As we move nearer to the second month of the new administration, the contours of the regulatory reform landscape are coming into sharper focus. Set forth below is a review of recent developments related to establishing a systemic risk regulator for all financial services-related complexes, and federal insurance regulation. The alert highlights recent congressional testimony and press conferences, as well as several prominent reports issued in the past month related to regulatory reform initiatives.
Senate Banking Committee Testimony.
On February 4, 2009, the Senate Committee on Banking, Housing, and Urban Affairs held hearings on Modernizing the U.S. Financial Regulatory System, where senators heard testimony from, among others, Paul Volcker, former chairman of the Federal Reserve Board of Governors, and from Gene Dodaro, the Acting Comptroller General of the U.S. Government Accountability Office (GAO).1
Mr. Volcker outlined a plan for broad fundamental changes and reform of the financial system along the lines of the recommendation in the Group of Thirty Report (discussed below). Mr. Volcker testified that lawmakers must create “clear boundaries” between those institutions and financial activities capable of creating significant systemic risk to financial systems and those not posing that risk. Mr. Volcker urged that lawmakers move aggressively in designing a regulatory body that will oversee such institutions with the appropriate quality and independence, depending on whether the institution is critically important. Interestingly, Mr. Volcker stopped short of recommending that the Federal Reserve take on the role of the systemic risk regulator, and he identified possible conflicts between managing monetary policy and serving as a systemic risk regulator. In response to questions from the senators, Mr. Volcker agreed that too many responsibilities entrusted upon the Federal Reserve may undermine its independence and ability to conduct effective monetary policy. Mr. Volcker did not address the issues of federal regulation of insurance nor did he identify whether and to what extent an insurance company and its operations should be subject to oversight of a systemic risk regulator.
The Senate Banking Committee also heard testimony from Mr. Dodaro. With respect to Mr. Dodaro’s testimony on systemic risk regulation, he primarily reiterated the views described in the section below from the GAO Report. As to federal insurance regulation, the testimony from Mr. Dodaro and his staff indicated the view that a federal charter option for insurers deserved significant consideration, particularly to address the difficulties imposed on insurers who must roll out products through 54 states and territories, where banks and others do not face those challenges with new products. Mr. Dodaro did indicate the view that preserving a role for the states appeared to be appropriate, as well.
Chairman Frank’s Agenda for the House Financial Services Committee.
In a sweeping press conference on February 3, 2009, Barney Frank, Chairman of the House Financial Services Committee laid out his plans for financial services reform. Chairman Frank indicated that his Committee would likely be addressing financial services reform in two distinct phases: putting the Federal Reserve into place as a systemic risk regulator; and providing for broad overhaul of financial services regulation. With respect to systemic risk regulation, Chairman Frank stated that “there is an emerging consensus, I believe, that probably the Federal Reserve will be given the power to do systemic risk regulation covering all forms of financial activity.” In addition, Chairman Frank addressed federal insurance regulation from the backdrop of systemic risk regulation indicating that (1) international cooperation is important for effective systemic risk regulation, and (2) international regulators will press for consideration of the federal insurance charter. More specifically, Chairman Frank stated, “I know one of the first things I will be asked by the E.U. and the British is ‘What about an optional federal charter for insurance?’ And particularly for life insurance, that question is going to be dealt with. Paul Kanjorski will be working on that.”2
Congressional Oversight Panel.3
On January 29, 2009, the Congressional Oversight Panel issued a “Special Report on Regulatory Reform” entitled “Modernizing the American Financial Regulatory System: Recommendations for Improving Oversight, Protecting Consumers, and Ensuring Stability” (COP Report).4 The COP Report sounded a similar message as the Group of Thirty Report — that the present regulatory system, particularly at the federal level, has failed to (1) effectively manage risk, (2) require disclosure of risk with sufficient transparency and, (3) ensure fair dealings. The COP Report in particular noted that such unfairness and opacity of the financial markets caused the loss of confidence in the marketplace.
The COP Report identified eight specific areas most urgently in need of reform, among which is the need to regulate financial institutions that pose systemic risks. The COP Report recommended as a first step to identify the systemic risk posed by particular financial institutions. Once these systemically significant institutions are identified, they should face enhanced regulation to limit any excessive risk-taking and to ensure their safety.
While the COP Report did not directly address regulation of insurance companies, two of its members added their own recommendations to the Report.5 These recommendations directly addressed federal insurance regulation and recommended that insurance companies be permitted to choose a federal insurance charter at their discretion. The recommendation further suggested that Congress could “build upon the success of state guarantee pools and maintain [state] jurisdiction over premium taxes” in regulating insurance at the federal level.
Group of Thirty Report.
On January 15, 2009, the Group of Thirty6 issued a report entitled “Financial Reform: A Framework for Financial Stability” (Group of Thirty Report), which contained 18 recommendations to address a range of financial and economic problems. The Group of Thirty Report discusses policy issues related to redefining the scope and boundaries of prudential regulation, including the roles of central banks and other systemically important institutions. Any policy changes, the Report stated, should aim to improve governance, risk management, transparency, financial infrastructure, regulatory polices and accounting practices.
A core recommendation made by the Group of Thirty is to subject all systemically significant financial institutions regardless of type (e.g., government sponsored enterprise, investment bank, insurance company, commercial bank) to an appropriate degree of oversight. The Report recommended that significant non-bank financial institutions, such as large internationally active insurance companies, must be subject to national-level consolidated prudential regulation and supervision. As indicated in Mr. Volcker’s recent testimony (discussed above), the Group of Thirty Report recommends that the proper balance must be struck between the responsibilities of a prudential regulator versus the responsibilities of a central bank — both have an important role in preserving the financial stability, but central banks also have the paramount mission of conducting monetary policy.
While the Group of Thirty Report did not explicitly review or make recommendations on insurance regulation in the United States (other than related to systemic risk oversight described above), it recognized that several components of the U.S. financial system presented challenges in responding to the current financial crisis and that one of those challenges is the fragmented state-based framework of insurance regulation in the United States. According to the Report, the absence of national-level regulation of the insurance segment of the U.S. financial system has limited the effectiveness of oversight of the capital market activities of large, complex affiliates of regulated insurance companies.
On January 8, 2009, the GAO issued the report “Financial Regulation: A Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory System” (GAO Report).8 The GAO Report, again, echoed the message of the other two reports — that the U.S. financial system has relied for too long on a fragmented and complex arrangement of federal and state regulators that have not kept pace with major developments in the financial markets and products in recent decades.
The GAO Report recommended that a single entity be responsible for assessing threats to the overall financial system. Such entity will be tasked with the broad authority to collect and analyze the risks that financial institutions pose within specific sectors, across the nation and globally. The GAO Report cited to other reports suggesting that the Federal Reserve’s role is expanded to be a “market stability regulator” with responsibilities to gather information and collaborate with other regulators.9
The GAO Report expressly addressed the federal insurance charter issue but did not elaborate or provide significant detail on its position. More particularly, the GAO Report stated, “Congress could consider the advantages and disadvantages of providing a federal charter option for insurance and creating a federal insurance regulatory entity. We have not studied the issue of an optional federal charter for insurers, but have through the years noted difficulties with efforts to harmonize insurance regulation across states through the NAIC-based structure. The establishment of a federal insurance charter and regulator could help alleviate some of these challenges, but such an approach could also have unintended consequences for state regulatory bodies and for insurance firms as well.” The GAO Report does not elaborate on the unintended consequences.