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Volcker Suggests Financial Regulatory Shakeup

The Volcker Alliance, an organization launched in 2013 by former Fed Chair Paul Volcker, released a report last week calling for an overhaul of the United States financial regulatory system which it finds “highly fragmented, outdated, and ineffective.” Part of the issue, according to the paper, is that the system was developed piecemeal, “primarily in response to financial panics and periods of economic instability.”

While the financial system has undergone “significant transformation in the past few decades,” the foundation of the regulatory system was laid in the 1930s, the report notes. The recent financial crisis exposed the system’s weaknesses of overlapping and conflicting jurisdiction, the ability for institutions to perform regulatory arbitrage, and a lack of systemic understanding by any one regulator. The paper warns that “failure to reorganize the regulatory structure will contribute to the buildup of systemic risk and make us more vulnerable to the next financial crisis.”

The report suggests that “[t]he securities and derivatives markets are highly intertwined” and that having separate oversight “deprives regulators of a comprehensive understanding,” causes “asymmetrical regulatory treatment,” and reduces the effectiveness of the regulators. As a result, the report suggests that the SEC and CFTC should be combined to create an “independent investor protection and capital market conduct regulator.” The new agency would be governed by a five-member board, appointed by the president and confirmed by the Senate, without regard to political affiliation. The combined agency would cover “matters of investor protection, the structure of securities and derivatives markets, and the integrity of those markets.” Funding would be limited to fees and assessments, excluding fines and penalties.

Other current functions of the SEC and CFTC (and those of other agencies such as the Office of the Comptroller of the Currency, which would be eliminated) would transfer to a new Prudential Supervisory Authority (“PSA”). The report specifically cites supervision as an area in which the SEC and CFTC have “lacked experience, expertise, and sufficient resources.” The PSA thus would assume the “prudential supervisory functions” currently under the authority of the SEC and CFTC relating to “broker-dealers, swap dealers, [derivatives clearing organizations], clearing members, futures commission merchants (FCMs), and money market funds.” The PSA would also have prudential supervisory functions over “bank and thrift holding companies, state and federally chartered depository institutions, branches of foreign banking organizations, financial market utilities, and SIFIs.” The new agency would be headed by the vice chairman for supervision of the Federal Reserve and would be governed by a board that includes the chair of the FDIC, the head of the newly combined SEC-CFTC, and two presidential appointees.

The Fed would have “backup” examination authority which would allow it to examine any institution supervised by the PSA. It also would be responsible for prudential rulemaking for entities subject to PSA oversight and “establishing prudential standards, including setting capital, liquidity, and margin requirements.”

The report suggests that the FSOC should establish a Systemic Issues Committee (“SIC”), tasked with designating systemically important institutions and imposing “new or enhanced prudential standards and safeguards on all activities and practices that could pose a threat to systemic stability even if conducted outside the present sphere of prudential supervision.” However, the Federal Reserve would be responsible for promulgating new rules based on the SIC’s standards and safeguards, and the PSA would be responsible for enforcement. The report also proposes that the SIC would be able to require changes to the rules of constituent organizations “to the extent necessary to help maintain financial stability,” noting that “[t]he history of the MMF reform provides insight into the limitations” of the FSOC’s current power to only recommend changes.

SIC membership would include the chairs of the Fed, the FDIC, and the combined SEC-CFTC, a state insurance commissioner, and directors of the Federal Housing Finance Agency, the CFPB, and the OFR (which would become an independent agency). While the SIC membership would draw from the pool of voting and non-voting members currently serving on the FSOC, the SIC would be a subset of those members. For example, while the report recommends that the Secretary of the Treasury should still chair the FSOC, it suggests that the Secretary should be a non-voting member of the SIC. This would reduce the “appearance of Treasury’s encroachment on matters of regulatory policy, supervision, or enforcement” and help remove political influence from the SIFI designation process, while still keeping Treasury involved and informed in the process.