Global village

By announcing proposals for a significant package of reform to improve the framework and policies of US financial services regulation, the Obama administration hopes that a new risk regulator and a series of detailed changes to existing regulation will do a much better job of predicting, detecting, and minimising the effects of another financial crisis.

The defining feature of the current system of financial services regulation in the US is the number of separate agencies participating in the regulatory process. Unlike the reforms made in the UK in 2001 to create the FSA, the US still has an alphabet soup of different agencies responsible for different products and sectors within financial services. The reform plan is ambitious in that it proposes to create new regulators and to disband some others.

The proposals do not go so far as to create a single overarching regulator for the financial sector. Some commentators have suggested that is a missed opportunity. However, given that the single regulator model of the FSA was no more successful than the US regulators at detecting and avoiding the financial crisis in the UK, the emphasis of the reform plan on rule changes as well as structure may prove to be wise.

Whatever the eventual success of the plan, large financial services companies across the world are likely to see an increase in reporting requirements to US regulators. Similarly, the new US regulators are likely to liaise more than ever with the FSA and other major European regulators in an effort to ensure a global approach to regulation and enforcement.

Recommendations

The 85-page reform plan is organised into five key objectives under which are set out a series of detailed recommendations which the Obama administration hopes will become law by the end of the year. The detail of these recommendations is impressive. Some of the highlights of the proposals are summarised below.

Promote robust supervision and regulation of financial firms: The plan proposes the creation of a systemic risk regulator in the form of the Financial Services Oversight Council. The Council will comprise the Secretary of the Treasury and the leaders of the other main financial services regulators. A National Bank Supervisor will also be introduced.

Certain large financial institutions which could pose a threat to financial stability will be identified as Tier 1 Financial Holding Companies. Legislation will propose stricter prudential standards for these firms, including stricter capital adequacy requirements. Supervision of Tier 1 FHCs will extend to parent companies and all subsidiaries, both US and foreign.

Significantly, the reform plan proposes that hedge funds will be subject to registration requirements and regulated by the SEC. In the EU there has been calls for the regulation of hedge funds but as yet little progress.

Establish comprehensive regulation of financial markets: Credit default swaps and similar derivatives will be more closely regulated. Excessive securitisation of debt will be limited so that the originator must retain an economic interest in a material portion of the credit risk.