Dr. Josef Ackermann
Chairman of the Board of Directors of the Institute of International Finance
Chairman of the Management Board and the Group Executive Committee of Deutsche Bank AG

Good afternoon and thank you President Smith and the National Press Club for inviting me here today. I am here in my capacity as the Chairman of the Board of the Institute of International Finance, which is an association of more than 380 financial services firms across the world.

As many of you know, the IIF today provides its members with in-depth economic and financial market analysis. But it is also involved in advocacy work on an expanding range of critical issues related to improving industry practices, enhancing the efficiency and effectiveness of the regulation and supervision of financial firms, and strengthening the global financial system. Recent achievements of the IIF in the latter area of work include a major contribution to the Basel II Accord Process, as well as the development of the Principles for Stable Capital Flows and Fair Debt Restructuring in Emerging Markets. And it is in the context of this work that we are here today.

Of course, the financial stresses that first became so evident about a year ago are still very much with us, as painfully reflected in the latest episode surrounding the major Government-Sponsored Enterprises. What became a subprime mortgage crisis has since turned into a much deeper problem, spread across a wide array of global markets. All financial market participants, both in the private and official sectors, have a responsibility to work for a resolution of these difficulties as quickly as possible. I warmly applaud in this connection the sustained efforts of policymakers in both the United States and abroad to come to grips with the challenge. My focus today, however, is not on policy challenges the financial turmoil has posed. It is rather on what can be done by the financial industry worldwide to address the problem.

Last October the IIF established a Committee on Market Best Practices with a view to galvanizing the industry to develop practical ways to address market weaknesses and assist in the rebuilding of confidence. The Committee was also intended to facilitate the industry's interface with the official sector, the need for which was clearly recognized by both sides. During the last nine months, over 65 leading financial firms participated with an exceptional intensity and cooperative spirit in reviewing what went wrong and developing a consensus on ways to address the shortcomings.

I am delighted that the Co-Chairmen of this Committee are with us today - Rick Waugh, CEO and President of Scotiabank from Canada, and Cees Maas, former Vice Chairman, CFO and CRO of ING from the Netherlands. The Final Report represents the culmination of the efforts of the Committee and its six Working Groups, and I would also like to underscore the dedicated support of the IIF staff under the direction of its Managing Director, Charles Dallara. I am pleased as well to welcome here today two members of the Committee on Market Best Practices, both of whom made substantial contributions to the Report: Dr. Madelyn Antoncic, of Lehman Brothers, and Mr. Mark Lawrence of McKinsey.

In sharing my perspective on the Final Report, let me emphasize at the outset that the financial services industry recognizes its responsibilities. We acknowledge the serious weaknesses in business practices across a range of financial institutions that developed in the run-up to the turmoil in an environment of strong global growth, ample liquidity and low interest rates. But we are not here to assign blame; rather we trust that as an industry-wide group we can make a substantial contribution to finding a solution to the problems underlying the persistent market turbulence.

The Final Report is our response to the turmoil, put together in the form of actionable recommendations for best practices based on core principles. In presenting our program of action to resolutely strengthen our business practices, let me be clear that we are not suggesting a blueprint for "self-regulation". A voluntary set of best practice recommendations is not, and is not meant to be, an alternative to sound supervision. The two complement one another and need to work hand in hand to build a sound, resilient and dynamic global financial system.

The Final Report focuses on the areas of weakness most clearly revealed by the market turmoil. Notably, these include risk management, compensation policies, liquidity risk, conduit and securitization issues, valuation, credit underwriting, ratings, as well as transparency and disclosure issues.

In forging consensus on Principles of Conduct and Recommendations for Best Practices in these areas, members of the Committee and Working Groups worked with the conviction that private financial firms should play a leading role in addressing the problems. Although the results of these efforts reflect solely the views of the private sector, the Committee has consulted informally with the official sector, including major central banks, key regulatory bodies and ministries of finance. There is no doubt that the close and sustained cooperation of the private and official sectors is necessary to ensure the smooth functioning of global financial markets - which are among the most dynamic elements of the world economy.

The Report differentiates between Principles of Conduct, which capture broad standards of conduct reflecting core values and goals, and underlying Recommendations, which provide specific benchmarks for best practices. The IIF's Board endorses the Principles of Conduct for adoption by member firms, and strongly encourages that each firm apply the Best Practice Recommendations as appropriate in the context of their business model, goals and regulatory requirements. The monitoring of the implementation of the Principles of Conduct and Best Practice Recommendations will be based first and foremost on each firm's regular, critical self-assessment of their individual progress on implementation.

I would like to add here that, from my own personal conversations, I can attest to the solid commitment of our industry's leaders to the proposals we are presenting to you today. In fact, over 65 firms have already demonstrated their readiness - through their participation on the Committee and on the Board - to follow through on implementation of the Principles and Recommendations, as the foundation for improving business practices and helping to restore market confidence. We believe that support for our proposals will rapidly broaden, reaching the full complement of our member firms.

Today's report underscores the acute awareness at the highest levels of our industry that action - far-reaching action - is vital. We are determined not only to address the serious issues that have come to the fore over the last year, but to ensure that the financial industry is better able to manage future systemic crises by establishing a forum for market monitoring, which I will return to later.

Now, let me highlight some of the key proposals of our Final Report. Risk management is the centerpiece of our Report - and I must say for good reasons. Without taking risks, financial firms would not be able to earn returns that justify their existence - and if you want to avoid all the risks you will soon have nothing to avoid. At the same time, taking excessive risks is a sure way of getting into trouble sooner or later. The key is to strike the right balance between risk and return at all times. And this is the most fundamental task of financial firms.

It is a challenging job, especially in the context of the present-day global economy, which is very dynamic, but also fraught with uncertainty. There are multiple types of risk that firms need to deal with, including credit, market, liquidity, operational, reputational and legal risks, just to name the commonly cited ones, and firms have to manage all these risks in a fiercely competitive marketplace. The difficulty has been compounded by the steady increase of new and complex financial products that has accompanied the growing prevalence of the originate-to-distribute model.

Challenging as risk management has become, it is of course within our power to get it right. In fact, it is not our lack of technical capability in risk management that caused the trouble. It was, rather, a growing laxity in risk management practices in recent years, in the context of the favorable global economic and financial environment. The turmoil that ensued made the need to restore high standards in risk management practices absolutely clear.

The recent market turbulence has shown that a number of firms did not take a comprehensive approach to firm-wide risk management on a consistent basis, which meant that key risks were at times not identified or managed appropriately. This has underscored the need for financial firms to strengthen the engagement of the CEO, CRO and other relevant members of senior management, both in current risk issues and in forward-looking strategic risk management, under the direct oversight of their boards, in order to meet the highest standards of business practices in this area.

One of the most important tasks of senior management and the board in the risk management area is to ensure that a robust risk culture pervades throughout the firm and that, against this backdrop, a well-understood risk appetite is articulated. This should take into consideration all types of risk, including those noted above, but also those arising from the firm's relationship to off-balance sheet vehicles. As an aside, albeit an important one, allow me to draw your attention to the need to differentiate between off-balance sheet exposures and warehouse risk, which unfortunately are often lumped together indiscriminately. But they are very different, of course: while off-balance sheet exposures are the result of conscious risk-taking on a position, warehouse risk is the inevitable by-product of flow business, where the risk only materializes if markets close unexpectedly, as they did last summer. Therefore, stress-testing methodologies need improvement; the sheer scale of bank writedowns has made this clear. Above all, stress testing must be truly integrated with the overall management of the firm, and take into account firm-wide risk concentrations.

Let me turn to compensation, a difficult topic, but one that has become part of the problem and must now be part of the solution. Incentive pay has been a notable if uneven area of weakness in business practices, and correcting these weaknesses will require the industry to exercise greater self-discipline on compensation-related issues.

The very first Principle on Compensation in the Report states: "Compensation incentives should be based on performance and should be aligned with shareholder interests and long-term, firm-wide profitability, taking into account overall risk and the cost of capital." This is only one of the suggested Principles that can help put compensation practices on a more sound footing. Naturally, firms must make their own judgments based on competitive conditions.

In some of our other proposals on compensation, we suggest that compensation incentives should in no way induce risk-taking in excess of the firm's risk appetite, and that payout of bonuses should be carefully related to the timing of risk-adjusted profit. Importantly, our new Principles also explicitly address severance pay, suggesting that it should take into account not only the reason for severance, but also the performance realized for shareholders over time.

Compensation is not an area where tight formulas can be applied effectively. Rather, the industry should show leadership in coming up with a better approach. That said, we hope the Principles of Conduct that we are announcing today will serve as the broad common denominator for industry practice in this area and will have a meaningful impact on strengthening our industry and ultimately, public confidence.

Our report covers a number of other vital topics including liquidity risks, conduit and securitization issues. Rigorous liquidity-risk management is essential, and we believe that the recommendations detailed by the IIF a little more than a year ago in its report Principles of Liquidity Risk Management have been validated. Had this report been issued earlier, and had firms had more time for implementation, financial firms might have had fewer liquidity problems to contend with. These principles have been updated in the Final Report, in light of further experience, and the most important task now is for firms to complete their implementation where necessary.

As you all know very well, maturity transformation is one of the very basic jobs that financial firms do, in the process exposing them to liquidity risks that need to be carefully managed. The primary challenge in this area is the management of funding liquidity, i.e., to make sure that every amount falling due is paid without any difficulty. This requires careful analyses of market developments that could impinge on the ease with which short-term liabilities can be rolled over. The analysis should also cover developments that affect how easily liquid assets held for funding liquidity management purposes can be sold without undue capital losses.

Of course, we all remember how quickly the systemic environment for funding liquidity changed last summer, from very ample to very tight. This type of situation is a real test of the liquidity management capabilities of individual firms. The enhancement of these capabilities is precisely what this section of our Report is all about.

The Report also contains a substantive discussion of the role of central banks in the provision of market liquidity. We believe that their responses to the crisis have been effective, and concur with the Financial Stability Forum that policy should remain flexible during extraordinary market conditions. Such flexibility, particularly regarding the term auction, securities lending and swap facilities that have been put in place since last December, should be part of the "tool kit" of central banks.

Now let me turn to valuation. There have been significant technical issues in valuing complex instruments in illiquid markets that lack readily available price information. There is no question that fair-value accounting is an essential element of global capital markets, fostering transparency, discipline and accountability. Having said this, it has also become obvious that it is often difficult for all observers to distinguish short-term valuation effects which may reflect a temporary overshooting of market prices in a turbulent market period from the aggregate effect of such price developments as expressed in the new equilibrium price. In our view there are a number of valuation issues that would benefit from dialogues involving industry participants, regulators and accounting standard-setters.

First, a comprehensive technical dialogue should address the very real problems faced even by skilled financial professionals in assigning appropriate values in volatile or illiquid markets.

Second, we see a need for a high-level dialogue between all relevant parties and both international and U.S. accounting standard-setters to consider more generally the effects of fair-value accounting and mark-to-market techniques. As Paul Volcker recently stated in a speech at the Economic Club of New York: "I know very well that the seemingly simple approach of "fair value" accounting is a highly complex matter extending beyond financial markets. As it should be, resolution of these questions is in the hands of independent standard setters....I trust minds are not closed to the appropriateness of "mark-to-market" under particular circumstances."

There is clearly broad support within the industry on the need for dialogue on, if not solutions to, valuation issues, and it would be instructive to have an open discussion on a range of complex questions, including the critical issue of the potential procyclical effect of fair value accounting on financial market developments with possible macroeconomic implications. However, I would also stress that significant changes of interpretation of accounting standards should not be introduced under current market conditions, when they might be misinterpreted.

At the same time, the crisis has revealed the impact of differences in the existing accounting standards. This experience underscores our belief that convergence of U.S. GAAP and International Accounting Standards is more important than ever.

I will now turn to an area that has come in for a lot of criticism of late - credit underwriting, ratings, and investor due diligence in securitization markets. In the run-up to the credit market turmoil, a key source of weakness was the decline in lending and due-diligence standards in the U.S. mortgage markets. This decline in standards has led to a situation where many questions are raised about the viability of the wider originate-to-distribute model, and has undermined market confidence.

Non-bank mortgage lenders in the United States sometimes made loans without applying bank-equivalent lending standards. As the number of deals grew, the time between announcement and completion shortened substantially. This did not always allow enough time for sufficient due diligence. The use of such loans for asset backed securities and other structured products led to major problems.

In short, it is clear that in many cases due diligence standards were uneven, and sometimes fell short of requirements. We strongly recommend that all financial institutions involved in the originate-to-distribute process should conduct adequate due diligence and apply appropriate lending standards regardless of whether assets are to be held on the books or distributed.

And, as concerns the U.S. subprime mortgage market, our report recommends that non-bank institutions involved with originating mortgage loans should be held to the same standards as banks.

Although fixing the problems of banking industry is our primary concern, the Committee has reviewed the roles and performance of ratings agencies, and offers a number of recommendations. This is a critical issue as ratings assume such an important role in the functioning of financial markets and investment decisions of so many market participants. The Committee's point of departure in its work in this area, like so many others, was that ratings for securitized and structured products have fallen well short of what a well-functioning market for such products needs.

Chief among our recommendations in this area is that external review of rating agency processes against agreed standards is essential for the credibility of ratings. An external body should be created in the industry to develop standards and review rating agencies' internal processes against those standards. Thus, we support the recommendation of the Committee of European Securities Regulators to create an international rating agencies' standard-setting and monitoring body.

Both official and private-sector bodies have considered the question of whether there should be a separate rating scale for structured products, which in stressed market conditions can have much higher price volatility than corporate bonds. After extensive debate on the issue, the Committee has joined the Financial Stability Forum, IOSCO and the U.S. SEC in the view that rating agencies should develop a different or additional scale for rating structured products.

Also on the subject of ratings, we have several recommendations for institutional investors. Most fundamentally, institutional investors should not rely excessively on ratings, but conduct their own due diligence assessments based on their investment mandates.

Let me now turn to the next subject by saying that members of the National Press Club are particularly aware of the vital role of transparency and disclosure. Running throughout our report is a clarion call for enhanced efforts by our industry to strengthen transparency and disclosure. As firms have addressed the crisis over the last year, many of them have already raised the bar on their communications to investors and the broader public.

Investor confidence is to no small degree a function of information. But information needs to be better targeted and designed to avoid information overload. At the structured product level, a concise summary of risk factors would help investors evaluate ratings independently. Global standardization and harmonization of market definitions and structures is essential for the future development of the structured-product market.

I would like to conclude by putting the work that has gone into our Final Report into a broader context. We are meeting here today at a time when the world economy and global financial markets are facing the simultaneous challenges of soaring commodity prices and the ongoing credit market turmoil. Against a backdrop of decelerating world economic growth and rising job losses, it is troubling to see commodity prices up 15% this year. The impact of this price shock - including the surge in food prices - is visible.

Consumer price inflation in the G3 economies has risen from lows near 1.5% early in 2007, to about 3.5% in mid-2008. Indeed, U.S. headline inflation is likely to top 5% year-on-year over the next few months, which would be the highest level since the Gulf War-related spike in the early 1990s. News is no better from emerging markets, where consumer prices have risen from under 4.5% early in 2007 to over 8% at present. Together with lingering financial market turmoil, those price shocks are weighing heavily on the momentum of economic activity.

The increased focus on macroeconomic risks over the past few months adds another dimension to credit concerns. The risk of second-round effects from oil and other commodity prices are real, particularly as some key surveys of inflation expectations have moved up considerably, with the potential of adversely affecting financial market performance. A more generalized inflation problem would be a significant medium-term threat to global growth as monetary policy is tightened in response, with predictable effects on a number of asset classes. Central banks will need to walk a fine line between fighting inflation and trying to prevent tail risks on growth (for example, a severe recession in the U.S.) from materializing.

As we work through these credit problems in a more challenging macroeconomic environment, it is crucial that the financial services industry persevere in its reform efforts. The Report I have presented to you today should provide solid guidance in this challenging task.

Ladies and gentlemen, as the Committee developed proposals aimed at dealing with weaknesses revealed by the turmoil, it also considered how best to guard against future crises. This led to the concept of a new market monitoring group, under the auspices of the IIF, to serve as a forum for member firms to assess global financial markets for vulnerabilities having systemic implications and examining possible changes in market dynamics that could lead to financial strains and to discuss ways to address such risks.

Findings of the Market Monitoring Group could assist firms in their risk management. We also envision regular exchanges of views between this Group and appropriate counterparts in the official sector, which should help contribute to systemic stability. The Group is expected to include individuals reflecting a broad and balanced mix of functional responsibilities, institutions and geographic regions. It will combine both current market experts and seasoned veterans in global finance, offering a highly credible forum. This forum will provide a unique opportunity to harness industry expertise, bringing a valuable private market perspective to those exchanges.

In conclusion, let me reiterate that the Committee's Final Report is the culmination of concerted efforts on the part of the industry, and conveys our determination to address past weaknesses revealed by the turmoil. Implementation of the full complement of Principles and Recommendations in this report will contribute very substantially to the strengthening of the industry and the financial system. This is an essential precondition to building resilience in a global economy that is facing increasing challenges.

Thank you.

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