One more thing before I go

As most followers of the US political system know, long time Democratic Senator Chris Dodd is soon retiring.  A major legacy for the financial industry will be the passage of a large number of financial reforms that we have been covering in this blog since President Obama was elected.

Leading US law firm, K&L Gates, has posted a very good summary of the current status of the Dodd Bill, the House Bill that was similar and the conference proceedings which begin any day now.

In short the Obama Financial Reforms should be signed into law by early July.

The reforms will bring a lot of change in areas like bank regulation, OTC derivatives, US registration of hedge funds and other private pools of capital, credit agencies and the sale of financial products to consumers.  Each change is actually quite significant and as a group they certainly are the biggest changes to US financial services since the 1930's.

With such considerable change and new rules across multiple types of business models it is all going to take a while to digest.  Indeed as K&L Gates point out, you should expect further legislative amendments and clarifications to as the provisions begin to be tried in real life.

A few wags referred to the Sarbanes Oxley legislation as the Accounting and Audit Remuneration Act and the Dodd Bill is certainly the Legal and Compliance Providers Remuneration Act of 2010.

We expect to see a decent volume of work in 2011 arising from the requirement for overseas managers of hedge funds to be registered with the US SEC and to remain compliant with it rules and directives. 

We also expect broad international acceptance of many of the US banking, OTC, consumer protection and credit reference agency changes to result in corresponding changes at the local level in the major Asian jurisdictions of Japan, Australia, Hong Kong and Singapore.  Hong Kong recently announced it is issuing new guideance for credit reference agencies and it has been quite active over the last 12 months in the area of rule changes for firms selling financial products to the public.  Singapore has of course made similar progess in the area of the sale of financial products and it is expected to soon require all previously exempt asset managers to be licensed by the MAS.

The costs of new provisions across multiple jurisdictions will be high.  This against a backdrop of sub-optimal economic growth in the US and Europe and challenging markets for asset managers and intermediaries in the Asian region.  It is fair to say that this is likely to mean that the industry will be smaller overall.  The larger players will find a way to meet the new requirements - even if it means splitting off parts of their business - while the ones who have been marginal to this point simply won't have the capital to go on.  Mr Dodd may not be the only one retiring soon.

House Passes Financial Reform

By Lisa Valentine

It’s official – the U.S. House of Representatives passed financial regulatory reform legislation. The bill: H.R. 4173, The Wall Street Reform and Consumer Protection Act of 2009, was passed by a vote of 223 to 202. Not overwhelming, not by a long shot.

In the news release describing the passage, the house specifically mentions protecting Americans from “unscrupulous big banks.” It’s interesting that the house felt it necessary to qualify the type of bank that can be unscrupulous. Apparently the bill will do nothing to protect Americans from unscrupulous small or mid-sized banks.

The bill also will “hold Wall Street accountable” and “end taxpayer-funded bailouts.”

The bill now moves on to the Senate.

Here’s an overview of the act:

• Create a Consumer Financial Protection Agency (CFPA).
• Create a Financial Stability Council of regulators who are tasked with identifying those financial firms “too big to fail” and slapping them with increased oversight, standards and regulation.
• Instill an orderly process for shutting down big firms such as “AIG or Lehman Brothers” without taxpayer bailouts. (Of course, Lehman didn’t receive a taxpayer bailout but were allowed to fail, a point overlooked in the news release.)
• Give shareholders a “say on pay” and give regulators the power to ban “inappropriate or imprudently risky compensation practices.” It also requires financial firms to disclose incentive-based compensation structures.
• Strengthen the SEC.
• Regulate OTC derivatives.
• Outlaw predatory mortgage lending. Here’s a novel idea: financial institutions should ensure that any mortgages they make have a chance in hell of being repaid.
• Require hedge funds to register with the SEC.

Mary Schapiro, Chairman of the SEC, had this to say about the passage: “I applaud the House for taking this historic step to bolster investor protections and fill gaps in our financial regulatory framework. I look forward to continuing to work with Congress on this very significant legislation.”

From Gary Gensler, Chairman of the Commodities Futures Trading Commission: “I commend the House of Representatives for passing historic, landmark legislation that, for the first time, will bring regulation to the over-the-counter derivatives marketplace. The bill comprehensively regulates swap dealers and major swap participants and lays out the framework for the use of clearinghouses and transparent trading facilities. I look forward to continuing to work with Congress on this crucial issue as the bill moves to the Senate.”

Hmmm. Do you think Schapiro and Gensler worked on their remarks together? The SEC and CFTC have agreed to work in harmony, but mimicry is going a bit too far.

It’s an amazingly comprehensive (and we don’t mean that in a necessarily positive way) piece of legislation. If passed by the Senate, it will change Wall Street. This post just gives an overview of the bill; we’ll be looking at the impact on parts of our financial system in the days ahead.



Geithner’s Solution for Too-Big-To-Fail

By Lisa Valentine

U.S. Treasury Secretary Tim Geithner called for five reforms to deal with the problem of U.S. financial firms that are “too big to fail,” creating a moral hazard where these firms benefit from knowing that the government will catch them if they fall.

The five reforms Geithner presented to the House Financial Services Committee are:

1.    Give the government the ability to resolve failing major financial institutions in an orderly manner that doesn’t rely on taxpayer bailouts. Instead, equity holders, unsecured creditors and possibly even financial institutions should bear the failure. The bankruptcy code doesn’t cut it—it’s too slow to implement and doesn’t take into account the ripple effect from the failure of a large, interconnected financial institution.

2.    Eliminate open bank assistance to failing financial institutions. The government could not put money into a failing firm unless the firm is in government receivership or being unwound, sold or liquidated.

3.    Protect taxpayers from losses. The government should be able to recoup any losses by charging a fee to large financial firms.

4.    Limit the Federal Reserve and Federal Deposit Insurance Corporation (FDIC) emergency authorities so they could step in and support a failing financial firm only to protect from systemic failure. This would mean appealing section 13(3) of the Federal Reserve Act which gives the Federal Reserve the ability to extend credit to failing non-bank firms. (Geithner said that the Fed should be able to use 13(3) during “periods of severe stress in the financial markets or U.S. economy” as long as they get permission from the Treasury and two-thirds of the members of the boards of the Federal Reserve and the FDIC.)

5.    In addition to imposing stricter capital and liquidity requirements, regulators should be able to force major financial firms to reduce their size or restrict the scope of their activities.

Number 5 is the kicker. Who are these major firms, and what constitutes a firm that is too large or is involved in too many businesses? Geithner said that the government will not prepare a blacklist of these firms, but it’s easy enough to figure out what firms he’s referring to.

Limiting the size of financial firms was mentioned almost toward the end of Geithner’s prepared testimony, which is interesting since solving the problem of moral hazard by not letting firms get too big to fail in the first place is not something that the Obama administration has focused on before.

It would be good to know who is responsible for cutting government down to size when it gets too big and gets its tentacles into all sorts of business it doesn’t belong it.
 

More Pay Cuts

By Lisa Valentine

Bank of America’s chief Ken Lewis, who we recently reported will receive no pay and no bonus, isn’t the only executive to get a pay cut. The U.S. Treasury’s Special Master on Compensation Kenneth Feinberg has announced that he will have the last word on the amount of compensation collected by the five most senior executives and the next 20 most highly compensated employees in seven firms receiving “exceptional” TARP assistance.

Those firms are AIG, Citigroup, Bank of America, Chrysler, GM, GMAC and Chrysler Financial.

Noticeably missing from the list are Fannie Mae and Freddie Mac—the government lending agencies slated to receive $290 billion in federal subsidies in 2009, according to The Pew Charitable Trusts. Do you think it’s any coincidence that President Obama nominated Fannie Mae Chief Executive Officer Herb Allison to run the Treasury office overseeing the $700 billion bank rescue?

Here are a few of the highlights of the Special Master’s decree:

• No cash bonuses based on short-term performance.
• Bonuses should be in the form of company stock that must be held for the long-term, sold only in one-third installments beginning in 2011 (or earlier if the firm repays TARP). Stock is immediately vested to ensure that execs have skin in the game.
• Limit salaries to $500,000 (although Feinberg does say that “exceptions where necessary to retain talent and protect taxpayer interests” will be allowed. He’s allowed a salary greater than $1 million for the new AIG CEO ad two employees of Chrysler Financial).
• Executives must meet goals set in consultation with the Special Master.
• Incentive awards can be paid only if the executive provides three years of service to the firm after the award is made.
• Limits on “golden parachute” severance packages.

As a result of this edict, Feinberg reports that cash compensation for these execs decreased by more than 90% and the total compensation decreased by more than 50%.

Treasury Secretary Tim Geithner released the following statements to support the Special Master: “We gave [Feinberg] the difficult task of cutting excessive pay, striking a balance between compensations and risk taking, and keeping strong management teams in place to help the companies recover—all in the public interest.”

In some altered sense of realty, does Geithner really think that these actions will keep strong management teams in place?  The executives are bailing out. According to the Washington Post, 14 of the 25 highest paid Bank of America executives have already left. At AIG, only 12 of the top 25 executives remain.

Having the government determine pay is ludicrous. Let the firms (and their shareholders) set their own rules. For example, Credit Suisse recently announced that it was introducing a new bonus payout plan to link awards to the bank’s profitability. That makes much more sense that letting pay be dictated by a Special Master.

In the Scheme of Things, Pay is Not That Big an Issue

By Lisa Valentine

How important is the issue of banker compensation to keeping the financial markets from another disaster? It’s important, but it’s simply not that important – at least it’s not as important as the G-20 sets it out to be.

I’ve never heard anyone blame excessive compensation—no matter how outrageous or ridiculous—as the cause of the financial crisis. Guidelines for compensation should exist, but they should exist as one small part of overall financial reform. The media and politicians understandably glom onto the issue of compensation because it’s more tangible then, say, credit default swaps. It also elicits much more indignation—how could that banker or trader or executive be worth that much. 

But, the issue of compensation takes focus away from more pressing matters such as whether capital requirements should be raised and ensuring that the credit ratings agencies do a better job.

 

Treasury Outlines “Core Principles” of Capital

All capital isn’t created equal. That’s one of the lessons learned from the financial meltdown. A bank may say it has enough capital to meet regulatory requirements, but if that capital is based on risk underlying assets, then clearly the bank is not as stable as it appears. The U.S. Treasury recently released its “Principles for Reforming the U.S. and International Regulatory Capital Framework for Banking Firms.” The Treasury has set a deadline of December 31, 2009 for issuing its domestic report on acceptable levels of capital requirement. The agency is looking to win international agreement on these capital requirement standards by December 31, 2010, with implementation set for December 31, 2012.

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SEC Commissioner Questions Approach

“Even during times of severe hardship, it remains possible for regulation to go to far,” SEC Commissioner Troy Paredes said in a speech to the Corporate Directors Forum on July 13. (Before beginning his remarks, he did note that his views are not necessarily the views of his fellow SEC commissioners. No doubt.) Finally, we have heard from a government regulatory official voicing concern that the regulations being bandied about that would lead to an expanded role for the Federal Reserve and increased registration requirements for financial instruments normally under the government radar may be too, shall we say, enthusiastic.

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Shopping for the Weakest Link

U.S. Senator Mark Warner has it right when he wrote in a op-ed piece in the Financial Times that the U.S. needs a single bank regulator rather than a hodge-podge of regulatory agencies that will continue to allow banks to shop for the regulator of least resistance. Because of overlap in the regulatory system, banks can basically select which regulatory agency will perform their audits. Naturally, banks will try to work with agencies that are less likely to flex their regulatory muscles, allowing the banks to slide through an audit. By the way, anecdotally, the larger financial institutions are most guilty of using their size to sway which regulatory body they work with. Community banks in the U.S. are less likely to put up a fuss. Again, that’s anecdotal information, but it makes sense.

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Harmony Talks Kick Off

When describing music, harmony is the use of simultaneous pitches or chords to make a pleasing sound. When describing financial industry regulations, harmony will be the ability for two separate and distinct government agencies to “harmonize financial regulations to protect the American public,” according to Gary Gensler, Chairman of the Commodity Futures Trading Commission (CFTC) in the opening remarks of the Joint Meeting on Harmonization of Regulation. It’s a historic meeting in that this is the first time that the CFTC and the Securities and Exchange Commission have met jointly in this manner. (The SEC regulates securities markets and the CFTC regulates the derivatives markets.) The September 2 meeting was held at the CFTC; the host of tomorrow’s meeting is the SEC.

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Say on Pay Continues Momentum

Should luxury brands such as Louis Vuitton and Gucci be concerned that their financial services clientele may no longer be able to afford their goods? They should be if Mary Schapiro, Chairman of the Securities Exchange Commission, has any say in the matter. On August 31, Schapiro sent a letter to chief executive officers at broker-dealers reminding them that “substantial inducements” to lure superstar registered representatives to their firms may get these execs in hot water with the federal regulators. In the open letter, Schapiro expressed dismay that broker-dealer firms are once again offering large up-front bonuses and enhanced commissions to encourage their registered reps to sell, sell, sell financial products. Schapiro goes on to say that CEOs of there firms have “significant supervisory responsibilities…under federal securities laws” to guard against sales that are not in the best interest of the investor.

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Seeking Harmony

By Lisa Valentine

Even before the Labor Day holiday on September 7, which signifies the de facto end of summer for the U.S., the Securities and Exchange Commission and the Commodity Futures Trading Commission have scheduled meetings for September 2 and September 3 to discuss how the agencies should work together and to “build on the progress the CFTC and SEC have made on designing a framework to regulate OTC derivatives,” said SEC Chairman Mary Schapiro in a statement.

Gary Gensler, CFTC Chairman, said the meetings will help the agencies “harmonize regulatory policies to improve market integrity by applying consistent standards to market participants.” Gensler listed three areas of concern: how to bridge the gaps between the authorities granted to the SEC and CFTC; how to lessen regulatory overlap; and to bring consistency to similar products, practices, and markets.

Harmony won’t be easy to achieve as two agencies seek to overcome years of independence but harmony is a goal well worth pursuing and is critical to the government’s effectiveness in protecting investors.

Summertime Blues

By Lisa Valentine

August is typically a slow time of the year for big news on the regulatory and compliance front as legislators, lobbyists, and everyone else takes vacation time. Expect lots of activity in September as the Obama administration strives to deliver financial reform by the end of the year.

In the meantime, the administration is taking some time to pat itself on the back for its work so far. Hopefully everyone will return from their summer repose with clear heads and a bit less urgency. Of course, clear-headed thinking is always welcomed and although a sense of urgency was required during the most tumultuous and downright scary times of the past 12 months, its now time for legislators and the like to more calmly assess the current environment and suggest changes that are more than a knee-jerk reaction to events.

The danger, of course, is that the current more upbeat economic news and the stock market rally will lull both elected officials as well as the general citizenry into a sense that we can go back to business as usual. Let’s keep our fingers crossed that the U.S. government will act swiftly yet prudently and that the focus will remain on the economy and won’t be wholly diverted to our other crisis and Obama priority—healthcare.

When asked what is most important, money or health, most individuals would select health. Rightfully so, but let’s not lose the focus on the economy.

US Treasury delivers details to congress on OTC regulations

The following announcement came from the US Treasury regarding the proposed OTC regulations: Acting on its commitment to restoring stability in our financial system, the Administration delivered legislative language to Capitol Hill today focusing on the regulatory reform of over-the-counter (OTC) derivatives. One of the most significant changes in the world of finance in recent decades has been the explosive growth and rapid innovation in the markets for credit default swaps (CDS) and other OTC derivatives. These markets have largely gone unregulated since their inception. Enormous risks built up in these markets – substantially out of the view or control of regulators – and these risks contributed to the collapse of major financial firms in the past year and severe stress throughout the financial system.

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Regulatory Reform Marches On

Three proposals announced as part of the Obama administration’s sweeping financial reform are making their way to Capitol Hill: systemic risk legislation, national bank supervisor and resolution authority legislation, and credit rating agency reform legislation. The contents of the legislation have been expected, as they were part of the President’s Financial Stability plan. This post will focus on the systemic risk legislation; following posts will focus on the other pending regulatory actions.

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Six-Month Report Card

It’s difficult to keep up with the proposed regulatory changes the Obama administration is recommending. Since taking office in January, President Obama has been busy selling his plan for financial reform. Timothy Geithner, U.S. Treasury Secretary, provided an overview of those changes to the House Financial Services Committee, just in case they’ve forgotten. Here are the five areas of focus for the administration, according to Geithner:

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Hedge Funds Latest Regulatory Victim

The Obama administration has delivered its expected proposal that all independent advisers to hedge funds and other pools of private capital such as venture capital and private equity funds register with the SEC. The administration has set a threshold of $30 million of assets under management – chump change, really – for registration.

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SEC Speech - Note comment on dark pools

Address before the New York Financial Writers’ Association Annual Awards Dinner Speech by SEC Chairman: Mary L. Schapiro, June 18, 2009 Ms Schapiro first commented on Obama’s financial reform. She thinks it is sweeping, because it seeks to create
a systemic risk regulator to help reduce the likelihood of a systemic shock;
an oversight council so that all aspects of financial markets regulation can be taken into account;
and a financial consumer protection agency that will properly look after the interests of those who purchase credit products.

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Lack of detail relating to private pools of capital

The US financial reform white paper released by the US Treasury had a section on private pools of capital. The headlines read: All advisers to hedge funds (and other private pools of capital, including private equity funds and venture capital funds) whose assets under management exceed some modest threshold should be required to register with the SEC under the Investment Advisers Act. The advisers should be required to report information on the funds they manage that is sufficient to assess whether any fund poses a threat to financial stability. But what about the detail?

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