9/28/2009

MACRO-REGULATION A FOREGONE CONCLUSION

Systemic regulation is coming to financial institutions, with the goal of limiting the risks posed to the overall economy by systemically important institutions — those deemed "too big to fail" in the recent financial crisis.

"Our sense is that the first thing we're going to see on this regulatory reform agenda is going to come out of the U.S. Congress," said Timothy Ryan, president and CEO of Securities Industry and Financial Markets Association (SIFMA), the American equivalent of the Investment Industry Association of Canada (IIAC).

Speaking at the IIAC's Annual Conference in Toronto on Thursday, Ryan said Congress is likely to table final legislation to establish "some type of systemic regulator" within the first half of 2010. Just as the crisis started in America, so too will the response.

"The U.S. is the best organized governmental process to move forward in a timely fashion and get something done," he told the audience. "The European Community is aggressive in their promotion of ideas, but very difficult to get a consensus and implement changes."

A systemic regulator would take a holistic approach to oversight in the financial services industry. While typical regulators focus on a single element, such as mutual fund dealers, the systemic regulator would keep an eye on all the working parts of the industry, with a goal of containing any new crisis.

The creation of such a beast will be very popular on the political front, as the public has demanded closer scrutiny on virtually everything: retail lending practices, leverage in the banking sector, capital ratios and even executive compensation.

While it's easy to point to the credit crisis that brought the global financial system to the brink of collapse and demand closer scrutiny, there is a risk that limits set on various ratios could be arbitrary.

"What's acceptable leverage? People in the industry are not even sure," he said. "You will find people in the industry, legislators and regulators talking about leverage ratios they think make sense. If 40 is too high, then maybe half of that is probably better. If there's a cap, we still don't know what is that appropriate range or number."

One of the key challenges that a systemic regulator will need to address is what activities are permissible for systemically important financial institutions.

"Paul Volcker, the former head of the U.S. Fed, will testify that if you're an insurance depository institution in the United States, there are certain things that you just should not be doing; they're too risky," Ryan said. "He is totally opposed to proprietary trading within these big banks, which is an important component of how these big banks make money."

There are many firms in the broker-dealer channel that have commodity business, and hold hard assets, such as pipelines, ships and storage facilities.

"Is that an appropriate role for a systemically important institution? These are all issues that require a very complex model," Ryan said.

Taken to their logical extreme, calls for tighter regulation of SIIs would see them ramp up capital, reduce leverage, lock up their liquidity and bar them from the more lucrative lines of business that they currently participate in.

"We're going to end up with large financial institutions which are really utilities, oh, and by the way, we don't want them to pay dividends," said Ryan. "And then we still view them as the engines of grow for the economy. Something's got to give."

One of the loudest populist calls, especially in Europe, is for government regulation of executive compensation, but Ryan points out that such limits will drive the "best and brightest" away from the industry.

"Our view is that the people who should be making decisions on compensation should be compensation committees and boards that are accountable to shareholders and to regulators."


Systemic regulation is coming to financial institutions, with the goal of limiting the risks posed to the overall economy by systemically important institutions — those deemed "too big to fail" in the recent financial crisis.

"Our sense is that the first thing we're going to see on this regulatory reform agenda is going to come out of the U.S. Congress," said Timothy Ryan, president and CEO of Securities Industry and Financial Markets Association (SIFMA), the American equivalent of the Investment Industry Association of Canada (IIAC).

Speaking at the IIAC's Annual Conference in Toronto on Thursday, Ryan said Congress is likely to table final legislation to establish "some type of systemic regulator" within the first half of 2010. Just as the crisis started in America, so too will the response.

"The U.S. is the best organized governmental process to move forward in a timely fashion and get something done," he told the audience. "The European Community is aggressive in their promotion of ideas, but very difficult to get a consensus and implement changes."

A systemic regulator would take a holistic approach to oversight in the financial services industry. While typical regulators focus on a single element, such as mutual fund dealers, the systemic regulator would keep an eye on all the working parts of the industry, with a goal of containing any new crisis.
The creation of such a beast will be very popular on the political front, as the public has demanded closer scrutiny on virtually everything: retail lending practices, leverage in the banking sector, capital ratios and even executive compensation.
While it's easy to point to the credit crisis that brought the global financial system to the brink of collapse and demand closer scrutiny, there is a risk that limits set on various ratios could be arbitrary.

"What's acceptable leverage? People in the industry are not even sure," he said. "You will find people in the industry, legislators and regulators talking about leverage ratios they think make sense. If 40 is too high, then maybe half of that is probably better. If there's a cap, we still don't know what is that appropriate range or number."br>
One of the key challenges that a systemic regulator will need to address is what activities are permissible for systemically important financial institutions.

"Paul Volcker, the former head of the U.S. Fed, will testify that if you're an insurance depository institution in the United States, there are certain things that you just should not be doing; they're too risky," Ryan said. "He is totally opposed to proprietary trading within these big banks, which is an important component of how these big banks make money."

There are many firms in the broker-dealer channel that have commodity business, and hold hard assets, such as pipelines, ships and storage facilities.

"Is that an appropriate role for a systemically important institution? These are all issues that require a very complex model," Ryan said.

Taken to their logical extreme, calls for tighter regulation of SIIs would see them ramp up capital, reduce leverage, lock up their liquidity and bar them from the more lucrative lines of business that they currently participate in.

"We're going to end up with large financial institutions which are really utilities, oh, and by the way, we don't want them to pay dividends," said Ryan. "And then we still view them as the engines of grow for the economy. Something's got to give."

One of the loudest populist calls, especially in Europe, is for government regulation of executive compensation, but Ryan points out that such limits will drive the "best and brightest" away from the industry.

"Our view is that the people who should be making decisions on compensation should be compensation committees and boards that are accountable to shareholders and to regulators."

Advisor.ca
Steven Lamb
09/25/2009



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