This is an author version of the contribution published on Journal of International Relations and Development,

This is an author version of the contribution published on: Journal of International Relations and Development, 2013, 16 (3), pp 380-405 doi:10.1057/jird.2012.10 The definitive version is available at: http://www.palgrave-journals.com/jird/journal/v16/n3/abs/jird201210a.html Designing the Financial Stability Board: A Theoretical Investigation of Mandate, Discretion, and Membership Manuela Moschella Introduction The global financial crisis of 2007-09 has propelled a variety of international and national responses At the domestic level, authorities adopted policies primarily aimed at restoring financial market stability and avoiding spill-over effects to the real economy At the international level, leaders and officials of international bodies have launched new regulatory initiatives and developed new modalities of cooperation Among the latter, the creation of the Financial Stability Board (FSB) certainly deserves special attention Indeed, at their April 2009 summit in London, the G20 leaders announced the creation of the FSB to replace the Financial Stability Forum that had been created almost exactly ten years earlier in the aftermath of the 1997-1998 East Asian financial crisis Interestingly, as compared to its predecessor, the Financial Stability Board has been given ‘a broadened mandate to promote financial stability’, ‘a stronger institutional basis and enhanced capacity’, and an ‘expanded’ membership, by including all G20 countries, FSF members, Spain, and the European Commission (G20 2009a, 2009b) This paper explores this empirical pattern of delegation to the Financial Stability Board Specifically, the paper investigates the factors that help explain some aspects of the new institutional design of the FSB, namely its mandate, discretion, and membership How can we account for the new functions delegated to the FSB, including that of assessing vulnerabilities affecting the global financial system and that of monitoring members’ behavior? How can we account for the degree of discretion afforded to the FSB in the conduct of the assigned functions? Finally, how can we account for the size of the FSB’s membership? In answering these questions, the paper provides a conceptual contribution to the analysis of the institutional characteristics of one of the bodies that has recently gained prominence in the governance of the financial system – according to the oft-quoted remark of the US Treasury Secretary Timothy Geithner, the FSB should be considered as the fourth pillar of global economic governance (US Treasury 2009) Indeed, while existing studies on the FSB have explored important empirical issues on the workings of the new body, focusing on policy implications in terms of efficiency and legitimacy (see, for instance, Helleiner 2010a, 2010b; Griffith-Jones et al 2010a), studies on the FSB’s creation have yet to investigated the issue with reference to theories of international organizations In order to fill in this gap, this paper takes a theory-oriented approach by assessing the extent to which one of the dominant theories in the field of delegation to IOs – i.e principal-agent (PA) theory – can help explain the functions, discretion, and membership of the FSB and by discussing alternative theoretical explanations Specifically, PA models predict that principals delegate powers and discretion to an agent in order to reduce the transaction costs related to the specific issue area in which the agent operates (Epstein and O’Halloran 1999; Kiewiet and McCubbins 1991; Moe 1984) The transaction costs associated with international financial cooperation that aims to minimize the probability of financial crises include costs of information collection on financial vulnerabilities and the costs of enforcing compliant behaviors with internationally negotiated agreement and standards The lack of quick and coordinated decision-making procedures in the event of global crises also adds to the list of transaction costs that principals aim to minimize with the creation of international agents Building on these insights, we would expect that the institutional design of the FSB reflects principals’ conscious attempt to reduce the transaction costs of financial cooperation to facilitate the collection of policy-relevant information, ensure compliance, and expedite the decision-making process We should also expect that decisions related to the optimum size of the membership aim to preserve the homogeneity of preferences among principals Indeed, as explained at greater length below, one of the key insights derived from the application of PA theory to processes of delegation is that principals have few incentives to delegate should conflicting preferences among principals exist Given conflict, the probability to strike a compromise among members decreases as does the capacity to make rapid decisions (Epstein and O’Halloran 1996; 1999; McCubbins and Page 1987) In order to test these propositions, this paper reviews the institutional characteristics of the FSB assessing the extent to which they are explicable in light of the hypotheses developed in principal-agent studies As will be shown, empirical evidence lends support to PA hypotheses according to which the functions assigned to the FSB help minimize the transaction costs related to the specific issue area of financial cooperation In particular, it seems that the new functions reflect G20 Leaders’ demand for policy-relevant information, and credible commitment Nevertheless, the empirical evidence also signals anomalous results with regards to the degree of discretion and the size of the membership Given principals’ pressing demand for expertise and credible commitment, the discretion granted to the FSB seems more limited than the theoretical model would lead us to expect Indeed, the autonomy of the FSB is constrained by its functions because of the limited size of its staff, the ambiguities surrounding its relationship with the standard-setting bodies (SSBs), its consensus decisionmaking rule, and the lack of legal obligations for members Finally, the size of the FSB’s membership provides the biggest anomaly for PA theory Indeed, given PA theory’s expectation of homogeneity of preferences among principals, it becomes difficult to reconcile the decision to increase heterogeneity by expanding the number of members In short, the application of PA theory to the study of the FSB’s design presents serious anomalies suggesting the need to expand the theorization of the FSB’s creation exploring alternative theoretical explanations In doing so, it will be possible to provide a theoretical underpinning to the study of the FSB that can complement the policy debate that has dominated the study of the FSB thus far Before proceeding, an important clarification is in order One can question the validity of the applying of PA models to the analysis of the FSB, as this international body does not perfectly fit with the commonly accepted definition of delegation in the literature Indeed, the common definition of delegation indicates the transfer of authoritative powers by a group of principals to a third-party agent In other words, in most PA studies in international relations, delegation takes place from a group of states to an international organization, a secretariat, court, or any other third party According to some observers, however, the FSB barely fits given a strict application of this definition The FSB certainly possesses an independent secretariat as explained at length below However, so the argument goes, it is still primarily a coordinating body among national authorities as was its predecessor (i.e the Financial Stability Forum – FSF) (on this point see, for instance, Griffith Jones et al 2010b; and Schinasi and Truman 2010: 3) Although the FSB is not strictly an agent in the language of the literature, a core claim of the article is that PA models can nonetheless be applied to the study of the FSB Indeed, although the FSB was not established by a formal international agreement ratified by governments, as is the case for most international organizations, the FSB was deliberately created by the G20 Leaders to replace the Financial Stability Forum Furthermore, it has been given a distinct institutional structure, that is to say, a structure that is separate from that of its members Of course, the question remains about the capacity of the FSB to express views independent of its members, but this question does not suggest that the FSB is not an agent To the contrary, to ask about the degree of independence of the FSB implies that it is an agent that may well deviate from principals’ original preferences, as any other agents in PA relationship Building on these observations, the point here is that we can still apply the insights of PA models to the analysis of the FSB although it is not an ideal-type example of delegation In other words, the FSB may look like an unusual institution but the creation of the FSB, and in particular the institutional characteristics devised for the FSB, poses the same problems that typically animate PA scholars The fact that G20 Leaders decided to create a new body to promote financial stability and they gave the body a distinct institutional framework raise the question of institutional design The paper is organized as follows In the next section, this paper introduces the issue of delegation in international financial governance Section specifies the hypotheses that will be tested in the empirical analysis Specifically, I develop the propositions that help explain the functions, the discretion, and the membership of the FSB from a PA perspective In section 3, I focus on some of the institutional features of the FSB, assessing to what extent they can be explained in light of the hypotheses derived in the previous section Section reviews two main alternative theoretical explanations to account for the institutional features of the FSB – the power-oriented and the transgovernmental explanations The last section concludes by reflecting on the theoretical underpinning to the FSB’s creation Delegation in International Financial Governance Current arrangements for the governance of the financial system are based on collaboration between various international bodies that share responsibility for promoting stability These bodies include the international financial institutions (i.e the IMF and the World Bank), international groupings of regulators and supervisors (Basel Committee on Banking Supervision (BCBS)), the International Organization of Securities Commission (IOSCO), and the International Association of Insurance Supervisors (IAIS), and even private sector bodies, whose members include representatives of accountants, service, industry, and commerce (i.e International Accounting Standards Board (IASB)) The governance of international finance is thereby distributed among multiple transnational public and private international institutions (Porter 2005) That is to say, transnational policy communities, made up of public officials, private representatives, and technical experts (Tsingou 2009: 24), stand at the centre of the process of creating and enforcing global financial regulations (see Baker 2006) They so alongside the traditional intergovernmental organizations that were created at the end of world war II The institutional configuration of the international economic and financial system has long been a privileged analytical field for scholars interested in processes of delegation In particular, beginning with the neoliberal institutionalism and extending through works on delegation, scholars have devoted great attention to the puzzle posed by the creation of international organizations to facilitate inter-state cooperation In one the most well-know analyses of the neoliberal institutionalist scholarship, Robert Keohane (1984) argues that the organizations through which interstate cooperation has taken place in the world political economy survive the hegemon, under whose influence they were created, because they perform important functions, primarily the provision of information and its distribution In other words, organizations are created and maintained over time because they reduce the transaction costs of cooperation (Coase 1960; Williamson 1983) This paper takes Keohane’s functional insight as a starting point to analyze the pattern of delegation to one of the new international bodies in the international financial regime Specifically, the paper develops a number of propositions that draw from principal-agent models of delegation in order to explain some specific institutional features of the FSB – i.e functions, discretion, and membership In particular, I build on the two core assumptions that unite principal-agent studies (Hawkins et al 2006) The first is that states delegate authority to international bodies because of the benefits deriving from it ‘States devise institutions to promote cooperation and make it more resilient’ (Koremenos, Lipson, and Snidal 2001: 766) As in a company where shareholders should profit from their participation, international institutions should bear benefits for member countries The second assumption is that states aim to minimize agents’ deviant behavior Indeed, although states create agents with functions that advance their interests, agents develop their own preferences that may be different from those of their principals Hence, they may pursue goals that principals had not intended or to pursue goals with modalities that principals had not approved In other words, P-A relationships are characterized by a certain amount of agency slack that principals attempt to keep under control This does not mean that international bureaucrats systematically pursue their own vested interests as public choice scholars claim they (Vaubel 1991) The point is simply that agents develop policy preferences of their own and may use their delegated powers to pursue them Under these circumstances, principals have to design mechanisms to control possible opportunism by agents (Hawkins et al 2006) that gives rise to different degrees of discretion for the agent in the conduct of their activities In short, PA theory features benefit-maximizing principals and agents that may deviate from the pursuit of the goals set by the principals that created them It follows that principals choose among differing institutional designs in order to maximize benefits and minimize agency slack by delegating specific functions and devising ad hoc control mechanisms (Pollack 2003) I proceed to review the most common hypotheses on the pattern of delegation developed by PA models, tailoring them to the case-study under consideration in this paper That is to say, I am going to single out a number of factors that may help explain the functions, discretion, and membership of the FSB Explaining design characteristics: delegation, discretion, and membership The literature on design and delegation has identified several factors that help explain the design features of the Financial Stability Board, including the functions assigned to it, the discretion accorded for conducting its functions, and the size of its membership Specifically, it is possible to extrapolate certain hypotheses on the emergence of these design characteristics by putting the emphasis on principals’ demand for policy-relevant information, credible commitment, and efficient decision-making Indeed, according to rationalist models of delegation, the functions delegated to an agent can be explained by the existence of asymmetric information That is to say, principals consciously choose to delegate a set of functions to an agent in order to gain an informational 10 among experts to the point that national interests become increasingly irrelevant in the decision-making process For instance, although the pursuit of self-interest and the exercise of power are not entirely absent from the activity of transgovernmental networks, the key factor in determining the course of debates and deliberations is more often the personal reputation and expertise of officials, governors and ministers than the country they represent (Baker 2006: 103; also Porter 2003, 2005: 192) How does the transgovernmental explanation fare in explaining the institutional features of the FSB? At a preliminary glance, the transnational explanation seems positioned to explain the empowerment of the FSB as compared to the FSF The expansion of the FSB’s mandate and its institutionalization can be read as an example of the influence of the transgovernmental network of regulators and their quest for insulation from their respective domestic political contexts and from interstate diplomatic pressures Upon further inspection, however, the transgovernmental explanation, like the PA explanation, has difficulty explaining some of the specific institutional features of the FSB, namely the limited autonomy and the expanded membership To argue that transgovernmental networks exert significant influence on the international financial regulatory reform process suggests that the FSB would have been granted far more autonomy than it currently holds In addition, we would expect that transgovernmental networks would have opposed the expansion of membership in order to preserve the homogeneity of preferences and like-minded environment that are recognized as the crucial resources through which networks influence international regulatory outcomes In spite of the limited match between the expectations derived from the transgovernmental explanation and the empirical record, the theory contains a number of claims that can help 30 account for the empirical anomalies just identified In particular, the scholarship has identified the conditions under which the influence of the network is more likely to be successful For instance, one crucial insight is that the influence of transgovernmental networks is crucially linked with their cohesive and consensual technical knowledge (Baker 2006; Porter 2005) Furthermore, the network’s influence is magnified by insulation from political and public pressures because insulation favors informality and personal relationships between the members of the network For instance, Kathleen McNamara (1998) has noted that finance ministries and central banks remain relative insulated from domestic political pressures However, the global financial crisis has weakened all the conditions under which we expect the influence of the transgovernmental network to work For instance, the crisis has exposed increasingly strong and public disagreements among financial officials on issues such as macroprudential objectives and the treatment of systematically-important financial institutions (Helleiner and Pagliari 2011: 182) Still, the crisis has led to the politicization of the debate on international financial regulation, and even to the public contestation of the activities of transnational regulators and supervisors (Helleiner, Pagliari and Zimmermann 2009) In this context, ‘the ability of internationally networked technocrats to set the agenda soon became more constrained by the greater activism of the G20 leaders and legislative assemblies such as U.S Congress and the European Parliament, which started to set detailed priorities and stringent deadlines for technocratic officials to meet’ (Helleiner and Pagliari 2011: 182) As this overview of theoretical explanations reveals, not only PA theory but also the poweroriented and the transgovernmental explanations have some difficulty explaining all the FSB’s institutional features Is it therefore a conclusion that we not have a good theoretical toolkit to study the design features of bodies like the FSB? The short answer is no Rather, we 31 observe that a number of theoretical explanations partially fit with the empirical record of the FSB’s creation, setting the foundation for further empirical research As anticipated, the literature on the FSB has been thus far been predominantly couched in the language of the policy debate, with scholars debating how the FSB is placed to effectively monitor and influence members’ financial policies A more theoretical-driven research could therefore add important insights to existing scholarship and to IO scholarship at large In particular, the study of the FSB can provide an interesting laboratory to test the relative explanatory power of a number of independent variables (power, knowledge, and functions) and to theorize about the combination of different theoretical strands A final remark concerns the explanatory potential of the theoretical explanations analyzed thus far Although it is not a purpose of this study to adjudicate among them, it is nonetheless possible to speculate as to their potential in addressing the puzzle of the FSB’s institutional features – features such as limited discretion and expanded membership Whereas both the PA and the power-oriented explanations account for these features only at the cost of incorporating insights developed in other theoretical traditions, the transgovernmental explanation appears to be the most theoretically promising because it already contains in nuce the arguments to amend the anomalies evidenced in the empirical analysis For instance, let us consider the puzzle posed by the expansion of the FSB’s membership Whereas the PA and the power-oriented explanations not contain a theory through which to account for the changes in states’ preferences, which, in turn, could help explain the decision to expand the FSB’s membership, the transgovernmental explanation can justify its inability to explain this institutional feature by pointing to the absence of the conditions under which the influence of transgovernmental networks is expected to be at play That is to say, since the global financial crisis left the transgovernmental network a target of political pressure and public contestation, 32 the expansion of the FSB’s membership can be read as an instrumental decision to assuage the growing criticisms Again, this discussion is merely speculative and significant empirical work is required to lend support to one of the alternative hypotheses outlined above Nevertheless, the mere theoretical comparison among the alternative explanation suggests that the transgovernmental perspective has an edge over the others in light of the conditions it has developed over time regarding the influence of its favored independent variable Conclusions This paper has investigated some of the key institutional features of the FSB, namely, the functions, discretion, and membership of the FSB Specifically, the paper tested a number of hypotheses derived from principal-agent theory in order to assess whether the specific functions assigned to the FSB, the discretion accorded to it in discharging the assigned functions, and its membership reflect principals’ demand for policy-relevant information, credible commitment, and rapid decision-making Analyzing the institutional structure of the FSB, the paper showed that the functions delegated to the FSB correspond closely to the functions predicted by PA models Indeed, the FSB’s mandate to collect information on financial vulnerabilities and monitor compliance with international financial standards are in line with the hypotheses according to which the functions assigned to an agent are devised to improve principals’ stock of information and to ensure credible commitments Indeed, in the case of the FSB, its functions are meant to spot risks and vulnerabilities that could lead to systemic shock and to lock-in member countries’ commitment to financial stability 33 Although the empirical evidence on the delegation of functions to the FSB neatly supports the PA hypotheses, PA expectations not closely fit the discretion accorded to the FSB and the size of its membership The discretion of the FSB fits only partially with the predictions of the PA theory because of its limited nature in spite of the need for technical information and credible commitment The limited size of the staff, the lack of clarity in the modalities through which to enforce compliance with international standards, the consensus rules that govern the decision-making and the lack of legal obligations are all factors that severely undermine the autonomy of the FSB Because of these shortcomings, several scholars have stressed that the FSB is unlikely to become a very autonomous agent in the governance of the global financial system (Pauly 2010) As Helleiner (2010: 3) notes, for instance, ‘rather than becoming a powerful international body, its role would remain primarily focused on facilitating transgovernmental networks, with ultimate responsibility for financial regulation and supervision still resting firmly at the national level’ Next to the anomalies identified in the area of discretion, PA theory also struggles to explain the membership of the FSB Indeed, if the hypothesis is that rational principals aim at speeding the decision-making process by minimizing the heterogeneity of membership, the expansion of the FSB membership in 2009 is a puzzle from a PA perspective In sum, although PA expectations are largely confirmed by the empirical analysis of the FSB’s mandate, there are areas in which PA expectations offer only a limited theoretical guidance in predicting the pattern of delegation and in particular the institutional features deriving from the decision to delegate The limited fit of PA theory with the discretion accorded to the FSB and the size of its membership raise the question of what are the theoretical alternatives to account for the institutional design of the FSB In this connection, the paper reviewed two alternative explanations – the power-oriented and the transgovernmental explanations – detailing their 34 underlying hypotheses and speculating about their potential application to the FSB In particular, it has been argued that both explanations have difficulty explaining all the institutional features of the FSB similarly to what has been found for the PA explanation Furthermore, although it was not a purpose of this paper to determine which of the three explanations has the greatest explanatory power, the paper has suggested that the transgovernmental explanation is the best placed to account for most of the features that are puzzling for the other theoretical perspectives Specifically, it has already developed a number of scope conditions under which the transgovernmental network is expected to influence (or not) the international regulatory reform process Reflecting on the strengths and weaknesses of alternative theoretical explanations, the paper has therefore 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Waterloo, Ontario: The Centre for International Governance Innovation (CIGI) 42 Vaubel, Roland (1991) ‘The Political Economy of the International Monetary Fund: A Public Choice Analysis’ in Roland Vaubel, and T D Willett, eds The Political Economy of International Organizations: A Public Choice Approach, 204-244, Boulder, Co.: Westview Press Walter, Andrew (2008) Governing Finance: East Asia’s Adoption of International Standards, Ithaca: Cornell University Press Williamson, Oliver E (1983) Markets and Hierarchies: Analysis and Antitrust Implications, Free Press Notes 43 The World Bank, for instance, assist member countries in the design and implementation of policies that strengthen domestic financial system and help countries in identifying risks in this system The BCBS, the IOSCO ands the IAIS, in turn, provides specialized knowledge by setting the standards in the field of banking supervision, securities and insurance supervision respectively PA models usually distinguish agents’ deviant behaviour between agents’ slippage and shirking The first occurs when agents takes positions different from those of their principals The second occurs when agents not competently carry out their principals' wishes The original members of the FSB were the national authorities of the G7 Australia, Honk Kong, the Netherlands and Singapore became members after its creation, and Switzerland was added in 2007 The list is non-exhaustive because, beyond the explicit functions listed bellows, Article provides that the FSB can undertake ‘any other tasks agreed by its Members in the course of its activities and within the framework of this Charter.’ Financial Stability Board Charter According to Helleiner (2010: 9-10) the peer-review process is one four new mechanisms devised to encourage compliance with international standards The other mechanisms include membership obligations to implement international standards, to publicize IMF/World Bank assessment; and the new FSB-led process to tackle noncooperating jurisdictions The first thematic peer-review completed in March 2010 focused on the application of standards for sound compensation practices In September 2010, then, the FSB completed the fist country peer-review of Mexico Financial Stability Board, Financial Stability Board holds inaugural meeting in Basel, Press Release, 27 June 2009 On the legal status of the FSB see, for instance, IMF (2010b): 3-6 ... (Basel Committee on Banking Supervision (BCBS)), the International Organization of Securities Commission (IOSCO), and the International Association of Insurance Supervisors (IAIS), and even private... empowerment of the FSB as compared to the FSF The expansion of the FSB’s mandate and its institutionalization can be read as an example of the influence of the transgovernmental network of regulators and. .. politicization of the debate on international financial regulation, and even to the public contestation of the activities of transnational regulators and supervisors (Helleiner, Pagliari and Zimmermann