21 Nov 2008, David Benyon, Operational Risk & Regulation
SIMI VALLEY, CA - US Treasury secretary Henry Paulson has spoken about the requirement for US regulatory and global reforms, at the annual Reagan Lecture at the Ronald Reagan Presidential Library.
Paulson referred to the enduring appropriateness of the US Treasury's Blueprint for a Modernized Financial Regulatory Structure published in March 2008 and drafted before the present crisis emerged. Paulson stressed that regulatory reform must be built on principles of transparency and accountability and should be based on an entirely new regulatory structure.
"In our model, a market stability regulator would have authority to review any systemically important financial company, and to look for problems anywhere in the financial system in order to protect against systemic risk," said Paulson. "Our continuing challenge has been what to do about non-depository institutions that may be too big or too interconnected to fail. We need a mechanism, essentially an amendment of the federal bankruptcy system, for the orderly wind-down of such institutions. Also, to ensure the market stability regulator can fulfil its role, large, systemically important institutions, including hedge funds, should be required to have a charter that would permit some type of oversight."
Responding to persistent calls for regulation of the opaque over-the-counter derivatives industry, Paulson referred to the President's Working Group's efforts to strengthen trade processing and moves towards centralised clearing. Paulson said that although not yet a complete solution, these moves should enhance transparency and promote standardisation.
Paulson also touched on the need for regulators to react intelligently to market events to lessen trends of pro-cyclicality that have exacerbated the current crisis.
"We must address those aspects of our system that reinforce rather than counterbalance cycles; regulators and ratings agencies often take actions after a problem emerges that exacerbates the cycle," he said. "For example, mark-to-market accounting is clearly pro-cyclical. Yet I know of no better accounting method, and welcome the steps to review and modify its implementation during severe market stress."
There was also a cautionary note to industry that regulators should be looking at remuneration packages as a factor in the crisis and that in the new regulatory environment no firm should automatically consider itself too big to fail.
Paulson said: "Under a new framework, which includes market infrastructure, transparency and wind-down authorities, we could achieve again the proper balance between market discipline and regulatory oversight, and no institution should be deemed to be too interconnected or too big to fail."
International collaboration through the International Monetary Fund (IMF), G-20 and the G-7 nations' Financial Stability Forum (FSF) was highlighted as being of particular importance. Weaknesses in existing international regulatory structures, especially "outdated governance structures and policies" and the exclusion of emerging economies from these bodies are an area for improvement, he said.
"The FSF needs to broaden its membership to include key emerging market economies," said Paulson. "The IMF and World Bank need to accord dynamic emerging market economies greater representation and participation in their daily operations. In addition, the IMF, the World Bank, as well as the regional development banks should consider how to reform their executive boards to make them more accountable, streamlined and effective.
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