[Senate Hearing 111-382]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 111-382
 
      INTERNATIONAL COOPERATION TO MODERNIZE FINANCIAL REGULATION

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                   SECURITY AND INTERNATIONAL TRADE 
                              AND FINANCE

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                                   ON

  COLLABORATIVE INTERNATIONAL EFFORTS TO PROMOTE FINANCIAL REGULATORY 
                                 REFORM

                               __________

                           SEPTEMBER 30, 2009

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html



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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman

TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         JIM BUNNING, Kentucky
EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          MEL MARTINEZ, Florida
DANIEL K. AKAKA, Hawaii              BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  JIM DeMINT, South Carolina
JON TESTER, Montana                  DAVID VITTER, Louisiana
HERB KOHL, Wisconsin                 MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             KAY BAILEY HUTCHISON, Texas
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado

                    Edward Silverman, Staff Director

        William D. Duhnke, Republican Staff Director and Counsel

                     Dean Shahinian, Senior Counsel

                   Julie Chon, Senior Policy Adviser

                Mark Oesterle, Republican Chief Counsel

                Hester Peirce, Republican Senior Counsel

                       Dawn Ratliff, Chief Clerk

                      Devin Hartley, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

      Subcommittee on Security and International Trade and Finance

                      EVAN BAYH, Indiana, Chairman

            BOB CORKER, Tennessee, Ranking Republican Member

HERB KOHL, Wisconsin                 ROBERT F. BENNETT, Utah
MARK R. WARNER, Virginia
MICHAEL F. BENNET, Colorado
CHRISTOPHER J. DODD, Connecticut

                      Ellen Chube, Staff Director

              Courtney Geduldig, Republican Staff Director

                                  (ii)


                            C O N T E N T S

                              ----------                              

                       WEDNESDAY, SEPTEMBER, 2009

                                                                   Page

Opening statement of Chairman Bayh...............................     1
Opening statements, comments, or prepared statement of:
    Senator Shelby...............................................     4
    Senator Corker...............................................     4

                               WITNESSES

Mark Sobel, Acting Assistant Secretary for International Affairs, 
  Department of The Treasury.....................................     5
    Prepared statement...........................................    26
    Responses to written questions of:
        Senator Corker...........................................    40
Kathleen L. Casey, Commissioner, Securities and Exchange 
  Commission.....................................................     7
    Prepared statement...........................................    30
    Responses to written questions of:
        Senator Corker...........................................    43
Daniel K. Tarullo, Member, Board of Governors of the Federal 
  Reserve
  System.........................................................     9
    Prepared statement...........................................    34
    Responses to written questions of:
        Senator Corker...........................................    45

                                 (iii)


      INTERNATIONAL COOPERATION TO MODERNIZE FINANCIAL REGULATION

                              ----------                              


                     WEDNESDAY, SEPTEMBER 30, 2009

                                       U.S. Senate,
                              Subcommittee on Security and 
                           International Trade and Finance,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 2:39 p.m., in room SD-538, Dirksen 
Senate Office Building, Senator Evan Bayh, Chairman of the 
Subcommittee, presiding.

             OPENING STATEMENT OF SENATOR EVAN BAYH

    Senator Bayh. I would like to call the Subcommittee to 
order and thank our witnesses for being with us today. I am 
well aware of how busy you are, and so in the midst of all the 
other things you have to deal with, I am very grateful for your 
insights. I apologize for being a little bit late. I was 
waylaid by some well-intended members of the fourth estate who, 
for some reason, wanted to talk about health care. But the 
matter that we are here today to discuss is very important. We 
will be turning to that very shortly, and so I am grateful for 
your presence.
    I am pleased to call the Subcommittee to order for our 
hearing entitled ``The International Cooperation to Modernize 
Financial Regulation.'' I want to begin by thanking Chairman 
Dodd of the Banking Committee as a whole and his hard-working 
staff for their cooperation and assistance in arranging this 
hearing and for the Chairman's support in looking into these 
important matters.
    I would also like to welcome my friend and colleague, 
Ranking Member Corker--I am grateful for his leadership on 
these and other matters--and my other colleagues on the 
Committee who are with us. Some will be with us later in 
person. Others will be reading the testimony. I want to thank 
them for their interest in this matter.
    To our three witnesses, I want to welcome you and thank you 
for appearing before the Subcommittee to give an outline on the 
efforts underway to harmonize our collective financial 
regulations. I understand these few weeks have been very busy 
for all three of you, with the G-20 summit and upcoming 
meetings abroad. I appreciate your rearranging your schedules 
and your overseas travel to be with us here today. Once again, 
thank you for your consideration.
    Our panel today consists of our country's leading 
representatives and experts on international economic and 
financial affairs, so I look forward to our upcoming dialog. 
But first I would like to go over why we are here today and why 
the international element of our financial regulatory overhaul 
is critical to our global economic recovery.
    One year ago, our country experienced a financial crisis 
fueled by home foreclosures and institutional failure. The 
markets dropped drastically and credit began to freeze as banks 
refused to lend to families, businesses, and even to one 
another.
    It soon became apparent that no one was immune. Our 
financial crisis quickly became a full-blown economic crisis, 
complete with a housing decline and our Nation shedding, on 
average, 700,000 jobs each month. My home State of Indiana was 
hit particularly hard.
    It was clear Congress needed to intervene with massive 
Government assistance to help stabilize our financial markets 
and prevent complete economic collapse. As I said at the time, 
it was a ``distasteful but necessary step to protect millions 
of innocent people.''
    Now, 1 year later we are on the path to recovery. It will 
take some time for our financial system to completely heal, but 
in the meantime, it is our responsibility and the duty of 
lawmakers to be willing to take the steps necessary toward 
long-term reform to make sure this situation does not happen 
again.
    The Senate Banking Committee has already held approximately 
30 hearings since this January on the issue of financial 
regulatory modernization. It would be challenging enough to 
reform our regulatory scheme here in the United States and 
ignore the efforts internationally. But that would neglect our 
economic reality. We live in an interconnected global economy, 
and as we have seen, that means interconnected global problems.
    Vulnerabilities and gaps in financial markets abroad can 
impact us here substantially at home. Any reform or rules we 
enact here at some level should be matched or harmonized abroad 
to ensure capital does not gravitate to the lowest common 
denominator. We sometimes refer to that as regulatory 
arbitrage.
    Two weeks ago, in a speech before Wall Street, President 
Obama reaffirmed his commitment to financial regulatory 
modernization and the need to close the gaps and harmonize our 
collective rules. He stressed that the United States needs to 
play a leadership role in lifting our global regulatory 
standards to ensure there is a global race to the top. This is 
necessary to, number one, prevent the regulatory arbitrage I 
just mentioned that puts our entire financial system at risk; 
and, number two, make sure we remain competitive with other 
nations.
    In light of that commitment, we are moving forward with 
today's hearing to show our support for this critical component 
of regulatory reform. Today we will hear from our three 
witnesses on the work that is underway to coordinate our 
regulatory structures.
    We have already laid the foundation to begin this process. 
In an effort to coordinate financial regulatory reforms, world 
leaders began working together at a series of international 
meetings to address changes in policy, regulations, oversight, 
and enforcement. The first was in November of 2008 here in 
Washington, D.C.
    At that meeting, the leaders approved an action plan that 
included instructing their Finance Ministers to make specific 
recommendations in a number of areas. Some of the most 
important included: avoiding regulatory policies that 
exacerbate ups and downs of the business cycle, reviewing 
incentives for risk taking and innovation reflected in 
executive compensation practices, and strengthening the 
regulatory scheme for credit derivatives and reducing their 
systemic risk.
    The G-20's next meeting was in April 2009 in London. There 
the leaders focused on the issues of coordination and oversight 
of an international financial system with the creation of the 
Financial Stability Board. The Financial Stability Board is an 
extension of a previous international organization, the 
Financial Stability Forum, with an expanded membership to 
include all G-20 countries, Spain, and the European Commission.
    Our three witnesses today are the United States' 
representatives to the Financial Stability Board, and I look 
forward to hearing their thoughts on this reinvented 
organization and how effective it will be in enacting change. 
Leaders of the London Summit also agreed to work on cross-
border cooperation, closer regulation of banks, hedge funds, 
and credit rating agencies, and a crackdown on tax havens--all 
important issues.
    Last, the United States asserted our leadership in these 
international economic issues by hosting the Pittsburgh Summit 
just last week. I am particularly interested in hearing from 
our witnesses on what was accomplished at the G-20 Summit in 
Pittsburgh on the international harmonization aspects of 
regulatory reform. Specifically, we would like to know the U.S. 
goals of the summit, if the objectives were accomplished, the 
roles played by the respective governmental witnesses, and the 
status of any proposals presented by the Financial Stability 
Board.
    The conventional wisdom on international coordination is 
that at summits countries talk globally but afterwards act only 
locally. This hearing and the oversight our Subcommittee will 
conduct on this issue throughout this lengthy process is one 
way to ensure that the momentum is not lost. However, the work 
is not completely laid at the feet of the administration and 
our international standard-setting entities. Congress has some 
responsibility in this debate as well.
    The biggest question for Congress is how much our 
regulatory modernization should be harmonized with 
international norms and standards and what we should do when 
there are conflicts on proposals that may not be consistent 
with U.S. interests or what Congress prefers. These are 
difficult questions. But I trust that my colleagues here in the 
Senate and the witnesses sitting before us today are willing to 
put in the work to make sure that we make the right decisions 
and get something done.
    Let me close by reiterating how critical these efforts are 
to our global economic recovery and future success.
    Last year, as Congress passed the Emergency Economic 
Stabilization Act, popularly known as TARP, I said:

        I am not a cynic, but I am a skeptic about the way Washington 
        can work in times like these. Congress will act in a moment of 
        crisis, but once it is abated, the sense of urgency will 
        dissipate. The forces of reform will not have the energy that 
        they have today. All the interests will circle this place like 
        hungry birds looking for carrion in order to prevent us from 
        taking the steps that are necessary. We must not let that 
        happen.

    Here we are a year later, and we must remain committed to 
seeing through long-term reform. We need to bring the same 
sense of urgency that was so palpable during the crisis.
    And now before we hear from our witnesses, I would like to 
turn to my distinguished colleagues, and I would like to 
acknowledge the presence of our Ranking Member of the entire 
Banking Committee, my friend Senator Shelby. Senator, thank you 
for your presence.
    Senator Shelby. Thank you.
    Senator Bayh. And I am not sure what the appropriate 
protocol is here, gentlemen. Robert, I had intended to turn to 
you, and it looks as if the Ranking Member agrees with that, so 
I will turn to my colleague Senator Corker for any opening 
remarks that he might like to make, although, Bob, I have been 
informed of something we call the Corker rule, which has to do 
with your unusual habit for a Senator of being very brief. So I 
do not know if you intend to invoke the Corker rule today or 
not, but you are not obligated to.

            OPENING STATEMENT OF SENATOR BOB CORKER

    Senator Corker. Listen, Mr. Chairman, I am looking forward 
to serving with you on this Committee, and I like working with 
you on numbers of issues. I am not fond of opening statements 
and not known for them, and I do not plan on changing that 
today. So thank you for coming as witnesses. We look forward to 
your testimony, and I do think our distinguished Ranking Member 
has someone in particular he wants to embellish, but certainly 
wisdom he wants to share with all of us.
    So, Mr. Ranking Member.

         OPENING STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. I believe I will stay with the Corker rule. 
By osmosis, you know, we are picking it up day by day.
    But, Mr. Chairman, this is, I think, a very timely hearing 
and a very needed hearing dealing with international 
cooperation, dealing with our financial regulation, our 
accounting system, and everything that goes with it. So I look 
forward to today's witnesses.
    Thank you very much.
    Senator Bayh. Thank you, Senator Shelby, very much.
    It is now my privilege to introduce our witnesses. Why 
don't I start moving from the panel's right to the panel's 
left, and I have very lengthy and detailed synopses of your 
very distinguished careers. I am going to dispense with that 
and just give your titles, and I will have the entire 
introductions entered into the record for those who are 
interested in the entire resume.
    Senator Bayh. First, Mark Sobel. Mark is the Deputy 
Assistant Secretary for International Monetary and Financial 
policy in the United States Treasury Department. Mark, thank 
you for your presence, and we are well aware of how busy things 
are in the Department these days. And please thank the 
Secretary for his cooperation in making your presence possible 
here today.
    Second, Commissioner Kathleen Casey. Ms. Casey is an SEC 
Commissioner and the SEC representative to the Financial 
Stability Board. Kathleen, thank you for your good work at the 
Commission, and I am grateful for your time here today.
    Finally, we have the Honorable Daniel Tarullo who has been 
kind enough to appear before our Subcommittee before. Daniel, 
it is good to see you once again. He took office as a member of 
the Board of Governors of the Federal Reserve on January 28, 
2009. You have had no lack of things to do since that time as 
well, Dan, so I am grateful for your insights and your 
testimony here today.
    Thank you and, Mark, let us begin with you, Mr. Sobel. You 
might want to push the microphone--there you go.

    STATEMENT OF MARK SOBEL, ACTING ASSISTANT SECRETARY FOR 
       INTERNATIONAL AFFAIRS, DEPARTMENT OF THE TREASURY

    Mr. Sobel. It has been pushed for me. OK. Thank you.
    Thank you for this opportunity to testify on international 
efforts to promote regulatory reform, especially following the 
Pittsburgh Summit.
    Immediately after the start of the crisis, policymakers and 
regulators worldwide redoubled efforts to repair financial 
systems and put in place a stronger regulatory and supervisory 
framework so that a crisis of the magnitude we have witnessed 
does not occur again.
    Good progress is being made, and much was achieved already 
through the Washington and London G-20 Summits. We strengthened 
prudential oversight, reached agreement to extend the scope of 
regulation, strengthened international cooperation, and have 
taken action to deal with jurisdictions that failed to commit 
to high-quality standards.
    A fundamental objective of the Pittsburgh Summit was to 
build on these accomplishments. Leaders agreed on four 
priorities:
    Capital. They agreed to develop rules to improve the 
quantity and quality of capital and to discourage excessive 
leverage by end 2010. This agreement tracks closely with 
Secretary Geithner's principles issued earlier this month.
    On compensation, leaders endorsed the implementation of 
standards to help financial institutions and regulators better 
align compensation with long-term value and risk management. 
National supervisors will impose corrective measures on firms 
with unsound practices.
    On OTC derivatives, they agreed that all standardized OTC 
derivative contracts should be traded on exchanges or 
electronic trading platforms and cleared through central 
counterparties by end 2012. Non-centrally cleared contracts 
will be subject to higher capital requirements.
    On cross-border resolution, they agreed to strengthen 
domestic resolution frameworks and that prudential standards 
for the largest, most interconnected firms should be 
commensurate with the costs of their failure.
    Leaders also called on international accounting bodies to 
redouble efforts to achieve a single set of high-quality, 
global accounting standards.
    Firms are now global in scope, as you noted, Mr. Chairman, 
and we derive benefits from open, interconnected markets. But 
the crisis highlighted that financial duress can spread quickly 
across national boundaries. And while the responsibility for 
sound regulation begins at home, different national standards 
open the possibility for regulatory arbitrage, gaps in 
oversight, and a race to the bottom. International cooperation 
is essential to avoid these pitfalls.
    Throughout the crisis, standard setters and other bodies, 
in addition to the G-20, have helped in this effort. But one 
body, the Financial Stability Board, has played a critical role 
in promoting international financial stability. Founded as the 
Financial Stability Forum in the aftermath of the Asia crisis 
with strong U.S. support, it brought G-7 officials together 
with key standard-setting bodies. At the outset of the crisis, 
the G-7 asked the forum to analyze the causes of the crisis and 
provide recommendations to increase the resilience of markets 
and institutions.
    Those recommendations have been at the center of the 
international consensus on how to overhaul the world's 
financial regulatory system. In April, with strong U.S. 
backing, the Financial Stability Forum was reconstituted as the 
Financial Stability Board, with an enhanced mandate and 
membership now encompassing all G-20 countries.
    The FSB has been a key venue to prepare for G-20 leaders 
summits. I have provided greater detail in my written testimony 
on the FSB's purposes and functioning.
    In the United States, we have set out a proposal for 
comprehensive regulatory reform, but to promote a global race 
to the top, we need our G-20 partners to be equally ambitious.
    The three institutions we represent have worked closely 
together in preparing for FSB meetings. In addition, U.S. 
regulatory officials are heavily involved in setting the agenda 
for international standard setters. This strong cooperation 
between U.S. and international officials is reflected in the 
closely aligned agendas pursued by the FSB in the United States 
and has allowed us to forge more consistent global standards in 
line with the U.S. agenda.
    As part of our work to help ensure a cohesive national 
vision at the international level, U.S. officials also 
coordinate through the President's Working Group on Financial 
Markets and at a working level conference calls hosted by 
Treasury with U.S. regulators to discuss implementation of the 
G-20 leaders and FSB work.
    Looking forward, consistent national implementation 
throughout the G-20 will increasingly be our focus. The FSB 
will be an important forum to assess progress.
    Despite our achievements, much more remains to be done. 
Some of the flaws in the U.S. financial system and regulatory 
framework that allowed this crisis to occur are still in place.
    In conclusion, the United States has led the effort to 
create the FSB, shape its agenda, expand its membership, and 
involve it closely in the G-20's work. In turn, the Financial 
Stability Board has been a key instrument for policy 
development. We can be confident knowing that the machinery to 
strengthen the international financial system is in place and 
has set forth principles for reform that are consistent with 
the administration's own plan.
    Again, thank you for having me here today.
    Senator Bayh. Thank you, Mr. Sobel.
    Ms. Casey.

 STATEMENT OF KATHLEEN L. CASEY, COMMISSIONER, SECURITIES AND 
                      EXCHANGE COMMISSION

    Ms. Casey. Chairman Bayh, Ranking Member Corker, and 
members of the Committee, thank you for inviting me to testify 
about the international cooperation to modernize financial 
regulation.
    I am very pleased to have the opportunity to testify on 
behalf of the Securities and Exchange Commission on this very 
important topic. International cooperation is critical to the 
effectiveness of financial regulatory reform efforts. In 
reaffirming their commitment to strengthening the global 
financial system, the G-20 Finance Ministers and Bank Governors 
recently set forth a number of actions to ``maintain momentum 
[and] make the system more resilient.''
    The G-20 banking statement correctly recognizes that, due 
to the mobility of capital in today's world of interconnected 
financial markets, activity can easily shift from one market to 
another. Only collective regulatory action can be effective in 
fully addressing cross-border activity in our global financial 
system.
    As an SEC Commissioner and Chairman of the Technical 
Committee of the International Organization of Securities 
Commissions, I bring the perspective of both a national 
securities market regulator and a member of the international 
organization charged with developing a global response to the 
challenges posed to securities markets by the financial crisis. 
I also represent the SEC and IOSCO in the Financial Stability 
Board, where the U.S. representation is led by the Department 
of Treasury, with the Securities and Exchange Commission and 
the Federal Reserve Board both serving as members.
    The financial crisis has made it clear that there are 
regulatory gaps that we must address. The Commission has 
recently proposed action to this end in a number of different 
areas, recognizing, however, that some regulatory gaps and 
market issues cannot be fully addressed without legislative 
action. The SEC already is working to achieve consistency on 
the domestic and international levels, including through IOSCO 
and the FSB, with banking, insurance, futures, and other 
financial market regulators. The Commission also is working to 
ensure respect for the integrity of independent accounting and 
auditing standard-setting processes in the global regulatory 
environment. This is essential for the benefit and protection 
of investors.
    The Commission has worked actively to achieve consistency 
in regulatory policy and implementation on an international 
basis through multilateral, regional, and bilateral mechanisms 
for many years. The SEC was a founding member of IOSCO and has 
maintained a leading role in the organization. The Commission's 
commitment to international cooperation has become increasingly 
important to its mission in recent years in response to the 
increasingly global nature of financial markets.
    In addition to my chairmanship of IOSCO's Technical 
Committee, Commission staff leads or is very active in IOSCO's 
standing committees and task forces, as well as many other 
multilateral organizations.
    While IOSCO represents the primary vehicle for development 
of common international approaches to securities market 
regulation, the Financial Stability Board is another key 
mechanism for the Commission to engage internationally on 
broader financial market issues. The Financial Stability Board 
has a broader scope, with membership comprised of national 
regulatory and supervisory authorities, standard-setting 
bodies, and international financial institutions, central 
bankers, and Finance Ministers. Its mission is to address 
vulnerabilities and to encourage the development of strong 
regulatory, supervisory, and other policies in the interest of 
financial stability.
    In addition to multilateral global engagement, the 
Commission participates in regional and bilateral mechanisms 
for discussion and promotion of common approaches to 
regulation, such as our engagement in a number of Treasury-led 
regulatory dialogues, including with the European Commission, 
Japan, China, and India, as well as with Australia and our 
North American partners, Canada and Mexico.
    Securities-regulatory-focused dialogues between the 
Commission and our counterpart securities regulators in these 
and other jurisdictions also complement these broader financial 
sector dialogues. Recently, the Commission and a number of 
other securities regulators have also entered into bilateral 
``supervisory'' memoranda of understanding that go well beyond 
sharing information on enforcement investigations. These 
supervisory MOUs represent ground-breaking efforts by national 
securities regulators to work together to cooperate in the 
oversight of financial firms that increasingly operate across 
borders.
    As these efforts suggest, the infrastructure for 
international cooperation on securities regulatory policy is 
well developed, and the Commission plays a key role in 
promoting rising levels of cooperation and building on our 
successes in raising standards of cross-border enforcement 
cooperation. Today the SEC has broad authority to share 
supervisory information as well as to assist foreign securities 
authorities in their investigations through various tools, 
including exercising the SEC's compulsory powers to obtain 
documents and testimony. In order to facilitate international 
cooperation, the SEC supports legislation providing authority 
to the Public Company Accounting Oversight Board, which the SEC 
oversees, to share confidential supervisory information with 
foreign counterparts. The Commission believes that granting 
this authority to the PCAOB would enhance auditor oversight, 
audit quality, and, ultimately, investor protection.
    In closing, the Commission looks forward to continuing the 
ongoing constructive dialogue with our colleagues at the Fed, 
Treasury, and other agencies, in developing common U.S. 
position on international cooperation in the future.
    While the Commission's particular focus--and that of IOSCO 
on investor protection and efficient and fair markets has 
remained constant and somewhat distinct from that of banking 
supervisors and regulators of other market segments, our recent 
collaborative work, both at home and internationally, continues 
to enhance our ability to identify and address systemic risks 
across the world's financial markets and will be central to 
efforts to strengthen the global financial regulatory system.
    Thank you again for the opportunity to testify, and I look 
forward to taking your questions.
    Senator Bayh. Thank you, Ms. Casey.
    Mr. Tarullo.

 STATEMENT OF DANIEL K. TARULLO, MEMBER, BOARD OF GOVERNORS OF 
                   THE FEDERAL RESERVE SYSTEM

    Mr. Tarullo. Thank you, Mr. Chairman, Ranking Member 
Corker, and Ranking Member Shelby. As Chairman Bayh noted, in 
less than a year we have had three G-20 leaders meetings at 
which financial stability was either the sole subject or, as in 
Pittsburgh last week, one of the most important subjects.
    During this period, the Financial Stability Board has 
emerged as an important forum for identifying, analyzing, and 
setting in motion coordinated responses to the financial crisis 
and to regulatory gaps and shortcomings.
    There is much promise in what is now a lengthy agenda for 
the Financial Stability Board and the many other important 
groups intended to foster international regulatory cooperation. 
But there is also some risk that progress will get bogged down 
or that the negotiation of standards or recommendations in a 
particular area will become an end in itself.
    Needless to say, it is essential to ensure that well-
devised standards are implemented effectively by all 
participating countries and that problems revealed during this 
implementation are cooperatively addressed and changes made.
    As we look ahead from Pittsburgh and all the international 
meetings that preceded it, I would offer a few thoughts on how 
we should proceed from here.
    First, it is important for the U.S. representatives to the 
FSB and other groups to focus on the topics and initiatives 
that we believe are most significant for promoting global 
financial stability and that are also susceptible to practical 
international cooperative action.
    My prepared testimony covers a number of these areas, but I 
would like to draw particular attention to the emphasis of the 
G-20 leaders on improvements to capital requirements, which is 
both an appropriate and critical emphasis.
    Second, we will need to work with our counterparts from 
other countries to rationalize the activities of the many 
international organizations and groups whose mandates involve 
financial stability. While overlap among these various 
institutions can sometimes be useful in fostering alternative 
ideas and approaches, uncoordinated duplication of effort can 
be inefficient and sometimes even counterproductive.
    A third and related point is that the expansion of both 
membership and mandate in certain of these international groups 
will require changes in operating procedures in order to 
maintain some of the advantages these groups have had.
    Fourth, while the financial crisis has understandably, and 
appropriately, concentrated international energies and 
attentions on the new standards that will be necessary to 
protect financial stability, we must guard against these fora 
being transformed into exclusively negotiating entities. One of 
the virtues of the original Financial Stability Forum was that 
is provided a venue for participating officials to exchange 
views on current developments and problems in a relatively 
unstructured fashion that provided at least the potential for 
new ideas to emerge.
    Similarly, a number of the international standard-setting 
bodies, such as the Basel Committee on Banking Supervision, 
traditionally provided a venue for senior supervisors to 
understand the perspectives of their foreign counterparts and 
at times to develop shared views of common supervisory 
challenges, quite apart from the negotiation of new 
international standards.
    These other purposes of international financial regulatory 
groups are, in my view, useful both as ends in themselves and 
as mechanisms to reinforce the implementations of the standards 
previously promulgated by these groups.
    Thank you, Mr. Chairman. I would be pleased to answer any 
questions you or your colleagues may have.
    Senator Bayh. Thank you, Mr. Tarullo, and thank you to the 
other panelists. Why don't I work in reverse order and start 
with you.
    On the issue of systemic risk, experts point out that the 
regulatory reform discussion during the summit meetings has 
still been fairly vague on critical and complex issues, like 
systemic risk, cross-border resolution authority, and what to 
do about derivatives. However, the political hot button issue 
of executive compensation seems to have been more on a fast 
track.
    My question is: What do you think we can end up doing on 
the issue of systemic risk, which gets to the heart of the 
problem that we face? And will we have more than just--and I 
understand there is a lot going on. It is a full plate. These 
things take time. But do you think we will end up with 
something more than unenforceable, you know, vague standards 
this time? Or can we look forward to something more specific 
with some real enforceability to it?
    Mr. Tarullo. Well, Mr. Chairman, I think the agenda 
responding to systemic risk is in some sense the biggest part 
of both the FSB's agenda and much of what the G-20 said. So it 
is not any one initiative. I would say that the elements of 
that agenda, internationally as domestically, are mutually 
reinforcing. So with respect to higher capital standards, for 
example, I think both higher capital standards applied to 
existing international agreements and new ideas about how to 
take steps that contain systemic risk are going to be equally 
important. The agenda for strengthening capital standards is 
well underway. There has been some progress already. I think 
the G-20 Summit is going to catalyze some more progress.
    Senator Bayh. Is this difficult for the Europeans, given 
the condition of several of their financial institutions?
    Mr. Tarullo. Well, I think it is going to be a challenge 
for most countries because we are talking about significant 
increases in capital over time. I think you probably noted that 
the G-20 leaders want to move forward with the agreement on 
tighter, stricter, more robust capital standards now, but the 
implementation of those standards is presumably going to take 
place as the financial institutions themselves strengthen.
    I think that with respect to some of these newer ideas, one 
I would draw your attention to is that of contingent capital 
requirements for large institutions. I think that is an example 
of where we in the United States have an opportunity to 
exercise some leadership to produce some good, innovative ideas 
that will bring market discipline and some protection for 
taxpayers to each of these very large financial institutions. 
And so I think that is one of the reasons why we and our 
colleagues have been promoting those ideas internationally and 
hope we see some progress on it.
    Senator Bayh. Mr. Sobel, or any of the three of you, the 
topic of derivatives came up several years ago and you 
mentioned that there have been some general statements in the 
Pittsburgh gathering about the importance of moving forward on 
this. The response that we always got previously to this was, 
well, if you regulate these instruments more closely in the 
United States, we will just take the business offshore and the 
risks will be run. It is just that there won't be the 
employment in the United States. So it is kind of a lose-lose 
situation. Do you think we will come up with something more 
specific and enforceable this time to prevent that kind of 
forum shopping?
    Mr. Sobel. I think one of the main points I wanted to 
emphasize today is that I think that there is real solid 
agreement in the G-20, in the FSB, certainly among the main 
players, certainly in the standard-setting bodies, such as the 
Committee on Payments and Settlement Systems, to really tackle 
these issues to make significant progress on them. So I think 
that the agreements that we have reached, for example, in 
Pittsburgh, there is a good paragraph there about our agreement 
on over-the-counter derivatives markets. I think it is a very 
firmly rooted and earnest agreement. There was no debate about 
it on the table, and the CPPs are beginning to get up and 
running. There is business happening on those exchanges.
    So I am confident that we are going to push forward. 
Secretary Geithner has had a personal and strong interest in 
this area dating back several years to when he was President of 
the New York Fed to bring transparency and greater data 
collection to this effort. So I am confident that we are going 
to push forward in this area.
    Senator Bayh. Well, I am confident of the Secretary's 
interest in this issue, as well, and his good faith efforts. I 
am a little more concerned about some of the other global 
players and would ask you, particularly in the area of 
derivatives, is there an enforcement mechanism for the 
standards that are going to be hopefully a consensus formed 
around? What will the role of the IMF be? The IMF is a 
wonderful institution. I have great respect for them. But 
historically, in some areas, they don't really have much of a 
way to enforce some of their authorities.
    Mr. Sobel. The way I see the answer to that question, Mr. 
Chairman, we are going to work together really hard with----
    Senator Bayh. And I had currency manipulation in mind, 
not--when they have loaned money to countries, they do have 
leverage there. But in some other areas--and they can make 
pronouncements, but moral suasion doesn't seem to be enough in 
some cases.
    Mr. Sobel. In terms of making progress on OTC and this 
enforcement question that you have raised, the way I see the 
answer to that question--and it is not just the OTC area, it 
pertains to other areas--is that we are going to work together 
really hard. We are going to work through the standards-setting 
bodies. We are going to work through the FSB to raise 
standards, to seek agreements. And then taking the standards, 
it is a question for national supervisors to implement while 
continuing the cooperative efforts that we are building.
    So ultimately, I see enforcement as having to happen at the 
national level, but we need to use the FSB to make sure that 
everybody is on the same page and that we are marching forward 
together.
    Senator Bayh. We will have multilateral standards but 
national enforcement. That may be the best we can come up with, 
but that does raise the prospect of different jurisdictions 
taking different levels of zeal in enforcing these things, 
which gets us back to the problem of forum shopping and 
regulatory arbitrage and all that kind of thing. Is this just a 
dilemma that we can only hope to limit but never completely 
eradicate?
    Mr. Sobel. In my view, we live in a world in which 
regulation is a national-based activity, but we do have global 
markets, as you were outlining in your opening statements. I 
think the question is, how do we bring these forces together?
    My answer is, one, I think the United States, and the 
Secretary in particular, are exercising a great deal of 
leadership. The FSB agenda, I think, is aligned very much with 
our principles for regulatory reform. You see that very clearly 
in the agreements reached in Pittsburgh on capital.
    Second, I have talked about the effort to raise standards. 
Again, I think this is a strong international commitment. I 
think leadership committed to it. I think that is going to put 
extra backbone to the effort. This is definitely the case with 
respect to the systemically significant firms, to make sure 
that they operate under a tougher regime.
    You know, one area where we are always--the subject of gaps 
comes up relates to, for example, the non-cooperative 
jurisdictions. And here, I think the Secretary in March, just 
after assuming office, put forward a three-pronged approach to 
basically raise standards in the prudential tax information 
exchange and anti-money laundering effort, and this was a major 
aspect of the April summit. Since then, you have seen 
substantial progress. You have seen many tax information 
exchanges signed around the world.
    We have put in place a process through a global forum, an 
OECD body, to develop carrots and sticks, which will be 
announced in March 2010. And similarly, we are working through 
the FATF processes and a new FSB process to raise adherence to 
standard by all jurisdictions. So I think that when you raise 
this question about gaps and arbitrage, you are putting your 
finger on a definite issue, a totally legitimate issue, and as 
you said, it is not an easy one to deal with, but we are bound 
and determined to do our best and we have our eye on the ball.
    Senator Bayh. Thank you. I am going to turn to my 
colleagues now. They have been most patient. I just observe, I 
very much appreciate the focus of the Secretary, the hard work 
that is being done in the Department. I know this is a very 
difficult diplomatic issue. We have made some progress here and 
in some other tangentially related areas. The Swiss are 
beginning to perhaps change some of their practices with regard 
to tax avoidance and that sort of thing, but it is a challenge 
we face when nation states enforce the rules but the 
consequences of their lack of diligence and enforcement go way 
beyond the border of those nation states. And given the 
experience we have just come through, heaven help us if we 
permit a repetition. But I understand it is a very difficult 
issue.
    Senator Corker?
    Senator Corker. Mr. Chairman, thank you, and thank you for 
your testimony. I think it is great that the G-20 is working 
together on so many of these issues. I think it will be 
interesting to see whether, as time moves on, this solidifies 
or sort of fragments, which I think could be a challenge as you 
move ahead.
    One of the issues that has been mentioned is just the whole 
procyclical nature of the way that we deal with our financial 
markets. I think it is interesting, Mr. Sobel, that you shared 
that as one of the issues that you all are working on, 
obviously, at the G-20. Here in our country, I think as history 
records what is happening right now, it will say, as it has in 
the past, that the herd mentality took over and that our 
regulators helped create, in many ways, a self-fulfilling 
prophecy. I think that is happening right now as really insane 
things are being asked at the local markets by regulators 
because of their concern about various types of credits. 
Obviously, when the market is rising, everybody levers up 
against appreciating assets.
    What is it that is being looked at--I would say the first 
thing we need to do is look at home. I think the OCC is in many 
ways creating far greater problems in our country than would 
otherwise exist. I don't think it, I would bet on that in major 
ways. But what are we doing at the G-20 level to focus on the 
whole procyclical nature of the way regulators work? They 
exacerbate bubbles and exacerbate problems.
    Mr. Sobel. Let me lead off, and if any of my colleagues, on 
the basis of their work, would like to amplify, I will turn the 
floor to them.
    I would say in the G-20 context, the main area of 
discussion relates to capital, the capital area. So, in 
essence, there is a feeling, obviously, that we didn't have 
enough capital in the system, but there is also a belief that 
banks should have more capital, that they should be able to 
draw down their capital in bad times. So there is a lot of work 
that is being now undertaken in the Basel Committee which has 
been referenced in the Pittsburgh Summit communique about 
establishing countercyclical buffers of capital.
    There are obviously broader macroeconomic questions you 
raise that lie more in the domain of other institutions than 
the Treasury. But again, the main focus has been on the 
countercyclical cushions. I don't know if any of my colleagues 
would like to----
    Senator Corker. So as the markets are rising, more capital 
is required, and as the markets are declining, less capital----
    Mr. Sobel. Yes, sir.
    Senator Corker.----the opposite of what we are doing right 
now in our country.
    Mr. Sobel. Yes, sir.
    Senator Corker. Well, let me ask you this, just out of 
curiosity. Why would we talk about this theory to save the 
world and yet not put it in practice today in our country? I am 
just curious. And maybe others might want to jump in.
    Mr. Tarullo. Senator, a couple of things. First, I think 
your identification of procyclicality is right on target. In my 
observation, problems of procyclicality pervade the financial 
regulatory system, and indeed they pervade financial practice. 
At some level, Senator, financial regulatory capital 
requirements of any sort are themselves procyclical, because 
when you think about it, if you have a capital requirement and 
a bank is taking losses because of a downturn in the economy, 
then all of a sudden, their capacity to lend has been reduced.
    I think what we saw in the run-up to the financial crisis 
was excessive procyclicality in financial regulation more 
generally. As Mr. Sobel has said, we definitely saw it in 
capital requirements. And one of the concerns that I had long 
before I arrived at the Federal Reserve was that some of the 
new kinds of capital requirements that were being thought about 
would increase procyclicality.
    Second, and Commissioner Casey may want to address this, 
accounting standards can be procyclical, and that is why her 
committee and the activities of the FSB on accounting have 
focused on that, as well.
    Third, even things as widely accepted and necessary as 
deposit insurance premium structures can be procyclical. If you 
are allowing lesser or no payments during good times, that puts 
you in a situation in which in bad times, the FDIC is in a very 
difficult position as the deposit insurance fund declines. So I 
think this is something we have got to think about across the 
board.
    Now, to your question of, well, if it is such a good idea, 
how come we are not already doing it? Let me give a two-part 
answer to that. First, it is a really attractive concept. In 
good times, banks have to buildup more capital, and as times 
aren't so good, they have to draw it down. But as you know, 
there is often a considerable distance between a really 
attractive concept and something which is technically feasible 
and which we know is not going to produce unintended 
consequences.
    So a lot of the activity right now, both in the Basel 
Committee and among the bank regulatory agencies here at home, 
has been an effort to come up with the right kind of 
calibration so that we do have the effects that we want to have 
in countering the traditional procyclicality while not doing 
more harm along the way. And this is really an integrated 
effort at this point because I think we would want to see major 
financial institutions in other countries do it at the same 
time that our institutions do.
    Ms. Casey. To just follow up on Dan and Mark's points with 
respect to the procyclicality focus of the G-20 and the FSB, as 
Dan mentioned, there is no question that, I think, accounting 
standards have been a key focus of concern with respect to how 
they might contribute to procyclical effects on the system, and 
I think that much of the work that was done in the FSB was 
largely focused on valuation and leverage questions, as well as 
looking at existing accounting standards and practices with 
respect to loan loss provisioning.
    And just as a more fundamental matter, if I could just step 
back with respect to accounting, I think from a securities 
market regulator perspective, one of the key issues that has 
been raised in this debate about procyclicality is also 
appreciating the role of accounting standard setting and the 
purpose of financial reporting, and I think that what we have 
found is that while there may be legitimate concerns about what 
the intersection is between accounting standards and capital, 
capital adequacy issues, at the same time, it is quite 
important from an independent standard-setting perspective, and 
again, the purpose and focus of financial reporting remain 
focused on the interest of investors. So that has been a key 
interest that we have brought to the table.
    But that being said, I would say that with respect to our 
work on provisioning, myself and John Dugan, the head of the--
the Comptroller of the Currency, headed up a working group 
within the Financial Stability Board aimed at looking at 
existing provisioning practices and standards, which currently 
rely on an incurred loss model, to give consideration to 
whether or not--what impact they do have on procyclicality, 
whether or not within existing standards there are ways to 
mitigate that, and then, alternatively, whether or not more 
forward-looking or alternative models might address 
procyclicality while also ensuring that an investor interest in 
terms of getting timely, relevant, decision-useful information 
could be met.
    And what we found through our work was that you actually 
had an interest of both investors as well as prudential 
regulators in perhaps looking at alternative models that were 
more forward-looking in terms of identifying credit losses more 
early in the cycle. And so some of the recommendations that 
came out of that work stream was intended to encourage the 
standard setters to look at a variety of different models that 
would be more forward-looking, including expected loss, dynamic 
provisioning, and fair value, and that is part of the effort 
that the standard setters are currently engaged in.
    But again, just to reinforce, I think that that is an 
instance perhaps where you have an intersection of interests, 
where both investors and the interested prudential regulators 
and broader interested financial stability could potentially be 
met.
    Senator Corker. Thank you.
    Mr. Tarullo. Senator, excuse me. I think the Commissioner 
is excessively modest here. Her role in trying to move some of 
these questions forward----
    Senator Bayh. That is unusual in Washington, D.C.
    [Laughter.]
    Mr. Tarullo. Her role in trying to move some of these 
questions forward productively in the FSB, I think has really 
been critical to getting more of a convergence around some of 
the very troublesome problems in accounting.
    Senator Corker. Thank you.
    Senator Bayh. Senator Shelby?
    Senator Shelby. Thank you, Mr. Chairman.
    Commissioner Casey, the Commission has proposed what you 
call the road map for the potential use of financial statements 
that were prepared in accordance with the International 
Financial Reporting Standards as issued by the IASB, the 
standard-setting body that you well know exists in London. 
Given the tremendous impact of accounting standards in our 
financial system, are you or any of your Commissioners at the 
SEC concerned that IASB's independence and objectivity could be 
compromised? Has that been discussed?
    Ms. Casey. Thank you, Senator. Sort of to step back to one 
of the key objectives or goals of G-20 leaders is convergence 
of accounting standards and the development of a single set of 
high-quality international accounting standards, and as part of 
that effort to achieve that goal, you have efforts by both the 
IASB, the International Accounting Standards Board, and the 
FASB to try to reconcile where it would improve the standard, 
reconcile differences between U.S. GAAP and IFRS, and where 
either standard is lacking, trying to come up with a better 
converge standard.
    They have been engaged in this effort for the past several 
years and I think that much progress has been made. I think 
over the course of the past year, however, there has been a 
tremendous amount of pressure placed on standard setters with 
respect to certainly issues of the appropriate use of fair 
value, mark-to-market concerns, and I think that what we found 
as a result of that is that it has placed some question about 
political pressure brought to bear on these standard setters.
    That being said, I think that despite that, I think both 
standard setters remain committed to their best efforts to 
achieve convergence on key projects, such as the Financial 
Instruments Project, and I think that as part of that effort, 
there is no question that the credibility of that process is 
going to be vital, and I think particularly for here in the 
United States, where the United States is giving consideration 
to whether or not we should allow U.S. issuers to use IFRS. And 
I think central to that will again be confidence in the 
independence and the credibility of the standard setting 
process.
    Again, I think that from the SEC's perspective, we remain 
committed to supporting both standard setting bodies in their 
efforts. We remain committed to achieving a single set of high-
quality international accounting standards. And I expect in the 
coming months that the Commission will speak more clearly about 
the next steps for contemplating potential user adoption of 
IFRS in the United States for U.S. issuers.
    Senator Shelby. Has the SEC staff considered, to your 
knowledge, or seen a particular financial statement prepared 
under the rules of the international standards as opposed to 
FASB, and how do they work? You are looking for equivalence, 
aren't you?
    Ms. Casey. You know----
    Senator Shelby. How do they work together?
    Ms. Casey. There have been a couple of mechanisms we have 
to take confidence in the application of IFRS and the rigor 
with which IFRS is being adopted. Certainly, our staff looks at 
filings of foreign private issuers who currently are allowed to 
file in IFRS, and so that gives us a very good sense of the 
quality of their reporting in IFRS.
    We also have an important workstream underway with the 
European securities regulators which was undertaken--I think it 
is actually one of the good examples of bilateral cooperation 
that we have had, where both the SEC and the CESR have 
undertaken to look at both the quality and the application of 
both U.S. GAAP as well as IFRS for large financial institutions 
that are registered with the SEC and also file in IFRS. And I 
think that those efforts are going to give us the opportunity 
to take greater confidence with respect to the state of IFRS 
and its application in a very company-specific way, and I 
think, ultimately, that will also assist us in taking judgment 
as we look to roadmap questions about implementation of IFRS 
more generally.
    Senator Shelby. Governor Tarullo, you noted that the Basel 
Committee, and this was referenced already in a sense, has been 
working on recommendations to improve the resolution of 
international banking organizations. As banking becomes 
increasingly global, the U.S. financial regulatory structure, I 
believe, needs to make sure it can adequately handle the 
failure of banks operating globally.
    What are some of the problems with resolving large 
international banking organizations? And other than the Obama 
administration's proposal for a new resolution authority, what 
changes should be made to make it easier for the United States 
and other countries to resolve large international bank 
failures, for example?
    Mr. Tarullo. Thank you, Senator. Let me reemphasize the 
premise of your question, which is that resolution is very much 
of a challenge. Let me step back for a second and suggest why 
it is such a challenge, even more than a lot of the other areas 
we are talking about.
    If we want to make changes in capital standards and the FSB 
gets together and we converge around a set of changes, we all 
have ample domestic legal authority under our own 
constitutional structures to go back and make those changes. In 
the area of resolution, of course, we are talking about 
bankruptcy law. We are talking about bank insolvency law under 
the FDI Act, things that the Congress and parliaments around 
the world have put into legislation. So here, each country has 
its own set of legal rights and priorities for creditors. We 
have our own set of laws on what constitutes a fraudulent 
conveyance, for example. We have our own set of practices as to 
what kinds of creditor adjustments can be made during a 
bankruptcy or resolution procedure.
    So, from some people's point of view, the first best or at 
least the cleanest solution would be one that would have to 
harmonize the bankruptcy and resolution mechanisms and laws all 
around the world----
    Senator Shelby. And that is no easy task.
    Mr. Tarullo. I think even to state it, Senator, suggests 
the difficulty, and when I talked in my opening statement about 
practical, this is one of the things I had in mind. Let us be 
practical when we are trying to move resolution forward.
    So here is what I think we can do. First, I think it is 
important that each country that has major financial 
institutions have at least a legal structure that creates the 
possibility for cooperative action for a failed or failing 
large financial institution. So here at home, that would mean a 
resolution mechanism for non-bank large financial institutions. 
And obviously, you are already thinking about that.
    Second, there are some things that can be done short of a 
binding international treaty or harmonization of insolvency 
regimes to get us closer to the point where we can handle these 
things better, at least, than they have been in the past, and 
here are the three things that I think have been the most 
promising.
    First, the contingency plans. Now, some people have 
referred to these as living wills or death plans for the 
company. You know, the basic idea is that each of the big firms 
would have to spell out how it could be wound down in the event 
of a crisis.
    Senator Bayh. I think we need to ensure that the record 
shows, Governor, that the death plans have nothing to do with 
the health care debate.
    [Laughter.]
    Mr. Tarullo. I am not going there, Senator.
    Senator Bayh. Thank you.
    Mr. Tarullo. That is a different committee----
    Senator Bayh. I just wanted to be clear.
    Mr. Tarullo. That is right.
    Senator Shelby. Not yet, anyway.
    [Laughter.]
    Mr. Tarullo. I prefer to think of them somewhat more 
broadly. I think that a contingency plan required of each major 
financial institution can do three things: One, it can be a 
very good supervisory tool, because when Lehman Brothers 
failed, Senator, it had almost 3,000 legal entities under it. 
So when people thought about resolution, the challenges were 
enormous to even figure out where are the vulnerabilities----
    Senator Shelby. Were they too big to regulate?
    Mr. Tarullo. Well, I do not know. If they had been subject 
to mandatory prudential regulation, one hopes that this would 
have been brought into mind.
    Senator Shelby. OK.
    Mr. Tarullo. So one thing you can do, you try to use their 
planning to get a rational, well-understood relationship among 
their subsidiaries and, indeed, make sure that you have legal 
entities aligned with business lines.
    Second, I think that the plan itself can be one that helps 
save the firm. If they know where their vulnerabilities and 
exposures lie and where the cross exposures lie, then as things 
begin to deteriorate, they are in a better position to act. And 
one thing we all learned during the crisis was that many firms 
really did not have a good handle on their own exposures, their 
own vulnerabilities.
    Third, if ultimately the firm is not able to survive, the 
planning may indeed have the salutary effect of helping the 
supervisors do a more rational job of resolving.
    Very quickly, the other couple of things I think are 
probably worth doing internationally are, first, expanding the 
scope of the so-called supervisory colleges to do some planning 
for bad things happening, the kind of information flows that 
different countries would need to know where the capital 
problems may lie.
    And, finally, I do think it would be worth the effort to 
try to get some standardization of a lot of the big contracts 
that go back and forth internationally. So, for example, 
termination clauses in various forms of financial contracts, if 
they were standardized so that each country was looking at the 
same contractual terms, it would be easier for officials in one 
nation to think about how they are going to deal with those 
problems.
    So I will not for a moment promise you that that solves the 
problem, but I think it is a practical agenda for moving us 
forward.
    Senator Shelby. Chairman, could I ask one more question?
    Senator Bayh. Of course.
    Senator Shelby. Credit rating agencies. Commissioner Casey, 
you mentioned in your testimony--is IOSCO how you say it? Is 
that right? IOSCO has refined its code of conduct with respect 
to credit rating agencies in response to the financial crisis. 
You have been a strong advocate for removing the Government's 
stamp of approval from the NRSRO ratings.
    My question is: Do you believe that if the SEC took 
meaningful steps to address reliance on ratings in its rules, 
this would help other countries to seriously consider doing the 
same thing? Because we are talking in an international context.
    Ms. Casey. Thank you, Senator. I believe that there is no 
question that many other jurisdictions, including the United 
States--and I would even note that the administration's plan 
notes regulators should look to reduce reliance on ratings 
wherever possible. But other jurisdictions as well have 
highlighted this as something that deserves particular 
attention in light of what we saw through the crisis that came 
from an undue reliance on the part of investors and markets on 
ratings. And I think for the SEC in particular, it is an 
opportunity for us to--and the Commission is currently 
considering removing--in fact, we have just removed several 
references in our last rulemaking, recognizing that we still 
have some daunting challenges with the tough ones, particularly 
with respect to money funds and then capital references.
    With that being said, I think that there is no question 
that I think for the markets and for investors, if we are going 
to promote the kind of necessary credit analysis that does not 
necessarily rely on ratings judgments, that I think removing 
the regulatory imprimatur would be an important step in that 
respect.
    I think also that as a result of the ratings references 
that we have had in our rules, we have played an important role 
in creating essentially the oligopolistic structure that has 
dominated and exacerbated the weaknesses and----
    Senator Shelby. In other words, no competition.
    Ms. Casey. No competition. And so I think that what you see 
is that with the removal of references, it removes that 
imprimatur and that franchise. It encourages hopefully the 
right incentives in the market. And I think it complements any 
kind of regulatory oversight that certainly the SEC has already 
undertaken pursuant to the law that was drafted in this 
Committee and passed by the Congress. And I think that there is 
a recognition that if we were to take those formative steps, 
longer term we would have probably--we would have much better 
quality and integrity in ratings than if we were to continue to 
rely on the regulatory uses that we see in our rules right now.
    Senator Shelby. Thank you, Mr. Chairman.
    Senator Bayh. Thank you, Senator Shelby.
    Senator Corker.
    Senator Corker. Thank you, Mr. Chairman. You are most 
generous today.
    Before the G-20 summit, Chairman Bernanke came out with a 
principles-based compensation process where, instead of looking 
at firm caps, nominal numbers like French and other governments 
were doing, he did that, I think, because you all are in a 
political sphere as it relates to this G-20, and you each need 
to influence each other. But, Mr. Tarullo, was he successful in 
sort of getting that mantra going, a principles-based focus? Or 
as you all left Pittsburgh the other day, were there still 
countries looking at an actual amount, a nominal cap on 
compensation?
    Mr. Tarullo. Senator, a little bit of history here may be 
useful. In the spring, the Financial Stability Board came out 
with its set of principles on incentive compensation, and we, 
meaning the United States, but specifically the staff from the 
Federal Reserve, have been very closely involved in the 
articulation of those principles.
    At that time, we began internally our process of thinking 
about how we would want to give guidance to the institutions we 
supervise to implement those principles. And the press reports 
which people saw a couple of weeks ago reflected, more or less 
accurately, the direction in which we are headed. The Board has 
not actually voted on the guidance yet, but it reflected 
accurately the direction in which we are headed. And that 
direction is one which, as you say, emphasizes that there is 
not a single formula that is sensible for all kinds of 
employees who have the capacity to assume a lot of risk for 
their enterprises in a variety of different companies.
    So our approach, I think, has been to want a rigorous 
internal process in firms in which the onus is on them to 
develop the right kinds of compensation contracts and 
provisions, taking into account their particular business and 
the kinds of responsibilities their employees have, but that 
those specific policies and practices need to be consistent 
with the overall goals of risk-appropriate incentive-based 
compensation.
    We worked on that and continue to work on it, but we worked 
on it through the spring and the summer, knowing what kinds of 
discussions were going on internationally as well. I think that 
our view has been that the direction in which we are going is 
completely consistent with the FSB principles of last spring, 
and I think if you look at the final FSB report which was 
referenced by the leaders this fall, that there was not a 
mandating of particular formulas applicable to all employees. 
It is, once again, an emphasis on the goals to be served, and I 
think you will see that our guidance, when it does come out, 
will be consistent with those principles.
    Senator Corker. The resolution mechanism--I know that our 
distinguished Ranking Member brought it up a minute ago--many 
of us--and, thankfully, Paul Volcker has been vocal lately and 
talked about the ``too big to fail'' category just should not 
exist. And I know that, you know, there have been discussions 
about whether there was or was not a mechanism in place when we 
started all of the things with did with TARP because maybe 
there was not an orderly way to resolve a highly complex bank 
holding company.
    So I know the administration has put forth a proposal that 
I think is exactly the wrong direction to go, but the fact is 
there is gaining momentum, I think, around actually having a 
resolution mechanism that says when an institution fails, it 
actually fails, and there is a process through which they go. 
They are not conserved and new life breathed into them with 
taxpayer money.
    If that type of solution prevails--and I hope that it 
does--what does that do as it relates to the international 
systems and the fact that there are different laws in different 
countries? You know, we may have a large entity here that 
obviously has subsidiaries all around the world. Talk to us 
about some of the complexities that might exist if that type of 
mechanism were put in place.
    Mr. Tarullo. Senator, I think that you will have 
complexities with or without the mechanism, but they will be of 
a somewhat different sort, and my instinct would be that the 
complexities with the mechanism in place here will be more 
manageable than under the status quo.
    Senator Corker. Where they actually go out of business?
    Mr. Tarullo. No, it is not that so much. It is just that 
the way I have thought about this is we really need a third 
alternative, somewhere between bailout and bankruptcy--or an 
uncontrolled bankruptcy, I should put it, a ``disorderly 
bankruptcy,'' as it is called. And that, it seems to me, should 
be the starting point for thinking about a resolution 
mechanism.
    Now, with respect to the complexities, for the reasons I 
indicated earlier, there is not going to be--and Senator 
Shelby's intermediate question I think emphasized that--an 
international treaty that says everybody has the same 
resolution mechanism, certainly not anytime in the foreseeable 
future. So there will be some potential discontinuities between 
the systems in each country.
    But I think a resolution mechanism can provide tools to 
each national government that could allow a more orderly or 
less disorderly resolution of a failed institution. For 
example, it may permit the creation of a bridge bank. It may 
create the possibility for dividing into a good bank or a bad 
bank, where right now you do not really have the legal capacity 
to do that.
    In your words, there will be complications and complexities 
because the rules may still be somewhat different elsewhere, 
and there may be assets located in other countries that you are 
not sure can be subject to the same legal treatment. But I 
think it gets you at least a step down the road.
    And, again, keeping in mind that the domestic or 
overarching purpose, this ought to be as an element of a broad-
based response to the problems of moral hazard and too big to 
fail. So we need multiple instruments, I think, to contain 
moral hazard, and that means that a resolution mechanism should 
be moving us toward more market discipline, not less market 
discipline.
    Senator Corker. Any comments by the other witnesses?
    [No response.]
    Senator Corker. A very complete answer. I will say--and I 
know this is the end of my time here. I can tell by the body 
language of our Chairman.
    Senator Bayh. Take your time.
    Senator Corker. But the procyclical issue, it sounded to me 
that the answers, which I very much appreciate were thoughtful, 
really do not come to a conclusion; that as you try to avoid, 
you know, an unnecessary steaming up of the economy, there are 
issues there as to what is happening right now. I mean, I think 
we are unnecessarily driving it into the ground. We talk about 
Main Street all the time. I do not even like that kind of 
terminology, and I cannot believe I let it come out of my 
mouth, where you separate the two because it is all 
intertwined. But the fact is that at local levels around our 
country today, there is no question that banks are doing things 
that are not in their best interest, and they are being driven 
there by regulators and a herd mentality. I mean, they are 
doing things that happen every time these cycles occur. There 
are absolutely ignorant things that are being done. They are 
hurting shareholder value. They are hurting their communities. 
And it is being driven by regulators who--you know, it is kind 
of like you yell ``Fire'' and everybody leaves. You yell 
``commercial real estate'' or you yell some kind of--and 
everybody--it is the same exact thing that happens in every 
cycle. And yet I have not heard a response--I am not 
criticizing you. I have not heard a response as to how to deal 
with that other than maybe the regulators acting sensibly. But 
I do not know how you put that in a formula, if you will, and 
then try to cause that to occur.
    And that is just one example. There are all kinds of 
procyclical issues, I understand. But I think that is going to 
be maybe the most important thing that occurs. I mean, the 
whole issue is to keep us from having a systemic failure, and 
so you have to sort of work on those procyclical things, which 
are tough to do when times are good.
    But, anyway, I have taken too long. I thank each of you for 
your testimony. And when you figure that out, if you would send 
us a memo, we would appreciate it.
    Senator Bayh. Thank you very much, Senator Corker.
    Senator Shelby.
    Senator Shelby. I would like to ask the Governor a 
question, picking up on what Senator Corker is talking about, 
and that is, resolution authority. We have got this ``too big 
to fail'' mentality, and maybe it is more than that, which a 
lot of people disagree with, and the majority of the American 
people definitely disagree with. But we have got it in Europe, 
too, and so forth.
    But there has to be an end to something sooner or later, 
and if we do not have some type of legislation with something 
definite for the regulators, whoever the systemic regulator 
comes up to be, where if something does get so bad you need to 
close it up, you need to sell it off, that you do it.
    What is bothering me is Citicorp has had all this money 
pumped into it. We have 36 percent of the stock, more or less, 
I guess. There is no resolution to that a year later.
    AIG, I do not know if we are getting our arms around--I 
hear we are getting our arms around them. There are going to 
have to be some long arms, some big arms to get your arms 
around that. But what is going to be the ultimate resolution of 
that? How long is it going to take, too, all of these things? 
Because as I look at a regulator that is going to wind down 
something, I think--and oftentimes, FDIC, you have got to give 
them credit for one thing. They can wind down an institution, 
sometimes faster than a lot of people would want. But they can 
wind it down. But can the Fed wind them down? Questionable.
    Mr. Tarullo. Well, Senator, the Federal Reserve is 
certainly not interested in being a receiver or conservator of 
any institutions. Let me say a couple of things.
    One, the complexity of the larger institutions is going to 
be a challenge, and I think we all just have to acknowledge 
that. The FDIC does a terrific job of winding down 
institutions, but if we look at the profile of those 
institutions, they are overwhelmingly fairly straightforward 
banking institutions.
    Second, I think that as we approach the resolution issue, 
as I said to Senator Corker a moment ago, we do have to make 
sure that we are increasing market discipline, and usually what 
that means is--forgive me for the vernacular--but guys are 
going to take some losses. And unless that is pretty clear, 
then you are going to lose the advantages of market discipline 
along the way.
    But the third thing I will say is--and I have said this 
before in this hearing and other hearings--I am not sanguine 
that any one tool is going to be adequate to contain systemic 
risk and, more importantly, in a direct regulatory sense to 
deal with the moral hazard and too big to fail problems. That 
is why I think that we should regard a resolution mechanism as 
one element, necessarily imperfect but I hope positive, along 
that road.
    Senator Shelby. We are always going to have in a market 
system winners and losers, failures and success, and that is 
the genius of the market in a sense. And you are going to have 
failures in banks ahead down the road. But do you believe as a 
regulator that you would have some responsibility to make sure 
that these banks are well capitalized and that are not into 
something that you--in other words, you do not let the banks 
run ahead of you and jeopardize themselves and ultimately the 
taxpayers in some way?
    Mr. Tarullo. Absolutely, Senator. I think capital is one of 
the key instruments to which I was referring earlier.
    Senator Shelby. OK. Thank you, Mr. Chairman.
    Senator Bayh. Thank you, Senator Shelby.
    I just had two quick questions, Governor Tarullo, for you, 
following up on my colleagues' very good questions. You 
outlined a number of sensible steps--you referred to them as 
``practical steps''--that could be taken with regard to the 
whole resolution issue. Are any of those being pursued by the 
FSB or by other entities or in other forums? What is the 
prospect of some of those actually being implemented?
    Mr. Tarullo. A couple of things, Senator. This is one of 
those areas where there are a couple of different committees 
internationally at work on these issues. The Basel Committee on 
Banking Supervision, I think yesterday, but certainly very 
recently, released a set of recommendations on cross-border 
resolution which included some recommendations I would say are 
congruent with what I just stated a moment ago, and now there 
is going to be a follow-up process to see if we can move 
internationally along that path.
    I am quite certain that with respect to the supervisory 
colleges and information issue that I mentioned, I think that 
will move forward. With respect to the contingency planning, I 
think that will move forward, too.
    The issue of an appropriate resolution mechanism is 
something--by the way we operate in democracies--our congresses 
and parliaments are ultimately going to decide.
    The standardization of contracts----
    Senator Bayh. If I could interrupt for just a second, 
Governor, so these recommendations were made to whom?
    Mr. Tarullo. To members of the Basel Committee----
    Senator Bayh. These are just best practices basically made 
to the different countries that comprise the----
    Mr. Tarullo. And that really launches the process by which 
people then go home and say, OK, now how are we going to----
    Senator Bayh. So now it is up to all of us, basically, to 
act on these recommendations.
    Mr. Tarullo. Correct, Senator. Correct.
    Senator Bayh. Very good. My last question is for you, Mr. 
Sobel, and Ms. Casey, I hope you are not insulted I didn't have 
a question for you today. I found your testimony to be quite 
excellent, however.
    I briefly mentioned, then we got off into a different 
aspect of a question earlier, the role of the IMF, Mr. Sobel. 
What is the status of thinking on that, the FSB or----
    Mr. Sobel. The role of the IMF with the FSB?
    Senator Bayh. Well, what role they might play ultimately in 
overseeing the recommendations that are--the FSB and the other 
recommendations that are made.
    Mr. Sobel. So the----
    Senator Bayh. I know they were searching for a mission. 
With the recent crisis, they have been resuscitated. God 
willing, that is a temporary state of affairs. So I am just 
wondering what role they might play in all this at the end of 
the day.
    Mr. Sobel. Well, I think the IMF has a very important role 
to play in promoting global financial stability. The FSB brings 
together national regulators, supervisors, Treasury officials 
with standard setters. The IMF attends the meetings. Sometimes 
the way I think about it is a bit simplistic, but there is kind 
of a micro focus on what are you doing in any given 
institution.
    But I think one of the things we have learned from the 
crisis is we need a macro focus to understand what are the 
macroeconomic phenomena and dimensions that interact with the 
performance of the institutions. If you just look at one 
individual firm, but you don't see what is happening across 
firms, you can miss some----
    Senator Bayh. Well, that is a role the IMF could----
    Mr. Sobel. Yes, and that is where I see--I think the Fund 
can play an important role in providing kind of a macro 
approach to vulnerabilities and building up in the system early 
warning, perhaps. The Global Financial Stability Report is, I 
think, a high-quality product. It provides a lot of insights 
into what is happening in financial markets. And, of course, 
the IMF also works with countries, first of all, through the 
Financial Sector Assessment Programs, but also through 
technical assistance to strengthen banking systems.
    Senator Bayh. Very well. Well, again, thank you all for 
your time. A lot of good progress has been made. A lot of good 
work has been done, but this is still very much a work in 
progress. And so perhaps a year from now, I think it might be 
appropriate to reconvene and to see how much of a consensus has 
actually been achieved, what continuing disparities exist with 
regard to individual countries following up on that consensus, 
and where any opportunities for--where any leaks in the system 
might continue.
    So again, I want to thank all of you. I realize how busy 
you are. I really appreciate it. Keep up the good work. Thank 
you.
    The Subcommittee hearing is adjourned.
    [Whereupon, at 4 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
follow:]
                    PREPARED STATEMENT OF MARK SOBEL
          Acting Assistant Secretary for International Affairs
                       Department of the Treasury
                           September 30, 2009
    Chairman Bayh, Ranking Member Corker, members of the Senate 
Subcommittee on Security and International Trade and Finance, thank you 
for this opportunity to testify on the subject of international efforts 
to promote regulatory reform. I commend the Subcommittee for bringing 
greater public attention to this critical issue and for choosing such a 
propitious time, coming on the heels of the G-20 Pittsburgh Summit, to 
hold this hearing. It is also a personal privilege to testify alongside 
Dan Tarullo and Kathy Casey.
G-20 Cooperation and Progress Made
    The Pittsburgh Summit marks another milestone in the effort to 
promote a more integrated approach between national and international 
regulation and supervision. In the wake of the onset of the crisis, and 
particularly over the last year, policymakers and regulators from 
across the globe have redoubled their efforts to repair financial 
systems and put in place a stronger regulatory and supervisory 
framework to help ensure that a crisis of the magnitude we have 
witnessed does not occur again, to strengthen our financial systems so 
they are more robust in the face of duress, and to create a culture of 
greater integrity and responsibility in financial markets that guards 
against reckless behavior and excessive risk-taking.
    Good progress is being made. Last year's Washington G-20 Summit 
produced a 47-point Action Plan to strengthen regulation. The London 
Summit in April advanced that work. Already, before we went to 
Pittsburgh, the international community working through the G-20 had 
achieved much. For example:

    Prudential oversight has been strengthened. Capital 
        requirements had been increased for risky trading activities, 
        some off-balance sheet items, and securitized products. 
        Principles had been developed for sound compensation practices 
        to better align compensation with long-term performance. Banks 
        were acting to put in place strengthened liquidity risk 
        management principles.

    Agreement had been reached to extend the scope of 
        regulation to all systemically significant institutions, 
        markets and products. Non-bank financial institutions, credit 
        rating agencies, and hedge funds are being subjected to greater 
        scrutiny, while the transparency and oversight of 
        securitization and credit default swap (CDS) markets are being 
        improved.

    International cooperation is being reinforced. More than 
        thirty colleges of supervisors have met to discuss supervision 
        of large, globally active firms. The Financial Stability Board 
        (FSB, previously the Financial Stability Forum--FSF) has been 
        strengthened, including by expanding its membership to include 
        all G-20 countries, promoting financial policy coordination and 
        regulatory cooperation throughout the world.

    Market integrity has been strengthened. The G-20 has acted 
        to improve adherence to international standards in the areas of 
        prudential supervision, anti-money laundering and counter 
        financing of terrorism, and tax information exchange as part of 
        a U.S. initiative to deal with jurisdictions that fail to 
        commit to high-quality standards in these areas.

    Core Principles for Effective Deposit Insurance Systems 
        have been developed to protect depositors around the world in a 
        more consistent fashion. On a personal note, I would commend 
        Martin Gruenberg, a former staff member of this Committee and 
        now Vice-Chair at the FDIC and chair of the International 
        Association of Deposit Insurers, for his leadership on this 
        front.
Pittsburgh Summit
    A fundamental objective of the Pittsburgh Summit was to build on 
these accomplishments and the critical work underway and to identify 
and gain agreement on the necessary financial supervisory and 
regulatory reforms to prepare financial institutions to better 
withstand shocks in the future. G-20 Leaders agreed on timetables to 
take action in four key priority areas: capital, compensation, over-
the-counter (OTC) derivatives and cross-border resolution.

    Capital. The crisis demonstrated that capital and liquidity 
        requirements were simply too low and that firms were not 
        required to hold increased capital during good times to prepare 
        for bad. Thus, G-20 Leaders agreed to develop rules to improve 
        the quantity and quality of bank capital and to discourage 
        excessive leverage by end-2010. The Leaders' agreement 
        recognizes that strengthening capital standards is at the core 
        of the reform effort and it tracks closely with the Principles 
        for Reforming the United States and International Regulatory 
        Capital Framework for Banking Firms, which Secretary Geithner 
        set forth just before the G-20 Ministerial meeting in London 
        earlier this month.

    Compensation. Compensation practices at some firms created 
        a misalignment of incentives that amplified a culture of risk-
        taking. Building on the principles developed by the FSB earlier 
        this year, G-20 Leaders endorsed the implementation of 
        standards to help significant financial institutions and 
        regulators better align compensation with long-term value and 
        risk management. National supervisors will review firms' 
        policies and structures and impose corrective measures on those 
        that fail to implement sound practices.

    Cross-border banking resolution. The global financial 
        system is more interconnected than it has ever been and the 
        crisis affected financial firms without regard to their legal 
        structure, domicile or location of customers. G-20 Leaders 
        agreed to establish crisis management groups for the major 
        cross-border firms and to strengthen their domestic frameworks 
        for resolution of financial firms. Further, it was agreed that 
        prudential standards for the largest, most interconnected firms 
        should be commensurate with the costs of their failure.

    Over-the-counter (OTC) derivatives. The OTC derivatives 
        markets, which were mainly used to disperse risk to those most 
        able to bear it, also allowed hidden concentrations of risk to 
        buildup. G-20 Leaders built on the work already undertaken in 
        this area, agreeing that all standardized OTC derivative 
        contracts should be traded on exchanges or electronic trading 
        platforms and cleared through central counterparties by end-
        2012. Further, they affirmed that non-centrally cleared 
        contracts should be subject to higher capital requirements.

    In addition, the Leaders called on international accounting bodies 
to redouble their efforts to achieve a single set of high quality, 
global accounting standards. Leaders also reaffirmed their commitment 
to maintain the momentum to raise standards to deal with tax havens, 
money laundering, and terrorist finance.
    These are important achievements. But by no means can we be 
complacent. Not only must the international community act to make sure 
that all G-20 commitments are put in place at the international level, 
each G-20 country must now intensify its effort to help ensure that 
these commitments are implemented at the national level.
The National and International Spheres
    The financial crisis has highlighted the global sweep of financial 
markets. As Secretary Geithner has said, we may not all be in the same 
boat, but we are in the same storm.
    Firms and markets are now global in scope. We derive benefits from 
open, interconnected capital markets. However, traditionally, the scope 
of financial regulation was nationally oriented, stopping at the 
water's edge. Further, different national standards open the 
possibility for regulatory arbitrage, gaps in oversight, and a race to 
the bottom.
    These pitfalls must be avoided. The recent crisis also highlighted 
that financial duress can spread quickly across national boundaries.
    Thus while financial regulation continues to be essentially a 
national activity--grounded in domestic laws, cultures, and history--
and the responsibility for sound regulation begins at home, we must 
seek to improve international cooperation in the regulatory and 
supervisory sphere. In particular, the major international financial 
centers must work together to make national laws and practices more 
consistent and convergent with high quality regulation.
The Machinery for International Supervisory and Regulatory Cooperation
    Throughout the crisis, a number of bodies, in addition to the G-20, 
have helped the international community advance its work in 
strengthening the international financial system.
    Let me be clear--international cooperation is not new. For many 
years, independent standard setting bodies--such as the Basel Committee 
on Banking Supervision, the International Organization of Securities 
Commissions and the International Association of Insurance 
Supervisors--have brought together regulators from key countries with 
the aim of fostering cooperation and forging more consistent global 
standards.
    But one body, the Financial Stability Board (FSB), has played a 
critical role and I would like to highlight it as its history provides 
meaningful insights into why it is such a useful tool for us today. It 
was founded in 1999 as the Financial Stability Forum (FSF), in the 
aftermath of the Asia financial crisis, by the G-7 Finance Ministers 
and Central Bank Governors. Secretary Geithner, then the Under 
Secretary of the Treasury for International Affairs, played a seminal 
role in its establishment. It was charged to promote international 
financial stability through enhanced information exchange and 
international cooperation in financial market supervision and 
surveillance. The unique feature of the FSF was that it brought 
together G-7 central bank, finance and regulatory officials, plus 
officials from a number of other financial centers, with the heads of 
the key standard setting bodies. The focus was not so much on the 
global macroeconomic situation but on financial sector developments and 
vulnerabilities as well the work of the standard setting bodies.
    At the outset of the crisis in September 2007, the G-7 Finance 
Ministers and Central Bank Governors asked the FSF to analyze the 
causes and weaknesses producing the crisis and provide recommendations 
to increase the resilience of markets and institutions. The FSF issued 
its first report in April 2008 and an update in October of that year. 
The report set forth recommendations on: strengthened prudential 
oversight of capital, liquidity and risk management; enhancing 
transparency and valuation; changes in the role and uses of credit 
ratings; strengthening the authorities' responsiveness to risks; and 
robust arrangements for dealing with stress in the financial system.
    These recommendations have been at the center of the international 
consensus on the necessary steps to overhaul the global financial 
regulatory system and tackle the root causes of the crisis and were 
reflected in the November 2008 and April 2009 G-20 Leaders 
Declarations.
    Reconstituted as the Financial Stability Board in April 2009, with 
an enhanced mandate and membership now encompassing all G-20 countries, 
the FSB has been a key venue for preparation for both the London and 
Pittsburgh Leaders Summits. Further, the expansion of the FSB to 
include all G-20 members has meant that officials around the world are 
working together to put in place best practices, that are designed to 
help reduce the potential scope for future regulatory arbitrage.
    Mr. Chairman, while my testimony today focuses on the role of the 
G-20, FSB and international standard setting process, the Treasury 
participates in many other bodies with a view to fostering 
international financial market cooperation. In particular, we have 
strong and ongoing dialogues with the European Commission through the 
U.S./EU Financial Markets Regulatory Dialogue, Japan, China, India, our 
NAFTA partners and many more countries. These fora offer us the 
opportunity to delve deeper on a bilateral basis into financial market 
issues and share our views on the international agenda.
The FSB's Role in Promoting International Coordination
    The FSB is an informal grouping. Working with national policy and 
regulatory officials and standard setting bodies, it promotes greater 
consistency and coordination in order to foster more effective 
regulatory, supervisory and other financial sector policies across the 
world. Since the onset of the current financial crisis, the FSB has 
been a critical mechanism for setting forth a comprehensive agenda for 
reform, reflecting an international consensus, and monitoring the 
implementation of G-20 Leaders' action points. Its role has been highly 
valued, and reflecting this, its mandate has been enhanced and its 
membership expanded, strengthening the network for global financial 
supervisory and regulatory cooperation.

    The FSB's Plenary is its decisionmaking body, which meets 
        at least two times per year. Representation is at the level of 
        central bank Governor or deputy; head or deputy of the main 
        supervisory/regulatory agency; and deputy finance minister. The 
        number of seats in the Plenary assigned to member jurisdictions 
        reflects the size of the national economy and financial market 
        activity of the member jurisdiction. Plenary representatives 
        also include the chairs of the main standard setting bodies and 
        committees of central bank experts, and high-level 
        representatives of the IMF, the World Bank, the Bank for 
        International Settlements, and the Organisation for Economic 
        Co-operation and Development. Decisions are taken by consensus.

    Its Steering Committee provides operational guidance 
        between Plenary Meetings to carry forward the directions of the 
        FSB. The Steering Committee may establish working groups as 
        needed which may include representatives of non-FSB members.

    Currently, three Standing Committees have been established 
        to support FSB workstreams. These committees are for the 
        Assessment of Vulnerability; Standards Implementation; and 
        Supervisory and Regulatory Cooperation. In addition, there is 
        an Expert Group on Non-Cooperative Jurisdictions and working 
        groups on Cross-border Crisis Management and on Compensation.

    The Secretariat, located in Basel at the Bank for 
        International Settlements, supports the activities of the FSB, 
        including its Standing Committees and working groups. It also 
        facilitates efficient communication among members.

    The Chair is the principal spokesperson for the FSB and 
        represents the FSB externally. The Chair is appointed by the 
        Plenary from members for a term of 3 years renewable once. The 
        Chair has recognized expertise and standing in the 
        international financial policy arena but when acting as Chair, 
        owes duty entirely to the FSB and to no other authorities or 
        institutions. The FSB's current Chair is Mario Draghi, who is 
        also the Governor of the central bank of Italy.

    Given the FSB's vital role, its stature was recently 
        enhanced through its Charter, which was set forth by its 
        members and welcomed by the G-20 Leaders at the Pittsburgh 
        Summit. Under this new Charter, the FSB will assess financial 
        system vulnerabilities, promote coordination and information 
        exchange among authorities, advise and monitor best practices 
        to meet regulatory standards, set guidelines for and support 
        the establishment of international supervisory colleges, and 
        support cross-border crisis management and contingency 
        planning.
Alignment of Domestic and International Reforms
    In the United States, we have set out a proposal for comprehensive 
regulatory reform. But to promote a global race to the top, we need our 
G-20 partners to pursue equally ambitious reforms.
    The agendas pursued by the FSB and United States have been and are 
closely aligned. This is a function of the close cooperation between 
U.S. and international officials through the FSB, especially through 
its Steering Group and Plenary, as well as standard setting bodies.
    Effective coordination at the international level is only possible 
by ensuring a cohesive national vision. The President's Working Group 
on Financial Markets is a key coordinating vehicle. At a working level, 
Treasury has taken the lead in facilitating coordination among U.S. 
regulators, hosting weekly calls to share information and discuss work 
underway within the FSB, standard setting bodies, and other 
international organizations to implement the vision of G-20 Leaders. 
This dialog has allowed us to reconcile our perspectives and speak with 
one voice, positioning the United States as a leader on the global 
stage as we set the course for a stronger and more stable international 
financial system.
    The FSB and standard setting bodies have allowed us to align our 
vision for the future of financial markets with that of the largest 
economies across the globe. Our proposed reforms have been informed by 
the international dialog, and international agreement on the path 
forward has been shaped by our own swift action domestically to prevent 
a return to banking as usual. The meaningful progress to emerge from 
the G-20 dialog on financial regulatory reform over the last eleven 
months is testament to the success of this strategy.
    Looking forward, consistent national implementation will 
increasingly be our point of focus in the G-20. The FSB will be an 
important forum via which we will assess progress, and thematic peer 
reviews of members are planned on the implementation of many of the G-
20 action items. Already, the FSB is poised to be a critical partner in 
implementing our strategy for dealing with non cooperative 
jurisdictions, particularly with respect to compliance with 
international standards for cooperation and sharing of prudential 
information. Further, in Pittsburgh, G-20 Leaders explicitly tasked the 
FSB to monitor implementation of commitments on compensation and OTC 
derivatives.
Conclusion
    We have made substantial progress in strengthening the 
international financial system, but much more remains to be done. 
Strong national and international regulatory coordination and 
convergence have been driving forces behind our swift and effective 
response to this global crisis. But some of the flaws in our financial 
system and regulatory framework that allowed this crisis to occur, and 
in many ways helped cause it, are still in place. Importantly, our 
proposals for regulatory reform of our domestic financial markets are 
firmly entrenched in a shared vision for the future of the 
international financial system.
    The United States has been a leader in the effort to create the 
FSB, shape its agenda, expand its membership and involve it closely in 
the work of the G-20. In turn, the FSB has been a key instrument for 
international policy development in response to the global financial 
crisis. Identifying a global response has been essential to avert 
regulatory gaps, arbitrage and spillovers and to safeguard market 
dynamism. In the wake of the most recent G-20 Leaders Summit in 
Pittsburgh, we can be confident knowing that the international 
machinery to strengthen the international financial system is in place, 
has set forth principles and standards for reform that are consistent 
with the Administration's plans for reform, and is working to bring 
global standards up. These efforts must continue, but building on the 
agreements made in the G-20, now is the time for national 
implementation of reforms.
                                 ______
                                 
                PREPARED STATEMENT OF KATHLEEN L. CASEY
            Commissioner, Securities and Exchange Commission
                           September 30, 2009
    Chairman Bayh, Ranking Member Corker, and distinguished members of 
the Committee, thank you for inviting me to testify about the 
international cooperation to modernize financial regulation.
Why International Cooperation is Necessary
    I am pleased to have the opportunity to testify on behalf of the 
Securities and Exchange Commission on this very important topic. 
International cooperation is critical for the effectiveness of 
financial regulatory reform efforts. In reaffirming their commitment to 
strengthening the global financial system, the G-20 Finance Ministers 
and Bank Governors recently set forth a number of actions to ``maintain 
momentum [and] make the system more resilient.'' The G-20 banking 
statement correctly recognizes that due to the mobility of capital in 
today's world of interconnected financial markets, activity can easily 
shift from one market to another. Only collective regulatory action can 
be effective in fully addressing cross-border activity in our global 
financial system.
    As an SEC Commissioner and Chairman of the Technical Committee of 
the International Organization of Securities Commissions (IOSCO), I 
bring the perspective of both a national securities market regulator 
and a member of the international organization charged with developing 
the global response to the challenges posed to securities markets by 
the financial crisis. I also represent the SEC and IOSCO in the 
Financial Stability Board (FSB), where the U.S. financial regulatory 
policy representation is led by the Department of Treasury, with the 
SEC and the Federal Reserve Board both serving as members.
    The financial crisis has made it clear that we must address 
regulatory gaps and overlaps. The Commission has recently proposed 
action to this end in a number of different areas, recognizing, 
however, that some regulatory gaps and market issues cannot be fully 
addressed without legislative action. The Commission already is working 
to achieve consistency on the domestic and international levels, 
including through IOSCO and the FSB, with banking, insurance, futures, 
and other financial market regulators. In this vein, the Commission 
also is working to ensure respect in the global regulatory environment 
for the integrity of independent accounting and auditing standard-
setting processes for the benefit of investors. The Commission looks 
forward to continuing and improving on this cooperation as part of a 
reformed regulatory landscape.
Mechanisms for International Cooperation in Securities Market 
        Regulation
    The Commission has actively worked to achieve consistency in 
regulatory policy and implementation on an international basis through 
multilateral, regional, and bilateral mechanisms for many years. The 
SEC was a founding member of IOSCO, and has maintained a leading role 
in the organization. The Commission's commitment to international 
cooperation has become increasingly important to its mission in recent 
years in response to the increasingly global nature of financial 
markets.
    In addition to my chairmanship of IOSCO's Technical Committee, 
Commission staff leads or is very active in IOSCO's standing committees 
and taskforces. Commission staff also represents IOSCO in the Joint 
Forum on Financial Conglomerates, which was established by the Basel 
Committee on Banking Supervision, IOSCO and the International 
Association of Insurance Supervisors (IAIS) to deal with issues that 
cut across the banking, securities and insurance sectors. For example, 
SEC staff participates in the Joint Forum's Working Group on Risk 
Assessment and Capital, which has undertaken a number of cross-sectoral 
initiatives that have arisen out of the financial crisis.
    While IOSCO represents the primary vehicle for development of 
common international approaches to securities market regulation, the 
FSB is a key mechanism for the Commission to engage internationally on 
broader financial market issues. The FSB has a broader scope, with 
membership comprised of national regulatory and supervisory 
authorities, standard setting bodies and international financial 
institutions. In addition, its mission is to address vulnerabilities 
and to encourage the development of strong regulatory, supervisory and 
other policies in the interest of financial stability.
    The Commission also is represented in oversight bodies charged with 
maintaining the public accountability of international accounting and 
auditing standard-setters. SEC Chairman Schapiro is a member of the 
Monitoring Board of the International Accounting Standards Committee 
Foundation. Through this Board, the SEC and other capital market 
authorities that permit, have proposed to permit, or require the use of 
International Financial Reporting Standards in their jurisdictions have 
a means to carry out more effectively their mandates regarding investor 
protection, market integrity, and capital formation. The Commission 
also is represented through IOSCO in the Monitoring Group for the 
Public Interest Oversight Board, which serves as a mechanism for 
promoting the public interest in the development of international 
standards for auditing by the International Federation of Accountants.
    In addition to multilateral, global engagement, the Commission 
participates in regional and bilateral mechanisms for discussion and 
promotion of common approaches to regulation. SEC Commissioner Aguilar 
is the Commission's liaison to the Council of Securities Regulators of 
the Americas, or COSRA, which aims to develop high quality and 
compatible regulatory structures among authorities in the Western 
hemisphere. Commission staff, alongside staff of the Federal Reserve 
Board, the Commodity Futures Trading Commission, and other U.S. 
Government agencies, also participates in a number of Treasury-led 
financial regulatory dialogues, including with the European Commission, 
Japan, China and India, as well as Australia and our North American 
partners, Canada and Mexico.
    Securities-regulatory-focused bilateral dialogues between 
Commission staff and our counterpart securities regulators in these and 
other jurisdictions also complement the broader financial sector 
dialogues; we are engaged in such bilateral efforts with, among others, 
the U.K. Financial Services Authority and the Japan Financial Services 
Agency, the Committee of European Securities Regulators (CESR), and the 
China Securities Regulatory Commission, Securities and Exchange Board 
of India, and Korea Financial Supervisory Commission. Furthermore, the 
Commission and a number of other securities regulators have recently 
entered into bilateral ``supervisory'' memoranda of understanding that 
go well beyond sharing information on enforcement investigations. These 
supervisory MOUs, such as those the SEC has signed with the U.K.'s 
Financial Services Authority and the German consolidated financial 
services regulator (known as the ``BaFin''), represent groundbreaking 
efforts by national securities regulators to work together to cooperate 
in their oversight of financial firms that increasingly operate across 
borders.
    Thus, the infrastructure for international cooperation on 
securities regulatory policy is well-developed, and the Commission 
plays a key role in promoting rising levels of cooperation. These 
efforts build on the success the Commission has achieved in raising 
standards of cross-border enforcement cooperation. Over two decades 
ago, the Commission entered into its first bilateral memoranda of 
understanding for the sharing of information in securities enforcement 
matters. To date, the Commission has concluded bilateral agreements 
with 20 jurisdictions that remain in force today. These bilateral 
agreements were the impetus for the creation of the IOSCO Multilateral 
Memorandum of Understanding (MMoU) in 2002. Since then, authorities in 
55 jurisdictions, including the SEC, have already implemented the 
principles for cross-border enforcement cooperation contained in the 
MMoU and another 27 jurisdictions have committed to do so. With each 
additional MMoU signatory, the scope and ability of the SEC to pursue 
wrongdoers across borders significantly increases. This ability is 
increasingly important as more and more SEC investigations involve some 
international component.
    In addition to continuing to work to increase the number of 
jurisdictions that share information pursuant to the MMoU, the 
Commission also is continually working to increase the level of 
enforcement cooperation that it provides foreign counterparts as well 
as the level of cooperation provided by our global counterparts. The 
SEC was among the first securities regulators to receive the legal 
authority to assist foreign counterparts in investigations of 
securities fraud. Today, the SEC has broad authority to share 
supervisory information as well as assist foreign securities 
authorities in their investigations using a variety of tools, including 
exercising the SEC's compulsory powers to obtain documents and 
testimony. To further facilitate international cooperation, the SEC 
supports the passage of H.R. 3346 that would give authority to the 
Public Company Accounting Oversight Board, which the SEC oversees, to 
share confidential supervisory information with foreign auditor 
oversight bodies. The Commission believes that granting this authority 
to the PCAOB would enhance auditor oversight, audit quality and, 
ultimately, investor protection.
Key Securities Regulatory Reform Issues and International Cooperation
    The Commission has led or supported the development of a number of 
international securities market regulatory initiatives to support the 
strengthening of the global financial system in the wake of the 
financial crisis. These initiatives, developed through IOSCO, its joint 
working group with the Committee on Payment and Settlement Systems 
(CPSS), and the Joint Forum, have been developed in conjunction with 
calls from the G-20 and FSB to ensure that all systemically important 
financial institutions, markets, and instruments are subject to an 
appropriate degree of regulation and oversight.
IOSCO
    IOSCO's Subprime Task Force issued its report in 2008, examining 
the underlying causes of the financial crisis and the implications for 
international capital markets. IOSCO launched a number of ongoing 
projects in response to recommendations in this report, including in 
key areas such as issuer transparency and investor due diligence; firm 
risk management and prudential supervision; valuation and accounting 
issues. Last fall, following on concerns highlighted by the G-20 
Leaders, IOSCO also established task forces on unregulated entities, 
unregulated financial markets and products, and supervisory 
cooperation, each of which is discussed in greater depth below. The 
Commission has contributed significantly to these projects with a view 
to ensuring that global capital markets address issues relating to the 
current turmoil in a sound and aligned way.
Credit Rating Agencies
    With regard to credit rating agencies, in February of this year, 
IOSCO established a permanent standing committee to continually 
evaluate and seek cross-border consensus for CRA regulation. IOSCO has 
built on the early work in this area that resulted in the IOSCO CRA 
Principles and Code of Conduct Fundamentals first adopted in 2003 and 
2004. The Code Fundamentals, as amended in 2008 as a consequence of 
``lessons learned'' during the early ``subprime crisis,'' has already 
been substantially adopted by at least seven rating agencies, including 
the largest ones. Staff of the SEC chair this committee.
Unregulated Entities
    With regard to unregulated entities, following extensive 
consultation, IOSCO agreed to a set of high-level principles for hedge 
fund regulation in June of this year. The six principles include 
requirements on mandatory registration for funds or their advisers, 
ongoing regulation and provision of information for systemic risk 
assessment purposes.
    They also state that regulators should cooperate and share 
information to facilitate efficient and effective oversight of globally 
active hedge fund managers and hedge funds. Work continues in IOSCO on 
defining what type of information should be provided by the hedge fund 
sector (and their counterparties) to allow regulators to assess the 
systemic importance of individual actors and identify possible 
financial stability risks.
Unregulated Markets and Products
    Earlier this month, IOSCO's Task Force on Unregulated Financial 
Markets and Products issued a number of recommendations concerning 
regulatory approaches that may be implemented with respect to the 
securitization and credit default swap (CDS) markets, as these two 
markets were key elements of the global financial crisis. The Task 
Force continues to consider whether additional work should be 
undertaken regarding implementation of the recommendations.
    In addition, the Commission has worked closely over the past year 
with international regulators and central banks in gaining first-hand 
experience in applying the Recommendations for Central Counterparties 
(RCCPs) to proposed arrangements for OTC credit derivatives 
transactions. This has highlighted some challenges regarding the 
application of RCCPs to credit default swaps (CDSs), particularly with 
respect to valuation models. The CPSS, under the leadership of New York 
Federal Reserve Bank President William Dudley, and IOSCO have created a 
joint working group (co-chaired by the European Central Bank) to 
propose guidance on how central counterparties for OTC derivatives may 
meet the standards set out by the RCCP and will identify any areas in 
which the RCCP might be strengthened or expanded to better address 
risks associated with the central clearing of OTC derivatives. This 
working group will complete its report by the middle of 2010.
Supervisory Cooperation
    As operations globalize, oversight and supervision require 
increased cross border cooperation. Supervisory cooperation is a 
critical tool in gathering information about risks and trends within 
institutions and across markets. To this end, IOSCO established a Task 
Force on Supervisory Cooperation this spring to develop principles on 
regulatory cooperation in the supervision and oversight of market 
participants, such as exchanges, funds, brokers, and advisers, whose 
operations cross international borders. Final principles are expected 
to be published in February 2010.
Commodity Futures Markets
    IOSCO's Task Force on Commodity Futures Markets, which was formed 
following concerns relating to price and volatility increases in 
agricultural and energy commodities in 2008, focused on whether futures 
market regulators' supervisory approaches were appropriate in light of 
market developments. The Task Force issued its report in March 2009 
with recommendations aimed at ensuring that regulators have the 
appropriate information and tools available to them to monitor futures 
markets effectively and act against any market manipulation. The Task 
Force was recently revived, with CFTC Chairman Gary Gensler and U.K. 
Financial Services Authority Chairman Adair Turner as co-chairs, to 
continue to address concerns about access to relevant information for 
effective market surveillance and to promote improvements to regulatory 
frameworks that may inhibit the ability to detect and enforce market 
manipulation cases.
Joint Forum Cross-Sectoral Projects
    The Commission, participating through IOSCO in the Joint Forum, 
which is led by Comptroller of the Currency John Dugan, is taking part 
in a review of the scope of financial regulation, with a special 
emphasis on institutions, instruments, and markets that are currently 
unregulated. The group's focus is on the differentiated nature of 
regulation in the banking, securities and insurance sectors; current 
consolidated supervision and unregulated entities or unregulated 
activities within a conglomerate structure; and the regulation of hedge 
funds; among other issues. The main deliverable of this workstream will 
be a report to the FSB and G-20 Finance Ministers and Governors, and is 
expected by the end of this year.
    In addition, the Joint Forum's Working Group on Risk Assessment and 
Capital (JFRAC) recently finalized its report examining the range of 
various Special Purpose Entities (SPEs) used by financial firms to 
transfer risk for capital and liquidity management purposes as well as 
derivatives vehicles and transformer vehicles. Finally, in recognition 
of the reality that prudential supervision is becoming increasingly 
risk-sensitive in the different sectors, JFRAC has also undertaken a 
project to consider methods for risk aggregation that incorporate a 
characterization and quantification of diversification effects within 
financial firms. The primary focus of this work will be on aggregation 
across different types of risk--such as credit, market, insurance, and 
operational risk--and on similarities and differences between the 
commercial banking, investment banking, and insurance sectors. A 
preliminary draft paper will be discussed at the October Joint Forum 
meeting.
FSB / G-20 Participation and U.S. Government Coordination
    With regard to my role at the FSB, I represent both the Commission 
and the IOSCO Technical Committee alongside the other U.S. Government 
participants, namely Governor Tarullo of the Federal Reserve Board and 
the Under Secretary for International Affairs of the Department of 
Treasury. The Commission places a high priority on coordinating the 
U.S. position with its fellow agencies and presenting a strong and 
unified position in policy discussions at the FSB level. This is 
accomplished through extensive and informal communication between the 
staffs of our agencies, including the Office of the Comptroller of the 
Currency (OCC), the Commodity Futures Trading Commission (CFTC), the 
Federal Deposit Insurance Corporation (FDIC) and the National 
Association of Insurance Commissioners (NAIC), among others, and has 
been highly effective. In this regard, the work that Comptroller of 
Currency Dugan and I jointly led, under theauspices of the Financial 
Stability Forum's efforts to reduce procyclicality of regulation, to 
explore possible improvements to the accounting for loan loss 
provisioning is particularly noteworthy.
Importance of the Role of Technical Experts and Independent, 
        Consultative Rulemaking
    The international financial regulatory architecture that I have 
just outlined has proven its robustness in the level of cooperation 
since the outbreak of the financial crisis. The G-20 leaders' focus on 
financial regulation has provided more high-level and political 
attention to these ongoing efforts. With the conversion of the 
Financial Stability Forum into the FSB and expansion of its membership 
to the G-20, the architecture is evolving to reflect the growing 
importance of emerging markets and international cooperation in light 
of the interconnectedness of the global financial system. While the 
Commission supports and participates in the work of all of these 
international organizations, I would like to take this opportunity to 
highlight the different roles that these international organizations 
should play as nations increasingly seek to cooperate with regard to 
international financial regulatory policy.
    The FSB, for example, comprises officials from across the spectrum 
of financial regulation, and so is very useful as a discussion forum to 
determine broad trends in the financial system. Through FSB 
discussions, gaps in regulation can be more readily identified and 
prioritized. The G-20 focus on these results also is helpful in 
ensuring that the pace of reform is maintained and that a clear 
international framework emerges.
    Given the complexity of the financial markets, however, it is 
critical that technical regulatory bodies such as those represented in 
IOSCO, as well as statutorily mandated independent regulators, such as 
the Commission, have control over their agendas and the ultimate 
outcomes of their regulatory and standard-setting work. The regulators 
and supervisors of each financial sector have specific goals for 
regulation, which may differ slightly from sector to sector, but are 
all important. For example, a key goal of securities regulators is 
investor protection; this goal is not the focus of bank or insurance 
supervisors, who have other priorities. Only by allowing the technical 
experts to develop regulatory approaches to address areas of concern in 
their sector can we ensure that all regulatory goals are being met. 
Moreover, implementation and enforcement depend on legal mechanisms and 
processes that vary jurisdiction by jurisdiction, and sector by sector.
    One example where this approach has been successful is raising 
standards for international securities law enforcement cooperation. The 
development of the IOSCO MMoU, and the push to further expand the 
number of jurisdictions providing cooperation as well as deepen the 
level of cooperation they provide, has significantly raised standards 
of cooperation in the securities sector over the past decade. The FSB's 
effort to promote standards in non-cooperative jurisdictions will 
provide opportunities to raise the level of cooperation across a broad 
range of financial regulatory enforcement concerns.
    The Commission looks forward to continuing the constructive dialog 
with our colleagues at the Fed, Treasury, and other agencies, in 
continuing to develop the common U.S. position in the future. For more 
specifics on the outcome of the recent G-20 meeting, I defer to Mark 
Sobel of the Treasury Department, as the Commission did not directly 
participate in the Summit or the G-20 process leading to Pittsburgh.
Conclusion
    While the Commission's particular focus--and that of IOSCO--on 
investor protection and efficient and fair markets has remained 
constant and somewhat distinct from that of banking supervisors and 
regulators of other market segments, our recent collaborative work--
both at home and internationally--has shown significant progress in 
strengthening the global financial regulatory system. It remains the 
case that investor protection and a focus on efforts to enhance 
investor confidence are vital to interests of financial stability on 
national and global levels.
    In its June White Paper, the Administration named as one of its 
five key objectives of financial regulatory reform the raising of 
international regulatory standards and improvement of international 
cooperation. The Commission, through IOSCO, the FSB, other cross-border 
mechanisms, and coordinating domestically with fellow financial 
regulators, stands ready to continue its collaborative work with the 
aim of enhancing our ability to identify and address systemic risks 
early across the world's financial markets. International cooperation 
is essential to the success of any financial regulatory reform that we 
undertake.
    Thank you for this opportunity to address such timely and relevant 
global regulatory issues.
                                 ______
                                 
                PREPARED STATEMENT OF DANIEL K. TARULLO
        Member, Board of Governors of the Federal Reserve System
                           September 30, 2009
    Chairman Bayh, Ranking Member Corker, and other members of the 
Subcommittee, I appreciate the opportunity to testify today on the role 
of international cooperation in modernizing financial regulation. 
International cooperation is important for the interests of the United 
States because, as has been graphically illustrated in the past 2 
years, financial instability can spread rapidly across national 
boundaries. Well-devised international financial regulatory standards 
can help encourage all nations to maintain effective domestic 
regulatory systems. Coordinated international supervisory arrangements 
can help ensure that every large, internationally active financial 
institution is effectively supervised. Both these forms of 
international cooperation can, at the same time, promote at least a 
roughly equivalent competitive environment for U.S. financial 
institutions with those from other nations.
    In my testimony this afternoon, I will review the responses of key 
international regulatory groups to the financial crisis, including both 
substantive policy responses and the organizational changes in 
membership and working methods in some of those groups. Next I will 
describe specifically the role of the Federal Reserve's participation 
and priorities in these international regulatory groups. I will 
conclude with some thoughts on the challenges for international 
regulatory cooperation as we move forward from the G-20 Pittsburgh 
Summit and the exceptionally active international coordination process 
that has preceded it.
The Response of International Regulatory Groups to the Crisis
    Over the past few decades, international cooperation in financial 
regulation has generally been pursued in a number of groups that bring 
together national authorities with responsibility for regulating or 
supervising in a particular area, or that served as venues for informal 
discussion. Several of the functional regulatory groups have undertaken 
initiatives in response to the recent financial crisis. During this 
period, the Financial Stability Board (FSB) shifted from being more of 
a discussion forum to serving as a coordinator of these initiatives. 
The FSB was also the direct line of communication between these groups 
and the G-20.
    The Federal Reserve actively participates in the FSB as well as in 
the following international groups:

    In the Committee on Payment and Settlement Systems, we work 
        with other central banks to promote sound and efficient payment 
        and settlement systems.

    In the Committee on the Global Financial System, we work 
        with other central banks to monitor developments in global 
        financial markets, reporting to the central bank Governors of 
        the G-10 countries.

    In the Basel Committee on Banking Supervision (Basel 
        Committee), we and the other U.S. bank supervisors work with 
        other central banks and bank supervisory agencies to promote 
        sound banking supervision by developing standards for bank 
        capital requirements and bank risk management, and by 
        promulgating principles for effective bank supervision. The 
        Basel Committee, which doubled its membership earlier this 
        year, now includes supervisors from 27 jurisdictions, including 
        both advanced and emerging markets.\1\
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    \1\ The Basel Committee's members come from Argentina, Australia, 
Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, 
Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, 
Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, 
Switzerland, Turkey, the United Kingdom, and the United States.

    In the Joint Forum, we and other U.S. financial 
        regulators--including bank, securities, and insurance 
        regulators--work with financial regulators from other countries 
        to enhance financial regulation that spans different financial 
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        sectors.

    In the Senior Supervisors Group, we and other U.S. 
        supervisors have worked over the past few years with the 
        supervisors of other major financial firms to share information 
        and sponsor joint reviews of risk management and disclosure.

    In bilateral and regional supervisory groups, we have 
        discussed regulatory issues with Europe, China, India, Japan 
        and other supervisors from the Western Hemisphere. Some of 
        these groups have quite a long history. Both the Committee on 
        the Global Financial System and the Basel Committee date back 
        to the 1970s. These groups are not formal international 
        organizations. They have operated with only a modest support 
        staff--often provided, along with a location for meetings, by 
        the Bank for International Settlements (BIS). The bulk of their 
        activity is conducted by officials from the national regulators 
        themselves.

    The FSB is a relatively new group, established in the wake of the 
Asian financial crisis in 1999 as the Financial Stability Forum, with a 
broad mandate to promote global financial stability. The FSB is an 
unusual combination of international standard-setting bodies (including 
those mentioned above) and a range of national authorities responsible 
for financial stability: treasury departments and ministries of 
finance, central banks, and financial supervisory agencies.\2\ Major 
international organizations such as the BIS and the International 
Monetary Fund (IMF) also participate.\3\ At the request of the G-20 in 
April 2009, the Financial Stability Forum's name was changed to the 
Financial Stability Board, its membership was expanded to add the 
emerging market countries from the G-20, and its mandate was 
strengthened.
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    \2\ International standard-setting bodies participating in the FSB 
are the Basel Committee, the Committee on the Global Financial System, 
the Committee on Payment and Settlement Systems, the International 
Association of Insurance Supervisors, the International Accounting 
Standards Board, and the International Organization of Securities 
Commissions.
    The jurisdictions represented on the FSB are: Argentina, Australia, 
Brazil, Canada, China, France, Germany, Hong Kong SAR, India, 
Indonesia, Italy, Japan, Mexico, the Netherlands, Russia, Saudi Arabia, 
Singapore, South Africa, South Korea, Spain, Switzerland, Turkey, the 
United Kingdom, and the United States.
    \3\ International organizations in the FSB are the BIS, the 
European Central Bank, the European Commission, the IMF, the 
Organisation for Economic Co-operation and Development, and The World 
Bank.
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    The financial crisis has underscored the importance of the original 
motivation for creating what is now the FSB. The connections among 
financial market sectors, and between macroeconomic policy and 
financial markets, mean that efforts to ensure international financial 
stability must incorporate a breadth of perspectives and include 
communication among the various international groups in which 
regulatory cooperation takes place. In its work to increase 
international financial stability and to promote financial regulatory 
reform, the FSB has tried to identify priorities and agree upon high-
level principles. It has then requested that the relevant standard-
setting bodies formulate detailed proposals and report back to the FSB.
    All these international groups, including the FSB, operate by 
consensus. Although this institutional feature can create significant 
challenges in reaching agreement on complex topics, it also serves as a 
check on potentially undesirable policy directions. The process of 
developing proposals in the standard-setting bodies allows a variety of 
ideas to be explored and exposed to critical examination by expert 
staff. Like any other process, alternative viewpoints emerge and 
dissenting opinions are voiced. Once a consensus is reached, it is then 
up to individual members to implement any statutory changes, 
administrative rules, or guidance under local law.
    As already noted, the FSB has played a leading role in guiding the 
official response to the crisis. In April 2008, it made a range of 
recommendations to increase the resiliency of financial markets and 
institutions. These recommendations are broadly consistent with similar 
principles articulated by the President's Working Group on Financial 
Markets here in the United States. The FSB has acted upon priorities 
identified by the G-20 leaders and has delivered to those leaders a 
series of proposals that have been adopted by them, most recently at 
the Pittsburgh summit last week. With its role now expanded and in the 
process of being formalized in a charter, the FSB will have the ongoing 
mandate of identifying and addressing emerging vulnerabilities in the 
financial system.
    The activities of some other groups have also broadened in response 
to the crisis. The Basel Committee was formed in 1974 in an effort by 
national authorities to fill supervisory gaps exposed by problems in a 
number of internationally active banks. Beginning in the late 1980s, 
its focus shifted to setting capital standards for internationally 
active banks. That emphasis continues today, notably with respect to 
strengthening capital requirements for securitization exposures and 
trading book exposures as well as disclosure requirements related to 
these areas. The Basel Committee has now begun to address a wider range 
of issues aimed at improving standards for capital, liquidity, cross-
border bank resolution, leverage, and macroprudential supervision.
    In March 2008, the Senior Supervisors Group released its first 
report on risk-management practices.\4\ The report, based on extensive 
discussions with large financial institutions, provided near-real-time 
analysis of the major failures in risk management and internal controls 
that led to outsized losses at a number of firms, and highlighted 
distinctions in practices that may have enabled some other institutions 
to better withstand the crisis. The group is now in the final phases of 
preparing a second report that will focus on the challenges that 
emerged as particularly critical last year, notably related to 
management of liquidity risk, and present the results of the self-
assessments by the largest financial institutions regarding their 
responses to the riskmanagement and internal control issues highlighted 
by the crisis.
---------------------------------------------------------------------------
    \4\ See Senior Supervisors Group (2008), Observations on Risk 
Management Practices during the Recent Market Turbulence (Basel: SSG, 
March 6), available at Federal Reserve Bank of New York (2008), 
``Senior Supervisors Group Issues Report on Risk Management 
Practices,'' press release, March 6, www.newyorkfed.org/newsevents/
news/banking/2008/rp080306.html.
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    International regulatory and supervisory bodies have been actively 
engaged in addressing a wide range of issues, many of which have been 
highlighted by the recent financial crisis. Let me now discuss in more 
detail a few of the areas that are most important from the perspective 
of the Federal Reserve.
Capital
    The financial crisis has left little doubt that capital levels of 
many financial firms, including many in the United States, were 
insufficient to protect them and the financial system as a whole. The 
FSB has called for significantly stronger capital standards, to be 
agreed upon now and phased in as financial and economic conditions 
improve. The communiquE issued Friday by the G-20 leaders echoed and 
amplified the need for improvements in both the quantity and quality of 
capital.
    One critical area for improvement is that of increasing capital 
requirements for many forms of traded securities, including some 
securitized assets. Some work has already been completed. We place a 
high priority on undertaking a comprehensive review and reform of these 
requirements. The Basel Committee is also working on proposals for an 
international leverage ratio to act as a supplement to risk-based 
capital ratios. The FSB has also devoted considerable energies to 
exploring sources of procyclicality in the financial system, which are 
those practices and structures that tend to amplify rather than dampen 
the cycles characteristic of financial markets, and to identifying 
possible strategies to reduce their effects, which were often quite 
visible during the recent crisis. One such strategy is to include a 
countercyclical capital buffer in the capital requirements for 
financial firms. Work on such a buffer is under way, though the 
technical challenges of devising an effective buffering mechanism are 
significant.
    It will be important for the international regulatory community to 
carefully calibrate the aggregate effect of these initiatives to ensure 
that they protect against future crises while not raising capital 
requirements to such a degree that the availability of credit to 
support economic growth is unduly constrained. The Basel Committee 
plans a study of the overall calibration of these changes for early 
next year.
Liquidity
    Liquidity risk is another key international agenda item. Although 
the Basel Committee had historically focused on capital standards, the 
crisis clearly demonstrated that adequate capital was a necessary but 
not always sufficient condition to ensure the ability of a financial 
institution to withstand market stress. We were reminded that the 
liquidity of a firm's assets is critical to its ability to meet its 
obligations in times of market dislocation. In particular, access to 
wholesale financing very quickly became severely constrained for many 
institutions that had grown quite dependent on it. The Basel Committee 
promulgated general guidance on liquidity risk management in June 2008 
and is now in the process of incorporating those broad principles into 
specific quantitative requirements.
Cross-Border Bank Resolution
    In the area of cross-border resolution authority, there is broad 
international agreement that existing frameworks simply do not allow 
for the orderly resolution of cross-border failures of large complex 
banking organizations and that changes are needed. Current frameworks 
focus on individual institutions rather than financial groups or the 
financial systems at large. These frameworks have proven problematic 
even at the national level. Policy differences and legal obstacles can 
magnify these shortcomings at the international level.
    The Basel Committee's Cross-Border Bank Resolution Group has 
developed 10 recommendations for national authorities.\5\ The 
recommendations, which aim at greater convergence of national 
resolution frameworks, should help strengthen cross-border crisis 
management. One key recommendation requires systemically important 
firms to have contingency plans that will allow for an orderly 
resolution should that prove necessary. Implementation of these 
recommendations is likely to require heightened cooperation throughout 
the international community.
---------------------------------------------------------------------------
    \5\ See Basel Committee on Banking Supervision, Cross-Border Bank 
Resolution Group (2009), Report and Recommendations of the Cross-Border 
Resolution Group (Basel: Basel Committee, September), available at 
www.bis.org/publ/bcbs162.htm.
---------------------------------------------------------------------------
Accounting Standards for Financial Institutions
    The FSB and the Basel Committee have an important role in 
supporting improved accounting standards for financial institutions. 
For example, the FSB has developed recommendations for improving the 
accounting for loan loss provisions. The Basel Committee consults 
frequently with those who set international accounting standards on 
these and other topics and provides comments on important accounting 
proposals affecting financial institutions.
Future Initiatives
    A number of other initiatives are at an earlier stage of policy 
development. A good deal of attention right now is focused on 
mitigating the risks of systemically important financial firms. Two of 
the more promising ideas are particularly worth mentioning. One is for 
a requirement for contingent capital that converts from debt to equity 
in times of stress or for comparable arrangements that require firms 
themselves to provide for back-up sources of capital. The other is for 
a special capital or other charge to be applied on firms based on their 
degree of systemic importance. Many of these initiatives still require 
much work at the technical level before policy proposals will be ready 
for a thorough vetting in the national and international regulatory 
community.
How the Federal Reserve Pursues Our Objectives in International Groups
    The Federal Reserve promotes U.S. interests in these international 
groups by actively participating and by coordinating with other U.S. 
participants.
    The international groups that I mentioned earlier all hold regular 
meetings. The FSB meets at least twice a year, and the Basel Committee 
typically meets four times a year. Between meetings of the main groups, 
subgroups of technical experts meet to discuss proposals and lay the 
groundwork for issues to be discussed at the main groups. The Federal 
Reserve actively participates in both the main groups and the 
subgroups. For practical purposes, not all members of a group can sit 
on each subgroup, although the United States is well represented on all 
major topics and chairs important subgroups.
    We have found that success in pursuing our objectives in these 
groups depends upon having well-developed ideas. One important basis 
for leadership in international groups is the quality of the 
intellectual and policy contributions that an organization can offer. 
To this end, we have tried to use the extensive economic and research 
resources of the Federal Reserve, as well as our regulatory experience, 
to produce well-considered proposals and useful feedback on the 
proposals of others.
    International groups operate on the basis of consensus. Policies 
are endorsed only when all members voice their support. This approach 
can make it challenging to come to agreement on complex topics. But 
international groups are made up of regulatory agencies or central 
banks, and they have particular responsibilities based on their own 
national laws. International groups are not empowered to create 
enforceable law, and agreements need to be implemented by member 
countries in the form of statutory changes, administrative rules, or 
supervisory guidance. Thus, the consensus orientation of the 
international policy development process is necessary to respect the 
domestic legal structures within which the various regulatory agencies 
operate.
    The President's Working Group on Financial Markets is the primary 
forum in which regulatory issues are discussed among the principals of 
the U.S. financial regulatory agencies. These discussions often cover 
the same issues being discussed in international groups. We strive to 
maintain a degree of intellectual rigor and collegiality in these 
discussions where consensus is again the norm, despite the sometimes 
different perspectives of the various agencies. In the past, there were 
some notable instances of significant disagreement among the U.S. 
agencies, but my observation since being appointed to the Federal 
Reserve is that the coordination process is working quite well. Indeed, 
it can sometimes be an advantage to have multiple U.S. agencies 
involved in international processes because of the complementary 
expertise we each bring to bear. In addition, at the international 
level, having multiple U.S. agencies at the table provides an 
appropriate counterweight to our European counterparts, who for 
historical reasons are usually overrepresented in international groups 
relative to their weight in the global financial system.
    Like other central banks, the Federal Reserve did not participate 
in the G-20 summit, which is attended by heads of state and finance 
ministers. However, we are involved in a significant part of the 
relevant preparatory and follow-up work, both through the FSB and in 
joint meetings of the G-20 finance ministers and central banks.\6\ In 
preparation for the Pittsburgh summit, as well as for the previous G-20 
summits in London and Washington, the Federal Reserve has also 
collaborated with other U.S. financial regulatory agencies in 
considering the financial regulatory issues on the agendas for these 
meetings.
---------------------------------------------------------------------------
    \6\ The FSB prepared three documents that were presented to G-20 
leaders at the summit: ``FSB Principles for Sound Compensation 
Practices,'' ``Improving Financial Regulation,'' and ``Overview of 
Progress in Implementing the London Summit Recommendations for 
Strengthening Financial Stability.''
---------------------------------------------------------------------------
Challenges for International Financial Cooperation
    The testimony that my colleagues and I have offered this afternoon 
reflects the breadth and depth of the tasks associated with improved 
regulation and supervision of financial markets, activities, and firms. 
An ambitious agenda has been developed through the interactions of the 
G-20, the FSB, and international standard-setting bodies, and much work 
toward completing that agenda is already under way. At the same time, 
there will inevitably be challenges as we all intensify and reorient 
the work of these groups. I will now discuss four of those challenges.
    First, for all the virtues of the consensus-based approach 
involving the relevant national authorities, some subjects will simply 
be very difficult to handle fully in this fashion. Crossborder 
resolution may prove to be one such issue. Although there is 
undoubtedly potential for achieving improvement in the current 
situation through the international processes I have described, the 
complexities involved because of the existence of differing national 
bankruptcy and bank resolution laws may limit what can be achieved.
    Second, there will likely be a period of working out the 
relationships among the various international bodies, particularly in 
light of the increased role of the FSB. We will need to determine how 
extensively the FSB and its newly constituted committees should 
themselves develop standards, particularly where an existing 
international standards-setting body has the expertise and mandate to 
address the topic. Similarly, while simultaneous consideration of the 
same issue in multiple international bodies can sometimes be a useful 
way to develop alternative proposals, there may also be potential for 
initiatives that are at odds with one another.
    Third, the significant expansion in membership of many of the more 
important of these bodies may require some innovation in organizational 
approaches in order to maintain the combination of flexibility and 
effectiveness that the FSB and some of the other groups have, at their 
best, possessed in the past. The substitution of the G-20 for the G-8 
at the level of heads of government is the most visible manifestation 
of the salutary trend toward involving a number of emerging market 
economies in key international financial regulatory arrangements. As I 
mentioned earlier, the FSB and the Basel Committee have recently 
expanded their membership to the entire G-20. Important as this 
expansion is for the goal of global financial stability, the greater 
number of participants does have an impact upon the operation of those 
groups, and we will need to adapt accordingly. I hasten to add that 
this is not at all a comment on the capacities of the new members. On 
the contrary, I have been impressed with the quality of the 
participation from the new emerging market members.
    Finally, the financial crisis has understandably concentrated the 
attention and energies of many of these international regulatory groups 
on the new standards that will be necessary to protect financial 
stability in the future. Combined with the enlarged memberships of 
these groups, however, this focus on negotiating standards may 
unintentionally displace some of the traditional attention to fostering 
cooperative supervisory practices by the national regulators who 
participate in these international bodies. It is important that, even 
as we represent our national interests in these bodies, we also promote 
the shared interests we have in effective financial supervision.
Conclusion
    Participating in international regulatory groups has helped the 
Federal Reserve and other U.S. agencies begin to shape an effective 
global regulatory response to the financial crisis. We look forward to 
continuing our collaboration in pursuit of effective, efficient 
financial regulation.
    Thank you for inviting me to present the Board's views on this very 
important subject. I look forward to continuing dialog with the 
Subcommittee on these issues. I would be pleased to answer any 
questions you may have.

  RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORKER FROM MARK 
                             SOBEL

On Resolution Authority
Q.1. The Administration's proposal asks for significant and 
broad resolution authority that is, in effect, TARP on 
steroids. While some will still advance the theory that the 
bankruptcy courts with a few tweaks would be enough of a 
solution, the challenges we have seen with Lehman's resolution 
abroad question the theory that with no globally astute and 
integrated resolution regime, the court systems will not 
function cohesively and instead will be inclined to ring fence 
and protect for their own taxpayers.
    Explain to me how would the Administration's proposed 
resolution process work overseas? Do you think that is the 
optimal model? Propping up failed institutions around the globe 
at taxpayer's expense into perpetuity? Is the Treasury 
Department conducting any economic analysis so the impact of 
any proposal is fully understood before it is uniformly agreed 
to and adopted? And if so, when will you be willing to share 
this information to help us inform our policymaking?

A.1. The United States, led by the Federal Depository Insurance 
Corporation (FDIC), is working closely with international 
counterparts within the Basel Committee, to study the important 
issue of resolutions at the international level. The Cross 
Border Bank Resolution Working Group has conducted serious 
analysis and published two reports with ten proposals to 
strengthen international and national frameworks for cross-
border resolution of international institutions and, 
importantly, used the recent crisis as ``lessons learned.'' 
(Available at: http://www.bis.org/publ/bcbs162.htm) Recognizing 
that strictly national approaches are inefficient and global 
approaches may not be viable, the Group has recommended that 
major financial centers adopt comparable, consistent domestic 
resolution regimes similar to the FDIC approach. These 
proposals were issued for comment, with a deadline of December 
31, 2009. The United States supports countries having strong 
and effective national resolution frameworks and an orderly 
resolution process, all of which will minimize the damage to 
the financial system and reduce cost to the taxpayer.
    As Secretary Geithner noted in his testimony before the 
House Financial Services Committee, the proposed resolution 
authority would not authorize the government to provide open-
bank assistance to any failing firm. That is, the government 
would not be permitted to put money into a failing firm unless 
that firm is in FDIC receivership and on the path to being 
unwound, dismantled, sold, or liquidated. The receivership 
authority would facilitate the orderly demise of a failing 
firm, not ensure its survival, and would strengthen market 
discipline and reduce moral hazard risks, while protecting the 
financial system and taxpayers. It also is important that there 
are appropriate checks and balances and that the special 
resolution regime may be used only with the agreement of the 
Secretary of the Treasury and two-thirds of the boards of the 
Federal Reserve and the FDIC. In addition, any losses from a 
special resolution must be recouped with assessments on the 
largest non-bank financial firms.
On Insurance Issues
Q.2. I want to ask you a couple of questions regarding the G-20 
and the Financial Stability Board's cooperative efforts on 
regulatory reform. I am curious if insurance issues fall under 
this effort and how so? I ask because it has been a challenge 
for European regulators' to not having a counterpart in the 
U.S. Executive branch on insurance issues. They complain that 
our current system not only represents inefficiency, but is 
also a barrier to global coordination on regulatory reform 
efforts. They also fear this is a potential problem in any 
future crisis and in resolving failed firms that have insurance 
subsidiaries.
    Can you tell me specifically if cooperation on insurance 
regulation falls under the G-20 and FSB mandates, and if yes, 
does the U.S. Executive branch have adequate authority to take 
necessary actions under this mandate, or is the United States 
lacking the proper tools to address insurance issues as part of 
a comprehensive effort to address crises such as that which we 
have just lived through?

A.2. The Treasury Department's International Affairs Office 
coordinates the USG position and participation in the Financial 
Stability Board (FSB), which is mandated to: deepen the 
resiliency of domestic financial systems; identify and address 
potential vulnerabilities in international financial systems; 
and enhance international crisis management. Senior-level 
officials from the Federal Reserve, Securities Exchange 
Commission, and the Treasury Department represent the United 
States in FSB meetings. Other Federal financial regulatory 
agencies (the Federal Deposit Insurance Corporation, the Office 
of the Comptroller of the Currency, the Commodity Futures 
Trading Commission), as well as the National Association of 
Insurance Commissioners participate in USG preparation for the 
FSB meetings and provide input. Treasury Secretary Geithner and 
Federal Reserve Chairman Bernanke represent the United States 
at meetings of the G-20 Finance Ministers and Central Bank 
Governors. At the Pittsburgh Summit in late September, Leaders 
designated the G-20 as the premier forum for our international 
economic cooperation.
    To date, neither the FSB nor the G-20 has offered 
regulatory guidance solely directed at the insurance sector. 
Certain cross-cutting issues, however, affect insurance, such 
as supervisory colleges, heightened prudential regulation for 
large, interconnected financial institutions, and cross-border 
resolution. The regulatory reform agenda in these fora largely 
reflects effective U.S. leadership and is consistent with the 
approach taken in the Administration's proposals, which are 
pending action by the Congress.
    As you have noted, some Europeans suggest that the absence 
of a Federal regulatory representative complicates their 
international dealings on insurance supervision, for example on 
issues of reinsurance collateral or Europe's evolving 
supervisory regime. The Administration's proposals would give 
the Treasury Department the authority to represent American 
interests in international fora regarding prudential measures 
for insurance. While the Office of National Insurance is not a 
regulator, it would provide a single coordinated USG voice on 
prudential matters related to insurance. It would serve as a 
Federal authority to represent U.S. interests to work with 
other nations within the International Association of Insurance 
Supervisors (IAIS) on prudential regulatory issues, cooperation 
and agreements.
Transparency of the FSB
Q.3. As it builds out to handle its new mandate, how will it be 
held accountable, to whom, how will input flow into the 
process?

A.3. The FSB membership consists of national and regional 
authorities responsible for maintaining financial stability 
(ministries of finance, central banks, and regulatory 
authorities), international financial institutions, and 
international standard setting, regulatory, supervisory and 
central bank bodies. All members are entitled to attend and 
participate in the Plenary, which is the decisionmaking body of 
the FSB. Representation on the Plenary is at the level of: 
central bank Governor or immediate deputy, head or immediate 
deputy of the main regulatory agency, and deputy finance 
minister or deputy head of finance ministry. Representation by 
the international financial institutions and the international 
standard setting bodies is at a similar level.
    The U.S. delegation to the FSB, represented here today by 
Treasury, the Federal Reserve and the SEC, supports and 
encourages the publication of FSB reports on its work. Many 
reports on the FSB's work and the work of member organizations 
are available to the public on its website at 
www.financialstabilityboard.org. We are also pleased to make 
Treasury staff available to brief your Committee, Members, and 
staff at your convenience on any issue relating to the FSB.

Q.4. I think it's important to talk about how our interactions 
with the FSB and Basel Committee will go with regard to the new 
regulations that they will recommend. We don't possess a treaty 
with these bodies, so in order for enactment to take place 
Congress will have to legislate and/or the independent 
regulatory agencies will have to adopt and adapt. The question 
that many are left with is if this will happen? How quickly? 
Will Congress end up leading the effort or lag? How is it all 
going to work? I think that the FSB/Basel agreements actually 
carry the force of law--or for conforming efforts--within the 
EU (hence the adoption of Basel II). Of course the United 
States did not adopt because small banks believed they were at 
a disadvantage. If this is indeed the case, won't a Basel III 
present a similar situation where the Europeans adopt the 
findings and we either do not adopt at all or adopt at a much 
slower pace. Quite frankly, the Europeans do not trust us to 
implement what we might agree to do, and they do not want to be 
put in a weakened position vis-a-vis the United States. All 
that said, I'd be interested in your thoughts on the role that 
the G-20 will play in the regulation writing process? Will it 
guide with specifics or simply bless proposals put forward?

A.4. The U.S. banking regulators are members of the Basel 
Committee on Banking Supervision (Basel Committee), as are 
banking authorities of all of the other G-20 countries. The 
U.S. banking regulators have adopted the Advanced Approaches of 
Basel II by issuing regulations after notice and comment. The 
Basel Committee is currently considering changes to Basel II in 
light of the weaknesses in it exposed by the financial crisis. 
The Basel Committee normally issues international standards 
following a notice and comment process and we expect this to 
continue for changes to Basel II. The Basel Committee does not 
currently have plans for a Basel III. Neither the G-20 nor the 
FSB has any legally binding rulemaking authority.
                                ------                                


RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORKER FROM KATHLEEN 
                            L. CASEY

Credit Rating Agencies
Q.1. It's clear that the Credit Rating Agencies have not been 
quite up to snuff over the last few years but it seems that the 
Basel accords and the regulatory regimes rely a lot on them. I 
know that you have discussed the idea of moving to simple 
leverage ratios, but how do you square the problem of 
continuing to rely on a system that has failed us in the past? 
Should we reform the agencies, reduce regulatory reliance or 
encourage a new system to evolve?

A.1. In my view, the Securities and Exchange Commission 
(``SEC'' or ``Commission'') should continue its efforts to both 
reform the credit rating industry and reduce the regulatory 
reliance on credit ratings issued by Nationally Recognized 
Statistical Rating Organizations (``NRSROs''). Over the past 2 
years, pursuant to authority granted by Congress under the 
Credit Rating Agency Reform Act of 2006 (``Rating Agency 
Act''), the SEC has adopted some significant reforms relating 
to credit rating agencies. These reforms are intended to 
further the Rating Agency Act's explicit goals of enhancing the 
transparency, accountability, and level of competition in the 
rating industry.
    But, in my view, the SEC needs to do more in this area. It 
is essential that the Commission finish its work with respect 
to the regulatory use of credit ratings. The Commission should 
adopt the remainder of its pending proposals to address 
overreliance on NRSRO ratings by removing the regulatory 
requirements embedded in numerous SEC rules.
    The considerable unintended consequences of the regulatory 
use of ratings--preserving a valuable franchise for the 
incumbent and dominant rating agencies, inoculating these 
government-preferred rating agencies from competition, 
promoting undue reliance and inadequate investor due diligence, 
and uneven ratings quality--have been evident for some time.
    It is vital that the Commission remove the government 
imprimatur from all SEC rules, particularly those relating to 
money market funds. The market, not the government, should 
decide which credit ratings have value.
On Regulation
Q.2. Other countries look to the United States for leadership 
in financial services regulation. I am especially, and 
increasingly, concerned about the potential for overregulation 
in the United States, not only for the effect on U.S. companies 
and the U.S. economy, but also for the example that it would 
set for regulators and policymakers in Europe and elsewhere.
    The financial crisis was not caused by deregulation. If 
anything, it was caused by too much government intervention 
with respect to entities such as Fannie Mae and Freddie Mac, 
artificially low interest rates by a hyperactive Federal 
Reserve, and so on.
    Now for my question: What would, in your view, be the 
dangers of overregulation in the United States? Let's take two 
issues that are mentioned in your testimony, hedge funds and 
credit rating agencies. What would be the practical impact on 
those two industries?

A.2. I share your concerns relating to excessive regulation. 
Overregulation would not protect or benefit investors. Instead, 
it would only serve to harm the competitiveness of the U.S. 
capital markets. Such a result hurts every American who is 
looking for a job, investing his money, or paying taxes.
    In my view, too much regulation of hedge funds would have 
the predictable effect of moving fund assets to jurisdictions 
with a more favorable regulatory approach. Regulators and 
policymakers cannot lose sight of the fact that capital is 
highly mobile. We can protect investors and oversee hedge funds 
in a responsible way that does not harm the competitiveness of 
U.S. markets. Those goals are not necessarily mutually 
exclusive.
    With respect to too much regulation of credit rating 
agencies, it is my view that before adopting additional 
regulations that are not market-based, the Commission needs to 
step back and take stock of all the new rules it has adopted 
over the past 2 years. The simple fact is that rating agencies 
are highly regulated today. That is not to say that they will 
always issue accurate ratings for investors. Government 
regulation could never deliver such results. And it does not 
mean that we can second-guess their rating judgments or seek to 
regulate their rating methodologies. The Rating Agency Act 
precludes the Commission from such actions, and properly so, in 
my view. But what it does mean is that we have adopted 
comprehensive regulations in many key areas. We should seek to 
establish regulatory certainty. At some point, we need to be 
able to see if the rules we have on the books are having their 
intended effect.
    Too much regulation of rating agencies would not protect 
investors by improving ratings quality. In fact, it would only 
increase the regulatory costs and burdens associated with being 
or becoming an NRSRO, and lead to predictably anticompetitive 
results. Ironically, these costs are manageable for the 
incumbent rating agencies, but serve as a competitive barrier 
to those contemplating entering the NRSRO space.
    Avoiding too much regulation and enhancing competition 
would have another important effect: As the Commission noted 
recently, ``[R]educing the barriers to entry in the market for 
providing NRSRO ratings and, hence increasing competition, may, 
in fact, reduce conflicts of interest in substantive ways.''
                                ------                                


RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORKER FROM DANIEL K. 
                            TARULLO

On the Financial Stability Board
Q.1. At the G-20, there was general agreement to match up the 
membership of the Financial Stability Board with that of the G-
20 and a focus on the ``monitoring of the international 
economy'' for new points of weakness and instability, I am 
skeptical that the FSB would be able to actually enforce 
actions by its member nations in response to any emerging risk 
it perceives. In April, the Economist magazine even said that 
domestic political pressures would trump any FSB call to 
action. The article said ``But if it warns, who will listen? 
Imagine the scene in Congress in 2015. The economy is booming 
but Americans cannot get mortgages because some pen pusher in 
Basel says the banks are taking too much risk. The banks would 
be freed faster than you can say ``swing voter''.'' Governor, 
what can we do to ensure that these moments of pro-cyclicality 
and crisis response are measured and consistent from the top 
down, end to end across the globe if the crisis is global and 
systemic?

A.1. Did not respond by printing deadline.
On Trade Finance
Q.2. U.S. manufacturers continue to struggle in these credit 
markets to get trade finance and this is yet another example of 
regulatory treatment creating a self fulfilling prophecy that 
will slow down the economy.
    The rules of Basel II discourage banks from extending trade 
finance by forcing them to assign to it unreasonably high risk 
weighting and too long a maturity. The G-20 in April promised 
to ask their regulators to use discretion when applying the 
rules. There has been some limited flexibility from the U.K.'s 
Financial Services Authority, banks say that capital 
restrictions continue to hinder the market and that there is a 
disconnect between what the G-20 is saying and the effect of 
banking regulation on trade finance.
    Because of the nature of the trade finance market would you 
see the necessity of a program of this nature to be kept in 
place past the 2 years it is authorized for?

A.2. Did not respond by printing deadline.

Q.3. Is Basel II hindering the recovery of the trade finance 
market?

A.3. Did not respond by printing deadline.

Q.4. Is the G-20 asking regulators to ``use discretion'' enough 
to alleviate regulations that may make extending trade finance 
difficult? Or will the G-20 have to address this in a more 
formal manner? Is that something you would support?

A.4. Did not respond by printing deadline.

Q.5. Is there anything else that can be done in the 
international finance community to mitigate the risk of these 
markets seizing and to ensure liquidity? Is the use of the 
Export Import Bank and its guarantees appropriate here?

A.5. Did not respond by printing deadline.

Q.6. Is there anything more that can be done to assist 
developing countries, like Africa, in assisting with the 
current high cost of trade?

A.6. Did not respond by printing deadline.
On Bank Regulation
Q.7. As we work on our regulatory structure and debate the 
merits of more or less regulators and the value or lack of 
value in friction and different sets of eyes and opinions 
looking at our regulated entities, I wonder if this plays out 
even more aggressively on the world stage. We worry about 
regulatory arbitrage . . . and should . . . but how do you 
avoid a rush for all regulators agreeing to the most draconian 
standards and then that be the way the contagion spreads? In 
other words, does the least common denominator equate to 
squeezing good risk and entrepreneurship out of the system.

A.7. Did not respond by printing deadline.
Transparency of the FSB
Q.8. As it builds out to handle its new mandate, how will it be 
held accountable, to whom, how will input flow into the 
process?

A.8. Did not respond by printing deadline.

Q.9. I think it's important to talk about how our interactions 
with the FSB and Basel Committee will go with regard to the new 
regulations that they will recommend. We don't possess a treaty 
with these bodies, so in order for enactment to take place 
Congress will have to legislate and/or the independent 
regulatory agencies will have to adopt and adapt. The question 
that many are left with is if this will happen? How quickly? 
Will Congress end up leading the effort or lag? How is it all 
going to work? I think that the FSB/Basel agreements actually 
carry the force of law--or for conforming efforts--within the 
EU (hence the adoption of Basel II). Of course the United 
States did not adopt because small banks believed they were at 
a disadvantage. If this is indeed the case, won't a Basel III 
present a similar situation where the Europeans adopt the 
findings and we either do not adopt at all or adopt at a much 
slower pace. Quite frankly, the Europeans do not trust us to 
implement what we might agree to do, and they do not want to be 
put in a weakened position vis-a-vis the United States. All 
that said, I'd be interested in your thoughts on the role that 
the G-20 will play in the regulation writing process? Will it 
guide with specifics or simply bless proposals put forward?

A.9. Did not respond by printing deadline.
