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The Securities Industry and Financial Markets Association today released the following statement from President and CEO Tim Ryan in connection with his speech to the National Economists Club:
—The Securities Industry and Financial Markets Association today released the following statement from President and CEO Tim Ryan in connection with his to the National Economists Club:235 rulemakings, 41 reports, 71 studies authored by eleven different federal agencies, bureaus and the Government Accountability Office.
That’s what, as legislated by the Dodd-Frank Act, needs to be studied and written over the next two-to-five years. And that’s just in the United States.
Parallel rulemaking is taking shape across the globe, initiated by the same financial crisis, and necessitated by the fact that we do business today in a global economy. It will be vital for global rules to be coordinated and to apply equally to the entire industry to avoid market distortions, regulatory arbitrage and competitive advantages among different jurisdictions.
Our focus—everyone’s focus—must be on how we safeguard our financial system without constraining capital formation, credit availability and our industry’s ability to contribute to economic growth and job creation.
With the breadth and depth of SIFMA’s membership—which includes global, national and regional securities firms, banks and asset managers active in financial markets around the world— we can and will be a trusted, credible resource for everyone participating in the regulatory rulemaking process.
This isn’t about simply meeting the rulemaking deadlines, it’s about getting it done right. The stakes are too high for anything less. Poorly crafted regulations that create market distortions or other unintended consequences could constrain capital formation or even increase systemic risk—the exact opposite of the intent of Dodd-Frank.
To be most effective, SIFMA is focusing primarily on seven areas:
· systemic risk, specifically the new Financial Stability Oversight Counsel and its research arm the Office of Financial Research;
· resolution authority and living wills;
· oversight of the over-the-counter derivatives market;
· securitization and the credit rating agencies;
· capital and liquidity standards via Basel and Dodd-Frank;
· the future of proprietary trading and private equity under what’s come to be known as the Volcker Rule; and
· the creation of a federal fiduciary standard for investment advisors and broker/dealers who provide personalized investment advice to retail investors.
With many firms operating in a global financial system, what happens in one jurisdiction does affect firms operating globally. In addition to the work we’ll be doing on Dodd-Frank rulemaking, we’re paying close attention to what is happening globally, focusing primarily on the west by looking at the regulatory efforts of the United Kingdom, the European Union and the Financial Stability Board.
Systemic Risk
To deal with systemic risk in the U.S., Dodd-Frank has created two new entities, the Financial Stability Oversight Council (FSOC), and its research arm, the Office of Financial Research, which will provide analytical support. FSOC will oversee bank holding companies with total consolidated assets of more than $50 billion. The FSOC can also designate non-bank financial institutions as systemically significant by a 2/3 vote of the FSOC’s 10 voting members.
In Europe, the European Commission is looking into what attributes beyond size alone make an institution financially risky, and, much like the FSOC, has established the European Systemic Risk Board, monitoring risk to the 27 EU countries and coordinating the actions of national supervisors. It is comprised of Europe’s Central Bankers, and to coordinate with among others the European Supervisory Authorities.
Resolution Authority
To address the failure of a large, interconnected financial institution the U.S. and UK has already created a new resolution authority, with Europe following. Dodd–Frank has granted the FDIC the explicit authority to unwind failing firms or covered financial companies, and large complex companies are now required to periodically submit living wills to the FDIC and the Federal Reserve.
In addition to the existing resolution authority, the UK is proposing a separate administrator for investment firms. The UK’s recently passed Financial Services Bill also requires firms to submit living wills. In addition, they are investigating the utility of contingent capital or “CoCos” and bail-ins. Questions remain as to what other countries within the EU might consider and how each of these processes will interact.
In the end, the goal is to provide for a process that will wind down failing institutions, end ‘too-big-to-fail,’ and ensure functioning financial markets.
Derivatives
For the first time, the trading of derivatives will move from a primarily over-the-counter market to one utilizing central clearing houses and exchange trading. Both the EU and the U.S. will soon have mandated central clearing of most swaps. In the U.S., beyond those swaps that are fundamentally not suitable for clearing, the only exception to the mandated clearing requirement is for trades where one party is a non-financial, hedging end-user. Otherwise, all swaps that are clearable will be cleared, and in addition required to be executed on an exchange or swap execution facility (SEF). Dodd-Frank also now makes the regulation of over-the-counter derivatives the responsibility of the Commodity Futures Trading Commission and the Securities and Exchange Commission.
In Europe, central clearing of standardized contracts also will take place through CCPs, with additional capital charges made for non-centrally cleared contracts.
SIFMA is working with ISDA and the FIA to ensure that these reforms, among others, will aid in more effectively managing the interconnectivity these products create, without making the cost of risk management prohibitive.
Securitization
When it comes to securitization, we again see very similar mandates on both sides of the Atlantic— mandatory risk retention of 5 percent. However, here in the U.S., Congress provided regulators discretion in imposing such retention and exempted any retention for securitizations of “qualified” residential mortgages, a new classification to be defined, but presumably your plain vanilla, well underwritten, 30-year home loan and allows regulators to implement retention regimes—and amounts—calibrated to different asset classes.
Dodd-Frank also states that regulators should reduce financial institutions’ reliance on credit rating agencies in regulation and supervisory practices. Bank regulators have put out for comment an initial proposal regarding this provision.
The EU has already addressed this by requiring EU market participants use only EU-registered CRA issued ratings for their regulatory purposes.
Getting these efforts right will help create more aligned interests of dealers and investors, without choking off consumer credit for businesses and families.
Capital and Liquidity Requirements
When it comes to capital and liquidity requirements for systematically important companies, Dodd-Frank and Basel III are both fairly specific.
Dodd-Frank requires these companies to maintain a debt-to-equity ratio of 15-to-1, with trust preferred and hybrid capital counting as Tier 2, not Tier 1, capital. Banks are required to hold a 30-day liquidity buffer. What we still need to formulate is a counter-cyclical means of permitting banks to build in capital buffers.
Basel III’s capital and liquidity rule sets out total capital requirements of 10.5 percent, broken out as 8.5 percent Tier 1 capital and 7 percent common equity. Liquidity requirements include a liquidity coverage ratio for 30-day systemic and idiosyncratic risk and a net stable funding ratio for 1-year idiosyncratic risk.
The leverage ratio will supplement, rather than replace, the current risk-based minimum capital ratio.
Still being explored by the committee is the utility of dynamic provisioning as a useful countercyclical measure.
Volcker Rule
Financial institutions in the United States will also have to work with the ban on proprietary trading and private equity within Dodd-Frank has come to be known as the Volcker Rule. All proprietary trading by bank holding companies is prohibited. The important aspect will be how regulators define what activities are deemed “proprietary”’ and thus prohibited, while ensuring that markets remain liquid and deep.
Also, bank holding companies are generally prohibited from investing in, advising on or owning hedge funds or private equity funds. Total investments are limited to 3 percent of tier 1 capital. Investments in a fund within the first year of its establishment are capped at 3 percent of that fund.
The UK’s Independent Banking Commission is calling for evidence on whether limits on proprietary trading and investment are warranted. But how will a U.S.-only rule such as this affect our nation’s competitiveness with Europe, who is generally not considering such a rule?
Fiduciary Duty
A strictly domestic, and far less cut and dry, piece of rulemaking is the creation of a federal fiduciary standard that would apply—uniformly—to all investment advisers and brokers providing personalized investment advice to retail investors about securities, regardless of their business model.
Making sure the standard is written in a way that preserves investor choice of the products and services that best fit individual investment needs is a little tougher. It’s writing rules about the intersection of conduct and offerings.
So, as you’ve seen, six out of the seven areas in Dodd-Frank we’re focusing on have a global, or at the least EU, equivalent.
But we’ll be involved in other areas of the Dodd-Frank rulemaking process, such as compensation, the regulation of hedge funds and short sales. And we’ll also be offering commentary on the convergence of FASB and IFRS and the resulting accounting standards that will emerge.
Reforming Housing Finance
And there are some issues that are vital to the U.S. economy and financial markets that are not in the Dodd-Frank Act. Two immediate concerns are reforming our housing finance system and the taxing capital gains and dividends.
The GSEs, government sponsored entities, primarily through Fannie Mae and Freddie Mac in mortgage finance, have made possible cost-effective lending to consumers for the past 30 years. Our members active in these markets believe some form of government support will be necessary to attract and maintain capital investment in the U.S. mortgage market anywhere near the historical level over the past several decades, but recognize there is no single, easy answer for the task of reforming them.
Additionally, recent press coverage has focused on issues within the mortgage foreclosure process and its impact on the securitization markets. Indeed, some have called for a national moratorium on all foreclosures until these issues have been addressed.
Let me be clear: imposing a system-wide foreclosure moratorium would be catastrophic to the housing market and to the economy.
The mortgage market, investors and the health of the economy are all inter-related. Investors in the housing market include American workers with pension funds, 401(k) plans, and mutual funds. These hardworking Americans would unjustly suffer losses in their savings from a foreclosure moratorium.
A foreclosure moratorium would create increased uncertainty in the already weak securitization and housing markets, further constraining consumer credit and spending and dampening our already unhealthy economic situation.
If mistakes have been made in relation to foreclosure processing, SIFMA firmly believes such mistakes should be corrected accurately and fairly.
While each situation may have variations, we believe the customary loan transfer and assignment practices used in securitization are legally sound an in accordance with generally accepted and settled legal principles. We believe sweeping generalizations regarding endemic defects are not accurate.
Foreclosures are in no one’s best interest, neither the bank nor the homeowner nor the investor, but in some cases are unavoidable. In those situations, moratoriums and similar actions will only delay the inevitable, and lengthen the timeline for housing recovery.
Capital Gains and Dividends Taxation
Investors also need certainty with respect to tax issues as nearly all of the Bush era tax cuts are set to expire at the end of this year. As to capital gains and dividends, without Congressional action—soon—the tax rates on capital gains will increase by 33 percent and the rates on dividends will increase by 164 percent—that’s right 164 percent— this coming January 1. Seniors on fixed incomes will be hit particularly hard by these increases, resulting for many in significant decreases in their discretionary spending. And higher tax rates on investment income will lead to fewer jobs, lower take-home pay and even slower economic.
January 1 is not far off, and that’s a very big change. Right now, the lack of action is already having a negative effect on investors. Investors like certainty, and they’re not getting it. Congress should provide that certainty by extending the current 15 percent tax rates in capital gains and dividends before the end of 2010.
Conclusion
The financial industry and federal regulators are faced with an unprecedented task over the next 2 to 5 years. Many of the agencies tasked with making these rules are taking on responsibilities outside their historical purview; the expertise needed to get these regulations right doesn’t necessarily reside within their walls. However, there is a robust rulemaking process that encourages comment. Again, we are committed to being a valuable resource during this rulemaking process, providing content-rich, fact-based commentary, drawing on the expertise of SIFMA’s member firms, And, when needed, we are moving beyond even that, contracting for third-party, in-depth economic analysis of the effects of proposed regulations.
We’re also concerned with how our new regulations will coordinate with similar efforts internationally. And how all of these new rules, working together, will affect capital formation, credit availability, economic growth, and ultimately the prosperity of consumers.
We’re doing all this because we must get these regulations right; the stakes are too high to do anything less. Unintended consequences of poorly crafted regulations could slow economic growth and stifle job creation; it could create capital market winners and losers.
This is not what any of us wants. We’ll be living with these regulations for decades. Let’s look back at the next two to five years as the time when we laid a foundation for growth and safety—as the time when we all got it right.
