Publications

---

President Barack Obama has announced the basic terms of his Administration’s proposals to dramatically revise the regulation of financial services firms in the United States.

These concepts, set forth in a speech delivered at the White House on June 17, are more fully elaborated in the White Paper made available that same day by the Treasury Department.

Although the White Paper does not contain precise statutory language and lacks clear details on many elements of the regulatory changes it recommends, it does contain the broad outlines of these important proposals, and it raises numerous questions that will need to be studied and resolved.

Next, the Administration will propose specific statutory language, which as ever will be modified as the proposals move through the legislative process. We will continue to monitor developments in this area and to prepare additional analytical updates as further circumstances warrant. As a starting point, we have prepared a brief review of the key proposals set forth in the White Paper and the principal concerns it raises.

To read the White Paper, click here. The same site also provides access to fact sheets and other summaries prepared by the Treasury Department relating to this proposal.

The key elements of the proposals set forth in the White Paper, and the principal concerns it engenders, may be organized around the following five categories:

1. Promoting Robust Supervision

The main topics considered in this portion of the White Paper include:

• The creation of a Financial Services Oversight Council to facilitate information sharing and coordination, identify emerging risks and advise the Board of Governors of the Federal Reserve System on the identification of firms, each to be known as a Tier 1 Financial Holding Company or Tier 1 FHC, whose failure could pose a threat to overall financial stability. Of great significance is the fact that the determination of a Tier 1 FHC status would not be limited to a bank or bank holding company (BHC), as is presently the regulatory practice and jurisdiction of the Federal Reserve. Tier 1 FHC status would be broadly defined to permit the Federal Reserve to supervise and monitor the operations of all banking and thrift institutions as well as insurance companies, investment banks and other entities whose failure would pose a risk to the overall financial system.
  
  Members of the Financial Services Oversight Council would include the Secretary of the Treasury, the chair of the Federal Reserve, the director of a newly established agency called the National Bank Supervisor, the director of a newly established Consumer Financial Protection Agency, as well as the chairs of the Securities and Exchange Commission, the Commodities Futures Trading Commission, the Federal Housing Finance Agency and the Federal Deposit Insurance Corporation.

• The National Bank Supervisor would be established by merging two existing federal banking agencies, the Office of the Comptroller of the Currency and the Office of Thrift Supervision. The Supervisor would conduct prudential examinations of all federally chartered depository institutions and all federal branches and agencies of foreign banks. The thrift charter would be eliminated, and bank holding company status would be proposed for any firm owning a thrift, an industrial loan company (ILC), a credit card bank or other non-traditional banks.

• Hedge funds and other private pools of capital would be required to register and to report information on the funds in question. Consolidated supervision by the SEC would be eliminated. The regulatory framework for money market mutual funds would be enhanced to reduce the risks of runs by investors.

• An Office of National Insurance would be established within the Treasury Department. Although not having regulatory jurisdiction over existing insurance firms, the office would gather information and coordinate the development of policy in this area.

• Standards and guidelines on executive compensation would be issued by federal regulators to prevent undue risk-taking by firm executives. Compensation would be subject to increased disclosure requirements, including “say on pay” legislation requiring shareholder ratification of compensation decisions, as well as increased independence requirements on the part of executive compensation committees.

• Decisions on the status of government-sponsored entities such as Fannie Mae and Freddie Mac would be made in the future.

2. Establishing Comprehensive Regulation of Financial Markets

This portion of the White Paper seeks to enhance existing regulatory institutions, by virtue of the following proposals:

• Establish comprehensive regulation of all over-the-counter derivatives, including credit default swaps, and impose mandatory retention of ownership interests (equal to 5 percent of the issue amount) by the originator of complex asset-backed securities;
• Harmonize recommendations by the SEC and the CFTC on regulation of futures and securities; and
• Strengthen oversight of systemically important payment, clearing and settlement systems, including through regulation of the activities of major participants in these systems.

3. Protecting Consumers and Investors from Financial Abuse

This section of the White Paper sets forth a number of new policy prescriptions:

• As noted above, a new Consumer Financial Protection Agency would be created, to protect consumers of credit, savings, payment services and other consumer financial products and services. This new agency would have jurisdiction over all entities covered by its implementing statutes, including insured depositaries, mortgage and other consumer finance entities, credit-card issuers and other institutions not previously subject to comprehensive federal supervision.
• The standards established by the agency would be a floor, not a ceiling, and states would retain the ability to adopt and enforce stricter laws for institutions of all types.
• The SEC would be required to provide increased protection for securities investors. Broker/dealers would be subject to the same standards of fiduciary duty as are investment advisors.
• The SEC, the Federal Trade Commission and other agencies would be mandated to address and protect the retirement security of individual investors.

4. Creation of Resolution Authority including Emergency Support Powers

This portion of the White Paper addresses problems that may emanate from such emergencies as the failure of a firm:

• The financial crisis entered the public conscience, for many, through the disorderly resolution of certain insurance and investment banking firms, including the attendant concern that such chaotic resolutions were harming the financial system and the economy. The White Paper calls for establishing a resolution regime that would avoid the disorderly resolution of failing BHCs, as well as Tier 1 FHCs, if such a resolution might have adverse economic effects. This regime would give Treasury authority over these firms, modeled on the FDIC’s resolution authorities over insured banks and thrifts, and would designate the FDIC (or the SEC, in the case of a group that is primarily a securities firm), as receiver or conservator. As noted, the range of potential entities that may be regulated as a Tier 1 FHC would be crafted to expand dramatically beyond the scope of banks and BHCs, and would include thrifts, insurance companies and investment banks as well as other broker/dealers, asset managers and firms that pose a systemic risk to the financial system.
• Legislation would be proposed to amend Section 13(3) of the Federal Reserve Act to require the prior written approval of the Secretary of the Treasury for any extensions of credit by the Federal Reserve to individuals, partnerships or corporations in those “unusual and exigent circumstances” set forth in that Section.

5. Raising International Regulatory Standards and Improving International Cooperation

A number of global initiatives are set forth in this section of the document, most notably:

• Improving oversight of global financial markets through increased Group of 20 coordination;
• Enhanced supervision of internationally active firms through increased communication among national regulators;
• Reforming and strengthening cross-border crisis prevention and management;
• Strengthening prudential regulations among member nations and extending the scope of Tier 1 FHC definitions for firms based outside the US;
• Introduction of better compensation practices mirroring US standards and designed to forestall excessive risk taking;
• Coordination and improvement of anti-money laundering, terrorist financing and tax information exchanges;
• Improving and coordinating international accounting standards, to provide consistency on loss provisioning, apply fair value accounting standards, regulate financial instruments and encourage greater financial transparency; and
• Tightening oversight of credit rating agencies, consistent with international standards.

Reactions and Next Steps

Given the breadth of the proposals contained in the White Paper, it is not surprising that some significant questions have already been articulated, both by members of Congress as well as by participants in the financial services industry. Among these:

• Would the Federal Reserve retain too much authority, even after the establishment of the Financial Services Oversight Council, in regulating virtually every financial institution doing business in the United States?
• Is it appropriate to not only eliminate the thrift charter as an alternative for federal banking organizations, but to potentially require the owners of ILCs and other non-traditional banks to divest themselves of these entities rather than face the increased capital and activity limitations of BHC status?
• Is it wise to designate a number of firms--the Tier 1 FHC entities--to be “too big too fail,” rather than requiring that they divest those portions of their business that pose systemic risks to the financial industry?
• The White Paper proposes requiring broker-dealers to abide by the fiduciary standards of investment advisers, rather than the “suitability” requirements applicable under current law. Will this force securities firms to disavow any recommendation that does not put customers first for all purposes, and which is not comprehensively reflective of an investor’s overall tax, capital as well as risk position?
• Is it efficient to eliminate the current norms of federal banking preemption and, instead, to permit state legislatures and attorneys general to regulate those products? This could saddle the marketplace with inconsistent and more onerous regulatory requirements than have been established under federal law.
• Why does a new Consumer Financial Protection Agency need to be established? Those areas of regulatory activity could be delegated to federal and state banking entities that are already in existence and already responsible for the operations of financial firms providing consumer-related services.

Representative Barney Frank (D-MA), chair of the Committee on Financial Services in the House, has indicated he will introduce legislation by July broadly containing the elements of the Treasury proposals contained in the White Paper. From there, hearings will be held and comparable legislative proposals will be produced in the Senate, where concerns relating to the Federal Reserve’s potentially increased powers remain very high.

It is expected that some form of legislation will reach both chambers of Congress in the fall.

Congress already faces a momentous fall session, in which it will act on a Supreme Court nominee as well as on health care, energy and tax initiatives. When it acts on the proposals set out in the White Paper, how close will the ultimate legislation be to the original? That remains uncertain at best.

For more information on the White Paper and the issues it engenders, please contact:

Richard Coll

Rusty Conner

Andrew Eskin

James Kaplan

Megan Kraai

David Krohn

Michael Reed