A not-for-profit think tank headed by Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, has called for a substantial overhaul of the federal regulatory system that oversees US financial services, including merging the Commodity Futures Trading Commission and the Securities and Exchange Commission.

Claiming that the oversight of US financial institutions “is highly fragmented, outdated, and ineffective,” the Volcker Alliance issued a report last week that recommended the creation of a so-called “twin-peaks” model of regulation. This paradigm would consolidate prudential oversight currently administered by a number of banking and financial regulators into one new independent federal agency—a prudential supervisory authority—and collapse the CFTC and the SEC’s investor protection and capital markets oversight functions into another new independent body.

Under the Volcker Alliance’s proposal, both the Federal Reserve and the Financial Stability Oversight Council would retain many of their current functions. However, the FSOC would establish a new Systemic Issues Committee (SIC) that would have the authority to designate systemically important financial institutions (SIFIs) and require adequate standards and safeguards to avoid threats to systemic stability even if arising from sources not currently under prudential supervision (e.g., so-called “shadow banking” activities)

The SIC would be composed of the heads of the Federal Reserve, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Consumer Financial Protection Board and the head of the new merged CFTC-SEC. The SIC would also include the director of the Office of Financial Research (which would be broken away from the Department of Treasury and become an independent agency), and one state insurance commissioner chosen by all state insurance commissioners.

The new PSA would take over prudential supervisory functions currently performed by the Federal Reserve, the Office of the Comptroller of the Currency (which would be eliminated entirely), and the FDIC related to most banks and SIFIs, and by the CFTC and SEC regarding broker-dealers, futures commission merchants and other financial entities currently under the supervision of the two regulators.

To the Volcker Alliance, the need for this reorganization is “unambiguously clear.” This is because a “regulatory framework developed in a piecemeal fashion over the past 150 years” is not sufficient to meet the challenges of today’s marketplace. According to the Volcker Alliance,

A fundamental weakness of the regulatory apparatus is that [the currently financial regulatory oversight system] allocates responsibilities among agencies based in significant part on rigid “functional” business lines, such as banking, insurance, securities and derivatives. However, the lines of separation between these markets have blurred as large, complex, and globally active firms have emerged to provide most of the broad array of products and services that cross these previously clear lines. In addition, the regulatory system has struggled to keep up with the market for non-bank credit intermediation, or shadow-banking market, which has become a bigger part of the financial system but operates largely outside the sphere of prudential regulation. The current system also has been outpaced by the rapidly evolving, increasingly complex, and sometimes opaque financial products that continue to emerge and transform the system, and that often migrate to less-regulated or unregulated yet critically important parts of the financial system.

While acknowledging many prior failed proposals to merge the CFTC and SEC, the Volcker Alliance suggests that a combination would be more palatable if the newly merged agency was placed under the jurisdiction of the Senate Committee on Banking, Housing and Urban Affairs and the House Committee on Financial Services with concurrent oversight by the Senate and House Agriculture committees. The Volcker Alliance proposes that the merged agency be funded solely through fees and assessments, including fines and penalties. No funding would come through congressional appropriations.

A separate 107 page memorandum published by the Volcker Alliance provides a comprehensive overiview of the history and functions of both the CFTC and SEC, and the principal laws under which they operate.

My View: For sure, the alphabet soup of federal agencies with oversight over financial firms, products and markets needs to be rationalized, and the CFTC and the SEC should long ago have been merged. To me, it is solely a naming convention to label financial products as either futures or securities (and now swaps too), and a terrible mistake to base regulatory structure on the titles of products rather than their essential characteristics and purposes. That being said, the Volcker Alliance report, albeit very thoughtful, is remarkable for its absence of any meaningful discussion of non-regulatory reasons for its proposed financial regulatory system overhaul. For example, perhaps some overhaul could help reduce duplicative regulatory requirements and costs, and promote more responsible lending, robust and sound markets, and financial structuration to help end users and other companies meet their ordinary capital raising, hedging and financing needs. Alas, for the Volcker Alliance, it appears that regulations exist solely to make banks and other financial intermediaries safe and sound. This is critically important—few would disagree. But it is also important that financial institutions are not excessively handicapped in performing their critical functions to help the economy. The financial regulatory system needs to be overhauled, but it must be structured in a way to address safety and soundness concerns, as well as to promote a robust financial services industry and liquid markets, and to save costs.