Integrating Socio-Economic Rights into the Regulatory

Architecture of the Financial System

Mary Dowell-Jones, Ph.D.

Research Fellow

Institute 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 OECD

2. Over 600,000 a month lost jobs in USA in Q1 2009

3. 20 million migrant workers unemployed in China

4. 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 jobs

2. Fall in State revenue/State spending for ESCR

3. 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 bankruptcies

2. Rise in foreclosures/loss of homes

3. Massive losses on pension funds

4. Rise in food insecurity (USA)

5. Sharp drop in government revenue/tax takes

Long term:1. Explosion of government debt – likely sharp spending cuts

2. Impaired bank balance sheets – era of sluggish lending/growth

3. Threats from inflation/new asset bubbles

4. 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 vehicles

3. Over-reliance on credit ratings ‘outsourcing risk’

4. Global search for yield

5. Fundamental failings of risk management

6. Leverage/under-capitalisation of banking system

7. 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 environment

2. Arrival of China into world trading system, suppressing CPI

3. Build up of enormous FX reserves in Asia + their recycling into treasuries – de facto currency pegs

4. Huge trade deficits/surpluses – Asia produced, the West consumed

5. 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 need

3. Proposals to simply insert a HR clause into Basel II Capital Adequacy Accord

4. Lack of engagement with technical financial detail or visibility of HRs in regulatory reform debates

5. 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