 percent in stocks.10
These long-term dynamics in financial markets
The G20 process make a very strong case for including key emerging
has arrived at economies in financial market reform at the global
level. The still-dominant U.S. and EU shares in
a low point. It
global finance, however, also illustrate that the
seems difficult
United States and Europe are in a unique position
for the United
to promote global financial reform, a position that
States and the EU for the time being remains unattainable for any
to reach beyond other economy around the negotiating table.
the minimum
consensus. Transatlantic Financial Market
Diplomacy at a Low Point
Being the most important financial markets
worldwide is one thing. Pursuing joint interests,
however, may be a completely different matter. In
principle, the United States and the EU may have
diverging, possibly competing interests when it
comes to financial market policy, and they could
use their economic and political weight as a
basis for pursuing these interests in a G20 setting
concurrently.
In fact, two years into the G20 process, transatlantic
cooperation on financial market policy appears
to have reached a low point. On the one hand,
some credit can be given to the United States and
the EU, as well as to the other nations represented
in the G20. Arriving at a joint agenda for policy
development and on broad policy directions
9
 All figures based on own calculations and data from Bank for
International Settlements, International Financial Services,
Transatlantic Business Dialogue, World Federation of
Exchanges.
10
 China’s share in the global total is expected to rise from 9
percent to 13 percent in banking, from 2 percent to 5 percent
in debt securities, and from 6 percent to 16 percent in stock
markets (Kern 2009).
6 Transatlantic Academy
especially in the area of financial market reform
marks an important political achievement that can
hardly be overestimated.
On the other hand, however, it has been difficult
for U.S. and EU policymakers to reach beyond
the minimum consensus on agenda items and
broad policy directions. Importantly, they differ
substantially in their approaches to the G20 agenda
and its implementation at home. While the United
States chose a single-package strategy that has
already resulted in the Dodd-Frank Act, covering
all major areas of financial reform. The EU, on the
other hand, follows a menu-type strategy of more
than 25 individual measures for final adoption in
the course of 2011. As a consequence, the political
processes have remained largely out of sync.
Apart from procedural questions, Americans and
Europeans also disagree on a number of substantive
issues. These include topics such as the U.S. Volcker
Rule, a proposal not directly contained in the G20
agenda. While the EU is not planning comparable
measures, there is widespread concern that its
implementation may have negative extraterritorial
effects. Similarly, there is, reflecting on earlier
experiences, concern that the United States may
not succeed in implementing the recent version
of the Basel Accord on bank capital, despite its
endorsement at the November 2010 Seoul Summit.
Americans, in turn, are ill at ease with the EU
rules on alternative investments as adopted in the
Alternative Investment Fund Managers Directive
(AIFM) and are critical of the treatment of third-
country funds under the new regime. Further
transatlantic deviations can be found in the
approaches to additional bank taxes and levies, as
well as to short selling.11
 For details on the differing policy positions between the
11
United States and the EU, see Atlantic Council (2010).
However, the rift between the United States and Transatlantic Securities Transactions and
the EU actually goes beyond crisis-related financial Savings Potential
reform and has pushed earlier initiatives from
the political agenda. Thus, the initial enthusiasm
over a new era of dialogue at political and agency
level, which was embodied by the U.S.-EU
Financial Market Regulatory Dialogue (FMRD)
started in 2004 and the Transatlantic Economic The economic
Council established in 2007, has disappeared, and evidence suggests
policymakers appear to find it difficult to maintain that there is a
necessary communication. Even more ambitious strong rationale
projects, including the 2008 plan of taking concrete
for a much closer
steps towards a more integrated U.S.-EU financial
alignment of
market by harmonizing and mutually recognizing
securities market rules across the Atlantic,12 are no
activities and
Sources: U.S. Treasury; own calculations
longer deemed realistic undertakings. measures on
financial market
The result of these rifts is regrettable. Lack of reform between
cooperation across the Atlantic has prevented the United States
both sides – and the other participants in the G20 and Europe.
process – from arriving at more ambitious, better
aligned, and more synchronised policy responses to
the financial crisis.

Joint Interest in More Stable

and Efficient Markets

But are American and European interests so

different after all? The economic evidence suggests
that there is a strong rationale for a much closer
alignment of activities and measures. In fact,
financial markets on both sides are not only very
large and sophisticated, they are also closely
intertwined and have reached a level of integration
unparalleled by other large economies. The trading
of securities between U.S. and EU investors serves
as an instructive example where American and
European stocks and bonds make up well over
one-third of foreign securities holdings in both
directions, and where the growth rates of these
Sources: U.S. Treasury; own calculations
bilateral shares have – interrupted by the crisis –
been double-digit over the past decade (see graph
above).13
Clearly, securities transactions between the United
States and the EU and other forms of capital
flows such as credit and direct investments have
benefitted investors on both sides over the past
years. Growing transatlantic financial interaction

 U.S. SEC and EU Commission, Joint Statement on Mutual

12

Recognition, February 1, 2008.  For detailed calculations, see Kern (2010a) and (2008).
13

The Real G2: Americans, Europeans, 7

and their Role in the G20
 has also raised the degree of interconnectedness
– i.e. the level of market integration – between
the two economic areas. As a result, there is
an increasingly strong rationale for enhancing
cooperation on financial regulation and oversight,
as was acknowledged by the U.S. administration
and the EU Commission when they issued their
The way the Joint Statement in 2008.
United States
If anything, this rationale has been reinforced by
and the EU are
the financial crisis, which highlighted the growing
implementing
risks of financial contagion given the level of
the G20 financial
cross-border capital flows already achieved.14
market reform The implementation of the G20 agenda, however,
agenda is gives rise to the concern that the regulatory
leading to even discrepancies between the U.S. and the EU may,
wider regulatory in fact, widen further. This is likely to aggravate,
discrepancies rather than facilitate, the oversight of increasingly
than before internationalized financial markets between the
the crisis. United States and the EU as well as beyond. Not
to mention the fact that substantial cost savings
for corporate and retail clients from a more
integrated financial market will be lost. In case of
an integration of U.S.-EU securities markets alone,
such savings would be non-trivial and may amount
to US$50 billion per year or more (see graph on
page 7).15
Looking Ahead – The Role of the
United States and Europe in the G20
In financial markets, the United States and the EU
are the real G2. They carry a responsibility that goes
far beyond that of their partners in the G20: They
remain the largest and most advanced financial
markets worldwide. They look back at the most
extensive experience in financial market regulation
and supervision – not least owing to their role as
the epicenters of the most severe financial crises
 TABD (2010).
14
 For a quantification of the potential benefits of transatlantic
15
securities market integration, see Steil (2002) and Kern
(2010a).
8 Transatlantic Academy
in history. And they continue to be the centre of
international financing and financial innovation. At
the same time, the benefits of achieving bilaterally
and globally coordinated reforms are evident.
As a result, it seems advisable that the United
States and the EU should be credible promoters
and forceful drivers of financial market policy
coordination in the G20. Reaching joint policy
positions will, in practice, require concrete
cooperation on the scheduling, design, and details
of regulation. This would optimally include ex
ante bilateral consultations on all new policy
measures in the area of financial market regulation
of national, bilateral, or international dimensions,
as well as a close coordination of policy positions
discussed in international forums, especially in
the G20 and the bodies entrusted with supporting
global financial reform.
Finally, the credibility of Americans and Europeans
as promoters of free capital flows and as key
innovators in the global economy will depend
in the long run on their ability to be good role
models and achieve a more integrated financial
market at the transatlantic level. This would require
systematic work on resolving existing bilateral
regulatory barriers on the basis of their existing
Joint Statement, i.e. towards a harmonised and
mutually recognized regulatory system. In other
words, they will at some point need to embark on
the journey towards a single transatlantic financial
market.
These are very ambitious objectives, and they
may run counter to the zeitgeist that prevails in
the political environment after the economic and
financial crisis. But the benefits of internationally
consistent financial reform are substantial and
real, and no other two economies know this
better than those of the United States and the EU,
whose prosperity is founded on the openness of
markets, the free flow of goods and investments,
and effective governance. The United States and
the EU should intensify their policy cooperation
and encourage their G20 partners to strive for more
effective global coordination of financial market
policies.
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The Real G2: Americans, Europeans, 9

and their Role in the G20
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