US financial regulatory structure poised for change

US Treasury releases a blueprint for its vision of an improved financial regulatory structure

WASHINGTON – Outdated and under stress, the financial regulatory system in the US is no longer fit for purpose, according to the US Treasury Department. It aims to “thoughtfully evolve to a more flexible, efficient and effective safety and soundness regulatory framework” to maintain the financial competitiveness of the US.

"We should and can have a structure that is designed for the world we live in, one that is more flexible, one that can better adapt to change, one that will allow us to more effectively deal with inevitable market disruptions and one that will better protect investors and consumers," said Secretary Paulson in remarks to the Treasury Department. "The challenge is to evolve to a more flexible, efficient and effective regulatory framework – and that is the purpose of this Blueprint."

In the 'Blueprint for a Modernized Financial Regulatory Structure' released yesterday the Treasury suggests a number of improvements, from the short term to the longer term, which would involve a complete overall of the regulatory system.

Short-term recommendations include improvements to regulatory co-ordination and oversight that regulators can make quickly, such as creating a new federal commission for mortgage origination to protect consumers better, and modernizing the President's Working Group on Financial Markets and clarifying the Federal Reserve's liquidity provisioning. Intermediate-term recommendations focus on eliminating some of the duplication in the existing regulatory system, and offer ways to modernize the regulatory structure for certain financial services sectors, within the current framework, such as eliminating the thrift charter, creating an optional federal charter for insurance and unifying oversight for futures and securities.

The most far-reaching recommendations include the creation of an entirely new regulatory structure using an objectives-based approach for optimal regulation. The structure will consist of a market stability regulator, a prudential regulator and a business conduct regulator with a focus on consumer protection.

The Federal Reserve would take the role of market stability regulator, and would have the responsibility and authority to gather appropriate information, disclose information, collaborate with the other regulators on rule writing, and take corrective actions when necessary to ensure overall financial market stability. To fulfil its responsibilities to gather information, the Fed would have authority to join in examinations with the prudential and business conduct regulators. This new role will replace the Fed’s more limited, traditional role as the supervisor of financial holding companies, bank holding companies and certain state-chartered banks. The Fed would have the ability to monitor risks across the financial system.

The Prudential Regulator would be similar in form to the Office of the Comptroller of the Currency (OCC), which would focus on safety and soundness of firms with federal guarantees but with appropriate authority to deal with affiliate relationship issues. Prudential regulation in this context would be applied to individual firms, and it would operate like the current regulation of insured depository institutions, with capital adequacy requirements, investment limits, activity limits, and direct on-site risk management supervision. The prudential regulator would also oversee firms with explicit government guarantees.

Similar to the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), a new business conduct regulator would monitor business conduct regulation across all types of financial firms. Business conduct regulation would include key aspects of consumer protection such as rule-writing for disclosures, business practices and chartering/licensing of certain types of financial firms. It would subsume most roles of the SEC/CFTC and have authority over rules such as mortgage disclosure. It is hoped this framework will eliminate gaps in oversight and provide effective consumer and investor protection.

NYSE Euronext was the first to issue a statement supporting such a significant change: "NYSE Euronext believes the recommendations put forth by US Treasury Secretary Hank Paulson are timely, thoughtful and have great merit,” said Duncan Niederauer, chief executive officer, NYSE Euronext. “Financial markets in America and globally have experienced significant change and challenge in recent years. As our market-place evolves, so too must our regulatory framework. Initiatives that protect investors, foster balanced oversight and ensure market integrity are welcome. We look forward to working with secretary Paulson, Congress and the SEC toward achieving their goals.”