[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.
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\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.
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\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.
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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.
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\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.''
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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.