March 27, 2009

Regulatory Reform Kick-Off

Yesterday marked what I think was the big kick-off of several months of debate about the future shape of financial regulation. Treasury Secretary Geithner outlined the Administration’s framework in testimony before the House Committee on Financial Services and, as noted in this Treasury Department outline, yesterday’s remarks focused particularly on addressing systemic risk.

Not surprisingly, the Administration’s proposals echo much of the conceptual framework that has been floated over the last several months by some legislators, academics and groups such as the Group of Thirty. In particular, the four focal points of the regulatory reform are: (1) addressing systemic risk; (2) protecting investors and consumers; (3) eliminating regulatory gaps; and (4) fostering international coordination. The Administration’s systemic risk proposals contemplate one “independent” regulator who is responsible for overseeing “systemically important firms” (i.e., too big to fail firms) as well as the payment and settlement systems. Systemically important firms would be subject to heightened capital requirements, strict liquidity, counterparty and credit risk management requirements and would be subject to an FDIC-like “corrective action regime.” These special firms could be any type of financial business: banks, brokers, insurance companies, etc.

The SEC figures prominently in the proposed systemic risk efforts, not as the systemic risk regulator of course but rather as the regulator of hedge funds and money market funds. The Administration envisions that advisers of hedge funds meeting as yet unspecified size requirements would be compelled to register with the SEC, and the funds would be subject to mandatory disclosure and reporting requirements, with the details of their reports to be shared with the systemic risk regulator. The proposals also call on the SEC to “strengthen the regulatory framework” around money market funds to make them less susceptible to a run on the funds and to reduce the credit risk and liquidity risk profile.

It is not clear from the proposals what role the SEC would play in a proposed new regulation of credit default swaps and OTC derivatives. The Administration calls for a “strong regulatory and supervisory regime” over OTC derivative markets, focused on central clearing of standardized OTC derivatives, encouragement of more exchange traded instruments, mandated standards for non-standardized contracts, transparency around trading volumes and positions, and robust eligibility requirements for market participants.

Chairman Schapiro’s Remarks on the SEC’s Role

At the same time the Treasury Secretary was outlining the regulatory reform proposals in the House committee room, SEC Chairman Schapiro was at a hearing before the Senate Committee on Banking, Housing and Urban Affairs focused on the regulation of the securities markets. In her testimony, Chairman Schapiro called for maintaining the independence of a capital markets regulator, consistent with preserving the Commission’s role as the investor’s advocate. The Chairman noted that, as an independent capital markets regulator, the SEC would be integral to dealing with the overarching concerns about systemic risks and serve to help the systemic risk regulator in evaluating risks. It seems clear from this testimony that, as the battle lines are being drawn, the SEC is going to fight to preserve its independence within the overall financial regulatory structure.

The Views of the Former SEC Chairmen

Among the many folks testifying at the Senate hearing yesterday were former SEC Chairmen Richard Breeden and Arthur Levitt. Breeden and Levitt both supported Chairman Schapiro’s call for maintaining a strong SEC as a separate capital markets regulator – and not subsuming the agency into some larger financial regulator. In his testimony, Levitt stated:

“The proper role of a securities regulator is to be the guardian of capital markets. There is an inherent tension at times between securities regulators and banking supervisors. That tension is to be expected and even desired. But under no circumstance should the securities regulator be subsumed – if your goal is to restore investor confidence, you must embolden those who protect capital markets from abuse. You must fund them appropriately, give them the legal tools they need to protect investors, and, most of all, hold them accountable, so that they enforce the laws you write.”

Breeden’s testimony called for merging the SEC, CFTC and PCAOB into a single regulator charged with overseeing trading in securities, futures, commodities and hybrid instruments. In this role Breeden would envision that the combined agency would also set disclosure standards for issuers and the related accounting and auditing standards.

Levitt didn’t mince words on his views about the SEC in an interview with the Washington Times, noting in this article that “The SEC has been grievously hurt over the past eight years” and that “It’s lost its best people. It’s been demoralized. It’s been humiliated [to the] point it is no longer the pride of government agencies.” As for the Congress’s oversight of the SEC, Levitt said it “is a function of perfectly terrible oversight of the SEC on the part of Congress. It’s neither a Democratic nor a Republican issue. It’s a national disgrace.”

– Dave Lynn