In a speech at the International Centre for Financial Regulation summit in London today, Tafara acknowledged that trying to get different jurisdictions to implement identical frameworks was practically impossible, but hoped the G-20 would agree on key issues.
“What I’m hoping will come out of the G-20 is an understanding on the broad parameters of areas where regulators and governments need to take action,” said Tafara.
He described the current financial crisis as a “once in a century event” in terms of cost, which had uncovered “fertile ground for additional crises”. Tafara warned governments and regulators needed to look past the roots of the current crisis to issues arising from the development of markets over the latter part of the twentieth century.
“In essence, this crisis finds its origin in the evolution of markets and financial services. Over the past 15 years, the world’s financial system has seen dramatic changes to its structure and principal characteristics. The current [downturn] might be as a result of the system failing to adapt to these fundamental changes,” observed Tafara.
He pointed to four specific areas that had presented lucrative opportunities for financial institutions but that also posed significant regulatory challenges: globalisation and the mobility of capital; increasing competition among financial services providers; the convergence of historically separate financial sectors; and the development of a large, liquid and unregulated market paralleling the regulated markets.
The possibility for two institutions with vastly differing risk tolerances being counterparties to a derivatives contract, and the potential for regulatory arbitrage thanks to certain sectors having less onerous regulatory restrictions were also areas of concern.
Tafara suggested six broad reforms he believed would address the main flaws in modern financial markets. First, he said, no single entity should be too big to fail. “We want a world where we can afford to let financial entities fail if they make bad decisions. If we cannot afford to have them fail, then they should be regulated so as to prevent them posing systemic risk,” asserted Tafara.
Second, to discourage excessive risk taking, remuneration should be reviewed, disclosure should be enhanced, and the regulatory framework should be extended to incorporate relevant institutions. Additionally, clearing houses and exchanges should be adopted to combat counterparty risk.
Where applicable, regulation should be consolidated to prevent regulatory arbitrage. “Many products, actors and markets have the same underlying economic characteristics or motivations, yet are regulated based on a connection to an institution that can be described as having a securities, banking or insurance function. This leads to market participants searching for the path of least regulatory resistance and pursuing regulatory arbitrage,” said Tafara.
Regulation should strike an appropriate balance between cost-efficiency and investor protection, while also being comparable to other regulatory frameworks across developed markets. Lastly, Tafara stressed the need for “ruthless” regulation that protects investors.
Above all, though, the SEC official believes channelling all efforts towards current issues could be fatal in the long run. “Systemic risk is only one of the many problems our markets face. In my view, failing to take a broad view of the crisis could risk shoring up financial institutions in the short term, only to assiduously undermine market confidence in the long term,” he concluded.