Global Financial Market Watch : Global Financial Lawyer & Attorney : K&L Gates Law Firm : Government Enforcement, Investment Management

• Email This
• Print
• Comments
• Trackbacks

By: Daniel F. C. Crowley and Karishma Shah Page

As Congress increasingly focuses its attention on the Obama Financial Regulatory Reform (FRR) plan, the biggest change of late has to do with timing. For months, most observers have expected the House Financial Services Committee to consider the Obama proposals piecemeal, with Senate consideration following House approval. Now it is clear that the House and Senate are moving forward simultaneously, but on divergent paths. House Financial Services Committee Chairman Barney Frank (D-MA) is championing and improving the Administration proposals, and plans to move legislation to the House Floor this fall in five basic pieces (Consumer Financial Protection Agency, OTC derivatives, systemic risk, National Banking Supervisor, investor protection). These pieces reflect the groupings of the various proposals as introduced by the Administration (e.g., “systemic risk” includes the Financial Services Oversight Council, Tier 1 Financial Holding Companies, and securitization). Senate Banking Committee Chairman Chris Dodd (D-CT) has his own ideas in key areas, many of which go further than the Obama plan. Chairman Dodd currently plans to bring a single, omnibus reform bill to the Senate Floor. Short updates on the major FRR provisions follow:

1. The Financial Services Oversight Council (FSOC) - The FSOC is one of the simplest aspects of the FRR and therefore almost certain to occur. It is basically the successor to the current President’s Working Group on Capital Markets, with a dedicated staff at the Treasury Department and the addition of the heads of the FDIC, and the new Consumer Financial Protection Agency and the National Bank Supervisor. A key question is what role the FSOC will play with respect to systemic risk. If Chairman Dodd has his way, it will assume some of the functions contemplated for the Federal Reserve in the Obama/Frank plan.
2. Tier 1 Financial Holding Companies (FHCs) - As expected, serious questions have been raised about the Fed’s capacity to provide consolidated supervision of large, integrated financial institutions. There is a growing political backlash to what some view as overreaching to position the Federal Reserve as the primary systemic risk regulator. The fact that large non-depository institutions could be regulated as Tier 1 FHCs is reminding many on the Hill that they really do not trust the Federal Reserve, and that the role of a central bank may be somewhat inconsistent with such a prominent regulatory function.
3. National Bank Supervisor - As many expected, the Administration’s effort to squeeze all federally chartered financial institutions into the bank model is falling short. The thrift charter appears likely to be preserved, industrial loan companies (ILCs) grandfathered, and credit card lenders will not be deemed banks. Given the failure to close the other Bank Holding Company Act “non-bank loopholes,” many also see no reason to abolish the exception for non-depository trust companies. Nonetheless, Chairman Dodd has said the Administration proposal does not go far enough and would like to see further consolidation among the banking regulators. Chairman Frank favors preserving the dual state and federal banking systems. The outcome is uncertain.
4. Securitization - This remains a four-letter word for the time being. It is currently disfavored and, certainly, the days of passing along 100% of the default risk to investors are over. In short, keeping originators’ “skin in the game” remains a primary objective of Chairman Frank and other key policy makers.
5. The Consumer Financial Protection Agency (CFPA) - In the interest of co-opting business interests, Congressional Oversight Panel Chairwoman Elizabeth Warren, who first proposed the CFPA, has been thrown under the proverbial bus. Chairman Frank recently circulated an updated CFPA bill. In its current form, the bill exempts non-financial companies and jettisons requirements for “plain vanilla” products. As such, Chairman Frank has made it much harder for even some Republicans to oppose the CFPA. Indeed, banks may even conclude that subjecting their competitors (e.g., non-depository mortgage originators, payday lenders, etc.) to the same regulatory burdens they have faced for years might be worthwhile after all. 
6. Private Fund Investment Advisor Registration Act - As currently drafted, the Obama plan would require the registration and regulation of virtually all private fund managers, including hedge funds, private equity funds, sovereign wealth funds, and even family investment pools. Much of the alternative fund industry seems to have embraced “reform” in hopes of being favorably positioned in the rulemaking process. Alas, such a strategy failed convincingly in the context of Sarbanes-Oxley.
7. Resolution authority - There has been much discussion about how to unwind systemically significant failing institutions. Chairman Frank has referred to such powers as a “death sentence.” The FDIC resolution powers regarding banks will be expanded, probably extended to Treasury, and the SEC will be given similar responsibility with regard to the regulated entities within its purview. As an aside, requiring Treasury to sign off on Federal Reserve uses of authority under FRA section 13(3) is (discount) window dressing, since Treasury is de facto fulfilling that role now.
8. OTC derivatives - In the wake of AIG and its credit default swaps, there is a clear consensus around centralized clearing of all derivatives, and a majority preference for exchange trading of standardized contracts. On August 11, the Administration introduced its OTC derivatives proposal as the “final piece” of its legislative proposals. However, there are a number of competing proposals, including S. 1691, which was recently introduced by Senate Securities Subcommittee Chairman Jack Reed (D-RI). All of these proposals would provide strong regulation of all major participants in the OTC derivative markets, and would create new anti-fraud and market manipulation enforcement powers.
9. Credit rating agencies - House Financial Services Capital Markets Subcommittee Chairman Paul Kanjorski (D-PA) recently circulated a discussion draft that builds on the Obama proposal to have the SEC comprehensively regulate Nationally Recognized Statistical Ratings Organizations (NRSROs), and would impose information sharing requirements, as well as “collective liability” on the entire industry for a monetary judgment against any NRSRO relating to a credit rating. It is difficult to imagine that this provision will survive, but it clearly reflects a great deal of consternation about the industry (see pp. 30-31).
10. Executive compensation - Shareholder say-on-pay proxy votes and compensation committee independence are soon to become part of the ever-expanding corporate governance montage.
11. Insurance - While the insurance industry appears to have escaped the CFPA, there will be a new Office of National Insurance at Treasury that will aggregate state insurance data. Together with the FSOC, and Tier 1 FHC supervision by the Fed, the insurance industry may end up wishing it had reached consensus on a federal charter. Stay tuned for more in the next Congress.

Finally, with both the House and Senate moving forward quickly, the timetable for successfully advocating changes in much of the legislation will likely be truncated. Ultimately, the differences between the House and Senate versions will be reconciled in conference committee, a process largely shielded from public scrutiny (or influence). Please see the K&L Gates alert Eye of the Storm: A Summer Recess Assessment of the Capital Markets Reform Effort for a comprehensive overview of the Obama plan. In addition, detailed analysis on many of the Obama proposals may be found on http://www.globalfinancialmarketwatch.com/.