In a speech this afternoon, President Obama unveiled his Administration’s proposal for reforms across the broad universe of financial regulatory agencies. The proposal, Financial Regulatory Reform, A New Foundation: Rebuilding Financial Supervision and Regulation, is designed to achieve five key objectives: (i) increasing oversight of systemic risk and financial regulation; (ii) strengthening regulation of core markets and market infrastructure; (iii) strengthening consumer protection; (iv) providing the government with tools to effectively manage financial crises; and (v) improving international regulatory standards and cooperation. Among the significant elements of the proposal are the following:

1) Creation of an Financial Services Oversight Council – The Council will “help fill gaps in regulation, facilitate coordination of policy and resolution of disputes, and identify emerging risks in firms and market activities.” The Council will:  

  • Have eight members, one from each of the principal federal financial regulators: the Secretary of the Treasury; the Chairs of the Federal Reserve, Commodity Futures Trading Commission, Federal Deposit Insurance Corporation (FDIC) and Securities and Exchange Commission (SEC); and the Director of the Federal Housing Finance Agency, the newly created Consumer Financial Protection Agency and the newly created National Bank Supervisor.
  • Identify firms “whose failure could pose a threat to financial stability due to their combination of size, leverage, and interconnectedness (hereafter referred to as a Tier 1 FHC), and provide a forum for discussion of cross-cutting issues among regulators.” Tier 1 FHC’s will be subject to “robust consolidated supervision and regulation, regardless of whether the firm owns an insured depository institution.” The Federal Reserve will be further responsible for and have a right to asses risk and set higher standards at all levels of a Tier 1 FHC to protect against excessive risk taking.

2) Creation of a new National Bank Supervisor and elimination of the federal thrift charter – In order to “close loopholes in bank regulation,” a new National Bank Supervisor (NBS) will be dedicated to the chartering and prudential supervision and regulation of national banks and federal branches and agencies of foreign banks. The NBS as an agency with separate status within Treasury, will “inherit the Office of the Comptroller of the Currency’s and Office of Thrift Supervision’s authorities to require reports, conduct examinations, impose and enforce prudential requirements, and conduct overall supervision.”

3) Provide for a single bank holding company structure –Require that all companies that own an FDIC-insured institution be subject to nonbanking activity restrictions of the Bank Holding Company Act (BHC Act), including industrial loan companies, credit card bank, trust company, or grandfathered depository institution that were not required to become BHCs, since “there is no economic justification for allowing these companies to continue to escape the activity restrictions and consolidated supervision and regulation requirements of the BHC Act.”

4) Registration of hedge funds and other private pools of capital - Require all advisers to hedge funds (and other private pools of capital, including private equity funds and venture capital funds) whose assets under management exceed some threshold to register with the SEC under the Investment Advisers Act. Such requirement would “allow data to be collected that would permit an informed assessment of how such funds are changing over time and whether any such funds have become so large, leveraged, or interconnected that they require regulation for financial stability purposes.”

5) Strengthening supervision of securitization markets - The proposal would impose at least two new conditions with potentially far-reaching effects. First, issuers of securitized loans , or the sponsor of a securitization will be required to retain at least 5% of the credit risk. Second, there would be different requirements for the ratings of asset-backed securities and of corporate securities.

6) Comprehensive Regulation for the over-the-counter derivatives market, including credit default swaps – Credit default swaps and all other “over-the-counter” (OTC) derivatives markets will be subject to comprehensive regulation including transparency in trades and positions, central clearing and execution mechanisms and higher capital charges for customized OTC derivatives, in order to:  

  • Prevent market manipulation, fraud and other market abuses, as well as activities that pose risk to the financial system;
  • Promote transparency, and efficiency in those markets; and
  • Prevent OTC derivatives from being marketed inappropriately to unsophisticated investors.

7) Creation of a new Consumer Financial Protection Agency (CFPA) – The CFPA will write rules across bank and nonbank firms, supervise and examine institutions for compliance, enforce such compliance and write rules that “serve as a floor, not a ceiling with respect to state laws.” The CFPA will be guided by “transparency, simplicity, fairness, accountability and access.”

8) Tools to effectively manage financial crisis – The Administration’s plan establishes a resolution authority for ht largest and most interconnected firms to help ensure that the federal government does not have to choose between bailouts (AIG) and financial collapse (Lehman Brothers). The proposal:  

  • Reduces the likelihood and impact of failures – Tier 1 FHCs will be subject to more stringent capital, activities, and liquidity standards, a prompt corrective action regime;
  • Plans in advance for orderly resolution – Each Tier 1 FHC will be required to prepare and continuously update a credible plan for its rapid resolution in the event of severe financial distress; and
  • Provides the government with emergency authority to resolve any large, interconnected firm in an orderly manner – The resolution would supplement and be modeled on the existing resolution regime for insured depository institutions under the FDI Act. Treasury can invoke the resolution after consulting with the President and upon the written recommendation of two-thirds of the members of the Federal Reserve Board, and the FDIC or SEC as appropriate.

9) Creation of the Office of National Insurance within Treasury – This Office will gather information, develop expertise, negotiate international agreements, and coordinate policy in the insurance sector.

10) International Cooperation – Foreign firms whose US operations pose risks to the US financial system will be subject to the same robust prudential regulation and oversight as US firms. In addition the proposal calls for:  

  • Strengthening the international capital framework – The proposal calls on the Base Committee on Banking Supervision to develop a simple, non-risk based capital measure to limit the amount of leverage built up in the international financial system, along with an in-depth review of the Basel II framework and improvements to Basel II by requiring more capital to offset riskier assets; and
  • Improving Oversight of Global Financial Markets – Standardization and improved oversight of credit derivatives and other OTC derivative markets – in line with G-20 commitments.

Some of the longer-term consequences of the proposal, if enacted, could be significant. For example, the proposal calls for the “harmonization” of the statutory regimes of the SEC and the CFTC. Differences between the two regimes customarily are is cited as a principal reason not to merge the two agencies; with harmonization, a merger may be more likely. Additionally, the proposal creates a National Office of Insurance, which does not have direct regulatory authority over insurance companies, but it may presage a federal insurance charter.

The proposal also is notable for its limitations in various respects. There is a net gain in federal regulatory agencies: the Office of Thrift Supervision would be eliminated, while a new consumer product agency and a new insurance office would be created. Additionally, there is no attempt to re-structure the entire federal regulatory structure: depositories still would have a choice of three different regulators.