[Senate Hearing 111-720]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 111-720




                               before the

                            SUBCOMMITTEE ON

                                 of the

                              COMMITTEE ON
                          UNITED STATES SENATE


                             SECOND SESSION




                             JULY 20, 2010


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

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

62-563                    WASHINGTON : 2010
For sale by the Superintendent of Documents, U.S. Government Printing Office, 
http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center, U.S. Government Printing Office. Phone 202�09512�091800, or 866�09512�091800 (toll-free). E-mail, [email protected]  


               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

                    Edward Silverman, Staff Director

        William D. Duhnke, Republican Staff Director and Counsel

                       Dawn Ratliff, Chief Clerk

                     Levon Bagramian, 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

                      Ellen Chube, Staff Director

              Courtney Geduldig, Republican Staff Director


                            C O N T E N T S


                         TUESDAY, JULY 20, 2010


Opening statement of Chairman Bayh...............................     1
Opening statements, comments, or prepared statement of:
    Senator Corker...............................................     3
    Senator Warner...............................................     4


Lael Brainard, Under Secretary for International Affairs, 
  Department of the Treasury.....................................     6
    Prepared statement...........................................    33
Kathleen L. Casey, Commissioner, Securities and Exchange 
  Commission.....................................................     8
    Prepared statement...........................................    37
Daniel K. Tarullo, Member, Board of Governors of the Federal 
  System.........................................................    10
    Prepared statement...........................................    45


                          FINANCIAL REGULATION


                         TUESDAY, JULY 20, 2010

                                       U.S. Senate,
      Subcommittee on Security and International Trade and 
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 10:05 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Evan Bayh (Chairman of the 
Subcommittee) presiding.


    Chairman Bayh. Good morning, everyone. I am pleased to call 
to order this Subcommittee hearing entitled, ``Continuing 
Oversight on International Cooperation to Modernize Financial 
    I want to thank and welcome my colleague, Senator Corker, 
and others who may be in attendance shortly. I know the issue 
of financial regulatory reform is very important to Bob and we 
have had a lively and productive discussion at our previous 
hearing on this issue that I look forward to building on today.
    To our three witnesses, I want to say welcome and thank you 
for appearing. I know you are very busy and have a lot of other 
issues on your plate, so I appreciate your accommodating our 
Subcommittee today. To some of you, it is welcome back. We 
appreciate your appearing once again. And I want to thank you 
for your work that is underway to harmonize international 
financial regulations.
    We have a new addition to our witness list since our last 
hearing the Honorable Lael Brainard. Lael--I hope I pronounced 
that correctly--was confirmed as Under Secretary of 
International Affairs to the Treasury Department. Lael, the way 
Congress is working these days, getting confirmed to anything 
is a major accomplishment, so I want to express my thanks for 
Congress acting in that area. My compliments to you for 
surviving the gauntlet, so we appreciate you being here today. 
This is her first hearing in front of this Subcommittee and 
before the Banking Committee, so I want to welcome her to the 
Subcommittee and to our continued dialogue. I look forward to 
her testimony as well as the testimony of our other esteemed 
    Before we turn to the panel, I would like to give some 
brief remarks and invite my colleagues to do the same if they 
so choose, and Bob, I think probably the best ground rules will 
be 5 minutes with a lot of leeway, of course, and then when we 
turn to questions, maybe 5 minutes and a second round, if that 
is in order.
    And I would say to our witnesses today, all of your 
statements will be entered into the record in full, so if we 
can keep it to about 5 minutes, that will be good and we can 
get to the questions and answers. But all of your thoughts and 
your prepared statements will be entered for the record, so 
please don't worry about that.
    Welcome to Senator Warner, as well.
    Last September, this Subcommittee met to discuss a critical 
but often overshadowed component of financial regulatory 
reform: The international efforts to harmonize and implement 
financial regulations. As I said then, quote, ``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 at home. The 
reverse is also true. 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,'' end 
    Immediately following the crisis, there was global 
consensus that regulatory changes were needed to strengthen the 
foundation of our markets and the global economy, and that 
those changes should be harmonized to prevent regulatory 
    At our hearing last September, our leading representatives 
and experts on international economic and financial affairs 
outlined their priorities and the work underway to follow 
through on the commitments made by global leaders at the G-20 
meeting. They described their roles on the Financial Stability 
Board and other international standard setting bodies and how 
effective those institutions can and will be during this 
difficult process. We discussed capital requirements, 
derivatives, accounting standards, and other policy issues.
    Nine months have now passed and there are important updates 
in the area of financial reform. Most notably, Congress passed 
the Dodd-Frank Wall Street Reform and Consumer Protection Act. 
When President Obama signs the bill into law, we will become 
the first country to adopt comprehensive financial regulatory 
reform that meets the principles outlined at the G-20 meetings.
    While the bill rightly focuses on reforming our domestic 
system, it also includes an international provision that 
requires the Board of Governors and the Administrative Office 
of the United States Courts to conduct a study on international 
coordination relating to the resolution of systemic financial 
companies under the Bankruptcy Code and applicable foreign law.
    Continued oversight by this Subcommittee and our progress 
toward international harmonization will remain very important. 
In fact, Senator Merkley and I filed an amendment that would 
make these hearings mandatory. Though our amendment wasn't 
included in the final bill, I am pleased that all of you have 
been able to join us today, and as long as we can count on you 
to continue making the trips up to Capitol Hill on a regular 
basis, we should be just fine.
    Over the last 9 months, we have also seen significant and 
disruptive international developments. The European debt crisis 
demonstrated once again the interconnectedness of our global 
financial system. The Basel Committee released a draft proposal 
on capital and liquidity requirements in December and met again 
last week to continue its work on that critical issue. The EU 
has been working on legislative proposals on hedge fund and OTC 
derivatives regulatory reform. And last month, Britain 
announced that it will abolish its main financial regulator, 
the FSA, and consolidate its authority into the Bank of 
    The G-20 met again last month in Toronto, and it appears 
that much of the discussion focused on the global economic 
recovery and the debate on fiscal austerity versus stimulus 
spending. I am hopeful, however, that our witnesses today will 
be able to provide some insight on the discussions on financial 
regulatory reform that took place at the summit.
    We meet today to continue our dialogue on these important 
issues to ensure that we do not lose any momentum or get bogged 
down in the details as the financial crisis becomes, hopefully, 
a more distant memory. We have asked the witnesses to provide 
updates on the key priorities for international alignment and 
to explore what the consequences may be to the United States 
and our financial institutions if international coordination is 
not achieved in those areas.
    As President Obama said last year, we need to foster an 
environment that encourages a global race to the top. Now that 
the legislative process is complete here domestically and we 
begin the process of implementing the new reforms, we must 
ensure that other countries follow our leadership in lifting 
global financial standards.
    I look forward to our witnesses' testimony and to our 
discussion to come.
    I would now turn to my colleagues, starting with Senator 
Corker, and Bob, once again, it is a pleasure working with you.


    Senator Corker. Evan, always good to be with you. I thank 
you for having the hearing and certainly appreciate each of you 
coming here to talk to us today.
    I don't give long opening statements, but I will say that 
last night, I spent a good deal of time meeting with someone in 
preparation for this meeting that I think is well respected by 
all three of you and, I think, all three of us. His number one 
take-away from what is happening right now is that as he sits 
down and meets with foreign ministers, one of the things that 
they are doing is sort of rubbing their hands and licking their 
chops at the fact that because of what we have done with the 
Dodd-Frank bill, there are tremendous opportunities in the 
countries that they represent for out-migration of jobs from 
our country, and also their ability, even if those jobs don't 
come there, their ability to actually expand their ability to 
serve, especially in some of the Asian countries.
    So as you testify today, and I am sure we are going to have 
a lot of questions, I appreciate your insights, number one, on 
our abilities to sync up as it relates to standards. I mean, 
the three of you and others involved in these G-20 negotiations 
have a major responsibility and it really affects all of us. 
Even in the smaller rural areas of our districts or in States, 
what you are doing is going to have a huge effect.
    And it is not just setting the standards, I think, and 
trying to cause those to sync up. It is actually applying 
those. I think all of us realize that there is a pretty big 
swath, a pretty big difference between the way countries 
actually apply these standards, and in that process, too, 
again, our country can become very noncompetitive.
    I don't think any of us are going to know the real impact 
of the Dodd-Frank bill until guys like you, the regulators, 
which this 2,300-page bill gave tremendous responsibility to, 
sort of ease through--hopefully not ease through, but work 
through all the many and various rulemakings that the bill 
really created.
    But I certainly have a lot of questions for you. I thank 
you for being here and just would say one more time, I know 
that you know this, but all of us are hoping that you all will 
do an outstanding job in these meetings because it is going to 
affect all of us. Thank you.
    Chairman Bayh. Thank you, Senator.
    Senator Warner.


    Senator Warner. Thank you, Mr. Chairman, and I will also 
try to be brief because I am anxious to hear, as well, from the 
    A lot of the international conversations so far seem to be 
about what is going on in Basel in terms of the capital 
standards, terribly important, but the areas where Senator 
Corker and I worked on this bill in terms of systemic risk, 
``too big to fail,'' and resolution, what I hope you will 
address, as well, is I had the belief, and I think Senator 
Corker did, as well, that we wanted to have a preferred process 
for bankruptcy and resolution being only as a remedy of last 
resort and a remedy that would be clear that if a management 
team went into it, they would not come out the other end.
    The challenge as we kind of, and I am by no means an expert 
on domestic bankruptcy, let alone international bankruptcy, but 
the difference between how a bankruptcy fence goes in 
international countries is something that we clearly need if we 
are going to have this preference, hopefully preferred 
preference toward bankruptcy, how we align our bankruptcy 
provisions on these internationally interconnected firms 
between American and international bankruptcy provisions, 
number one. It is something I would love to hear some comments 
    And we did add in this legislation two new tools that I 
hope are going to be very effective, but I think the jury is 
going to be out based upon how well they are implemented both 
domestically and internationally. One is the contingent debt 
and how contingent debt would convert to equity, what would be 
the triggers, and again, this is terribly important on 
internationally interconnected firms so that if there is this 
conversion process taking place, you don't have trading between 
balance sheets of domestic versus international subsidiaries. 
This is an area that seems to have gotten some growing interest 
on the international level.
    And then what history may look back and say we were really 
quite smart in putting into this legislation, or it may go into 
the category of great ideas that never carried much weight, and 
that is the so-called ``funeral plans'' that are going to have 
to be blessed by the council. It became evident in meetings 
with Senator Corker and I during this where there were certain 
large interconnected organizations that came in during the 
midst of the crisis and basically said they couldn't go through 
bankruptcy because they had so many international operations 
and, in effect, I think, left the regulators and left the Bush 
administration with very few choices.
    How these funeral plans are going to be blessed, 
particularly in terms of their international divisions and 
showing how they can orderly unwind themselves through a 
bankruptcy process, how that is coordinated with the 
international colleagues, and then our hopes, at least my 
personal hope would be that if firms can't meet that standard, 
particularly to our friends at the Fed, using this tool in 
terms of signing off on these funeral plans and making sure 
there is a real way and a clear path so that it can be used is 
something I am going to be anxious to hear and press you on in 
some questions.
    So again, thank you, Mr. Chairman, and again, echoing what 
the others have said, we have got a framework here. How well 
this framework gets implemented, both domestically but also 
internationally, I think is going to be one of the real 
challenges over the next few years and look forward to working 
with you. Thank you.
    Chairman Bayh. Thank you, Senator Warner.
    We have a very distinguished panel. I will try and give 
brief introductions to each. I think we will start right to 
left--well, from our perspective. That would be left to right 
from your point of view. So, Lael, I will begin with you and 
then conclude, Dan, with you.
    Lael Brainard was recently confirmed, as I mentioned, as 
Under Secretary for International Affairs at the Department of 
Treasury by the U.S. Senate. Brainard advances the 
Administration's agenda of strengthening U.S. leadership in a 
global economy to foster growth, create economic opportunities 
for Americans, and address transnational economic challenges.
    Most recently, Brainard was Vice President and Founding 
Director of the Global Economy and Development Program at the 
Brookings Institution, where she held the Bernard L. Schwartz 
Chair in International Economics and directed the Brookings 
initiative on competitiveness. Brainard received Master's and 
Doctoral degrees in economics from Harvard University. Lael, in 
our part of the world, we refer to that as the Indiana 
University of the East----
    Chairman Bayh. ----where she was a National Science 
Foundation Fellow. She graduated with highest honors from 
Wesleyan University. Lael, welcome.
    Next, the Honorable Kathleen L. Casey. Ms. Casey is the 
Commissioner of the Securities and Exchange Commission and is 
the SEC representative to the Financial Stability Board. Prior 
to being appointed Commissioner, Ms. Casey spent 13 years on 
Capitol Hill working for Richard Shelby, our colleague on the 
Banking Committee. She served as Staff Director and Counsel to 
the U.S. Banking, Housing, and Urban Affairs Committee for 
then-Chairman Shelby. So in some ways, Kathleen, this is a 
welcome home to you. It is nice to see that there is life after 
Capitol Hill.
    Chairman Bayh. Ms. Casey was primarily responsible for 
guiding the Chairman's and Subcommittee's consideration of and 
action on issues affecting economic and monetary policy, 
international trade and finance, banking, securities, and 
insurance regulation, transit and housing policy, money 
laundering, and terror finance-related issues.
    In looking at your background, Ms. Casey, I noted--am I 
correct--you were born in Libya?
    Ms. Casey. Yes.
    Chairman Bayh. That is fascinating, another example of the 
increased global integration. So welcome back to the Banking 
    Finally, the Honorable Daniel K. Tarullo. Mr. Tarullo is a 
member of the Federal Reserve Board of Governors and he is a 
frequent guest of this Subcommittee and the full Senate Banking 
Committee, so we welcome you back once again, Dan.
    An expert in international finance and banking supervision, 
Mr. Tarullo has published a book called, Banking on Basel. How 
far up the Amazon Best Seller List did that make it, Dan? Just 
    Mr. Tarullo. Not high enough.
    Chairman Bayh. Probably further than my book, I will just 
say that.
    It is subtitled, The Future of International Financial 
Regulation. In that book, he examined international banking 
regulations and recommended improvements.
    Prior to his appointment to the Board, Mr. Tarullo was a 
Professor of Law at Georgetown University Law Center, where he 
taught courses in banking law and international financial 
regulation. Prior to joining the Georgetown Law faculty, Mr. 
Tarullo held several senior positions in the Clinton 
administration. From 1993 to 1998, Mr. Tarullo served 
successfully as Assistant Secretary of State for Economic and 
Business Affairs, Deputy Assistant to the President for 
Economic Policy, and Assistant to the President for 
International Economic Policy. He also served as a principal on 
both the National Economic Council and the National Security 
Council. Welcome back again, Mr. Tarullo.
    Ms. Brainard, we will begin with you, and again, 
congratulations on your confirmation and thank you for your 
courtesy in attending the hearing today.


    Ms. Brainard. Well, thank you very much, Chairman Bayh, 
Ranking Member Corker, and Senator Warner. Thank you for the 
warm welcome. And the questions that you all posed, I think, 
are hard questions and questions that we are working very hard 
on every day.
    Tomorrow, President Obama will sign into law the strongest 
financial reforms this country has seen since the Great 
Depression. Thanks to the leadership of the President, 
Secretary Geithner, Chairmen Dodd and Frank, and Members of 
this Committee, the Dodd-Frank Wall Street Reform and Consumer 
Protection Act will lay the foundation for a sounder and more 
resilient financial system. It will protect America's long-term 
economic competitiveness. It will help prevent future crises 
and it will promote stable and sustained economic growth.
    The challenge before us now is to ensure that the world 
standards are every bit as strong as America's. In the wake of 
the most globally synchronized financial crisis the world has 
ever seen, we must develop the most globally convergent 
financial protections the world has ever attempted.
    Although global convergence will be critical in areas such 
as capital and derivatives regulation, our international 
efforts in other areas may be equally well served by 
coordinating different approaches across nations reflecting 
deeply rooted differences in national structures and 
institutions. In those cases, the mechanism that works best for 
other countries may not work best for the United States, 
although we are all seeking to advance common objectives.
    Let me speak briefly about the steps we are taking to 
ensure convergence around the world, focusing on addressing too 
big to fail, extending the perimeter of regulation, and 
establishing the right global architecture.
    Our international reform agenda is tackling head on the 
moral hazard problem associated with firms perceived to be too 
big to fail. A key lesson of the crisis is that more and higher 
quality capital must be at the core of our reforms and that 
capital rules must be harmonized internationally to be 
effective domestically. That is why in Toronto last month, 
President Obama and other G-20 leaders set the goal of ensuring 
that financial institutions hold enough common equity to 
withstand, without Government intervention, stresses of the 
magnitude seen in the last crisis, and they committed to reach 
a comprehensive agreement by November.
    The Basel Committee on which Dan Tarullo serves is working 
hard to establish common definitions of capital and risk 
weights and to determine the necessary amount of capital and 
appropriate liquidity ratio, along with specifying appropriate 
transition periods.
    A second key component to ending too big to fail is to 
improve market discipline on major financial players.
    Stress tests can help. In the coming days, the Committee on 
European Banking Supervisors will be releasing bank by bank 
stress test results for the large cross-border European banking 
groups as well as many smaller banks. While there is no one-
size-fits-all approach to stress testing, with the appropriate 
assumptions and disclosures, this effort could help to 
strengthen bank balance sheets in Europe, much as the SCAP did 
here in the U.S.
    Third, the web of bilateral derivatives trades became, as 
you know, a major source of contagion during the crisis. Our 
legislation here will reduce this risk by requiring the central 
clearing exchange trading of standardized OTC derivatives as 
well as by supervising and regulating all participants in these 
markets. Because these activities are highly globalized, it is 
absolutely critical that we work internationally, particularly 
with the EU, to make certain that critical OTC derivatives 
market infrastructure is subject to oversight in line with the 
strong standards adopted here in the U.S., which were also 
agreed in the G-20 and the Financial Stability Board.
    Let me briefly speak about extending the perimeter of 
regulation as well as making the system safe for failure. This 
is, of course, a critical part of ending the moral hazard that 
afflicted the system and we have a lot of work to do 
internationally to make sure that other countries have the same 
strong resolution authority we will have here and to work on 
cross-border resolution mechanisms, as well as developing 
credible resolution plans.
    So with regard to hedge funds, which is the one area I 
wanted to touch on before I close, the perimeter of regulation 
must also be extended to ensure strong oversight of these 
markets. We have worked to ensure international agreement on 
the U.S. approach, requiring advisors of hedge funds to 
register and report so that supervisors can assess whether any 
fund poses a threat to the system. As the EU works to establish 
similar requirements under their Alternative Investment Fund 
Managers Directive, we are going to make sure that U.S. 
managers and funds retain nondiscriminatory access to their 
    Let me just wrap up by saying that to accomplish these 
goals, we have been working hard to improve the international 
financial architecture. We have made the financial repair and 
reform agenda a central pillar of our work in the G-20. The 
Financial Stability Board in which all three of us participate 
was established to oversee our collective efforts in the G-20 
countries to identify vulnerabilities in the global financial 
system, to promote financial stability, and to encourage 
coordinated and comprehensive reforms.
    So we appreciate the leadership of this Subcommittee on 
these key challenges and we look forward to continuing working 
with you as we engage with our international partners to match 
the strength and sweep of U.S. reforms. Thank you.
    Chairman Bayh. Thank you, Ms. Brainard.
    Ms. Casey.

                      EXCHANGE COMMISSION

    Ms. Casey. Chairman Bayh, Ranking Member Corker, and 
Senator Warner, thank you very much for inviting me to testify 
on behalf of the SEC about international cooperation to 
modernize financial regulation.
    While Congress has been considering the scope and specifics 
of regulatory reform in the United States, discussions have 
been taking place in the G-20, the FSB, IOSCO, and other forums 
as to what regulatory reforms might be desirable and how best 
to coordinate such regulatory responses internationally. The G-
20 has proven helpful in forging a broad consensus about what 
major issues should be addressed. Although the G-20 is an 
excellent vehicle for discussion of the highest level policy 
objectives for financial regulation, regulatory objectives are 
just that. Different jurisdictions are likely to use different 
approaches in pursuit of those objectives.
    In this respect, I would note that the relevant provisions 
of the Dodd-Frank legislation are broadly consistent with the 
international principles articulated in the key areas of hedge 
funds, OTC derivatives, and credit rating agencies, and provide 
the Commission with the requisite authorities to craft 
regulations consistent with these principles.
    Currently, I represent the SEC on the FSB alongside the 
other U.S. Government participants, including the Federal 
Reserve and the Treasury Department. While the FSB is useful as 
a discussion forum to review broad trends affecting the 
financial system, the real work toward building international 
regulatory-level consensus and coordination rests with 
international technical bodies, such as IOSCO, which has the 
expertise and regulatory authority to establish a coordinated 
approach to common regulatory problems.
    As a securities regulator, the SEC has long been active in 
IOSCO as a member of both its Technical Committee and Executive 
Committee. During my recently completed term as Chairman of the 
Technical Committee, IOSCO took important steps in advancing 
approaches to regulations in the areas of credit rating 
agencies, hedge funds, OTC derivatives, securitization, and 
short selling.
    I would like to briefly highlight some areas where there 
has been some recent work at IOSCO, as well as other 
multilateral and bilateral work that may be of interest to the 
    IOSCO has continued its focus on hedge funds and short 
selling. With regard to hedge funds, last year, IOSCO published 
a report setting out six high-level principles for regulation 
of the hedge fund sector and has sought to provide a 
coordinated basis for hedge fund oversight by developing a 
common template to help regulators identify the types of 
information that could be gathered to assess possible systemic 
    With regard to short selling, IOSCO has developed four 
principles for the effective regulation of short selling and 
aims to identify opportunities for greater convergence in the 
implementation of and assessment of the effectiveness of these 
principles. In addition, IOSCO continues to monitor 
developments in short selling regulation, allowing its members 
to better understand each others' short selling regulations.
    The continued work on credit rating agencies and OTC 
derivatives provide excellent examples of the interaction of 
the various levels of cooperation among international 
organizations and national and regional authorities. With 
regard to OTC derivatives, in March 2010, IOSCO, the
    Committee on Payment and Settlement Systems, and the 
European Commission formed a working group to further the 
objective to improve the OTC derivatives markets. And 
separately, in May, IOSCO and CPSS issued two consultative 
reports containing proposals aimed at strengthening the OTC 
derivatives markets on CCPs and trade repositories.
    With regard to credit rating agencies, national and 
regional initiatives have been taken or are underway to 
strengthen oversight of credit rating agencies. In the U.S., 
the SEC has adopted or proposed amendments to its rules on 
NRSROs in order to foster accountability, transparency, and 
competition in the credit rating industry, as well as to 
address conflicts of interest. Likewise, many other G-20 
countries have also introduced or are planning to introduce new 
regulatory oversight frameworks for CRAs. As a result, the SEC, 
the European and Japanese securities regulators are engaged in 
talks to address significant issues that may arise as a result 
of differences among their new CRA regulations.
    Moreover, in response to the FASB and G-20 recommendations 
to review the use of ratings in the regulatory and supervisory 
framework, national and regional authorities, including the 
SEC, have also taken steps to lessen undue reliance on ratings 
and rules and regulations.
    In addition to our collaborative efforts with our 
counterparts in IOSCO, the SEC is developing much stronger and 
more extensive supervisory cooperation arrangements with a 
number of jurisdictions.
    In closing, I would like to briefly describe two additional 
initiatives, convergence and accounting standards and equity 
market structure, where regulators and standard setters must 
bear in mind the international repercussions of their work, but 
ultimately must take decisions that comply with the demands of 
their unique mandates.
    In the accounting area, the SEC supports efforts of the 
FASB and the International Accounting Standards Board to reduce 
disparities in financial reporting standards through their 
Convergence Agenda, this in support of the broader effort to 
develop a single set of high quality accounting standards.
    In the area of market structure, the Commission has begun 
an in-depth evaluation of the current structure to ensure that 
U.S. equity markets remain fair, transparent, and efficient, 
and to date, the Commission has proposed several rules, a 
concept release, and held a roundtable. And I would also note 
that many of our international counterparts are considering 
similar topics.
    In conclusion, increasingly, our success will depend on 
international consensus on fundamental objectives of securities 
regulation. As regulators, it is essential that we bear these 
principles in mind as they will help us support the strength of 
our own capital markets. Thank you, and I would be happy to 
take any questions.
    Chairman Bayh. Thank you very much, Ms. Casey.
    Mr. Tarullo.


    Mr. Tarullo. Thank you, Mr. Chairman, Ranking Member 
Corker, and Senator Warner. It is good to be with you again to 
review international developments in financial regulatory and 
supervisory cooperation.
    Since your last hearing in September on this subject, the 
inventory of developments, proposals, and work streams has, if 
anything, increased as the international standard-setting 
bodies have continued their work and the institutional 
evolution of the Financial Stability Board has produced some 
new ideas and initiatives.
    In these opening remarks, let me confine myself to making 
three points.
    First, the Basel Committee effort to strengthen capital and 
liquidity standards has been moving forward since we talked 
about it last in September, and I think it is on track to be 
completed this year, though some of the hardest decisions are 
yet to come. The market risk amendments have been completed and 
are now awaiting adoption in the various Basel Committee 
countries. The Basel Committee put out for comment last 
December a collection of concrete proposals to strengthen the 
quality and quantity of capital and to institute quantitative 
liquidity requirements. In the intervening months, the effort 
has been to shape these various proposals into a coordinated 
package of reforms, including assessing their cumulative, 
quantitative, and macroeconomic effects.
    Second, international cooperation on resolution matters has 
made more progress than I anticipated when I testified last 
September, though the conceptual and legal hurdles to a 
comprehensive international resolution system remain high. 
Right now there are ongoing a number of interconnected and 
related initiatives in this area. There is an effort to 
identify common principles and tools for national resolution 
regimes. There is work in four technical areas to lay the 
groundwork for more standardized practices on such matters as 
payment settlement so as to facilitate resolution efforts 
should they become necessary internationally.
    There are initiatives on recovery and resolution plans for 
specific firms. These track legislation to be signed into law 
tomorrow here in the United States.
    There is an exploration of mechanisms such as so-called 
``debt bail-in proposals'' which would help maintain firms as 
going concerns without requiring either governmental assistance 
or a formal resolution process.
    Now, much of this work is still in progress, and even if 
each of these various initiatives proves successful, they will 
in the aggregate fall short of a comprehensive solution. But I 
do think that this approach has taken reasonably far down the 
road the idea of trying to maximize cooperation and planning 
before a possible insolvency and, thus, to maximize the chances 
that a distressed firm can be satisfactorily dealt with 
    Third, as I suggested at last fall's hearing, we still need 
to do a good bit of work on the institutional and operational 
features of the organizations involved in international 
financial regulatory and supervisory cooperation, in such areas 
as sorting out which organization or committee does what and 
how similar efforts in different groups relate to one another, 
in making the transition from a dominant focus on negotiating 
rules and standards to their implementation and monitoring, in 
adjusting to the larger membership of the Basel Committee and 
the Financial Stability Board while fully incorporating the new 
members into their activities, and in ensuring that these 
organizations are helping to advance the shared regulatory 
missions of their members to supervise internationally active 
financial firms effectively.
    These institutional characteristics and considerations may 
seem a bit prosaic, but I think that they have the same kind of 
importance internationally as our implementation and your 
monitoring of our implementation of the reg reform act has 
domestically. And without a good set of institutional 
mechanisms, I think it is going to be difficult for us to 
achieve the goals which the three of us and all of you share as 
    So thank you for your attention, and I would be pleased to 
answer any questions you may have.
    Chairman Bayh. Thank you very much, Mr. Tarullo.
    Senator Warner, before you arrived, I indicated that the 
first round of questioning we are going to try and keep it to 5 
minutes apiece, with some leeway if we need to follow up 
questions, and then have a second round of questions if 
    Let me just begin by putting to all of you the broader 
question on the table here today. We have passed a 
comprehensive regulatory reform bill here domestically in the 
United States. Do you believe there will be enough convergence 
in global standards so that we will avoid arbitrage, regulatory 
forum shopping to avoid a recurrence of the crisis that we have 
been through? And let me analogize just for a moment to the 
euro and the problem we are seeing now with Greece.
    When the common currency was adopted, there were standards 
put into place for fiscal policy and supposedly some sort of 
enforcement mechanism, which obviously was not implemented very 
well, largely for reasons of solidarity and that sort of thing. 
So we had an example here where there were common principles 
and common ideals, but when it came to tough decision making 
and enforcing them in ways that would really make a difference, 
that did not happen very much. So will there be enough 
convergence and will there be a real enforcement mechanism to 
try and avoid a recurrence of what we have been through? I 
think that really is the issue on the table here today, so we 
have acted. Will we get enough cooperation from other countries 
to achieve the objective? Because if it is only us, that is not 
going to be enough to avoid a recurrence of this problem?
    Ms. Brainard, why don't we start with you if that is OK.
    Ms. Brainard. Well, I think that is the critical question. 
In many of these areas--not all, but many--if we are not able 
to achieve convergence, we will not be able to protect American 
consumers and businesses and workers the way that this 
legislation would like to.
    The reasons that I think we are going to make more progress 
than we ever have before are the following:
    Firstly, all of the major financial jurisdictions that are 
engaged in these talks have come through the common crucible of 
the crisis. So this is a common set of objectives, and that is 
clear from the discussions we have had at the highest political 
levels. We have leaders of G-20 countries talking about capital 
standards for banks. That is pretty unusual, and I think it 
shows the level of salience and commitment.
    Chairman Bayh. Could I interject just for a moment? I am 
delighted they are talking about the capital standards, but 
this is going to involve different levels of domestic political 
pain depending upon the country. Are they willing to actually 
follow through on those statements even if it is domestically 
somewhat uncomfortable for them?
    Ms. Brainard. I think the second----
    Chairman Bayh. And that gets to the efficacy of these 
stress tests that Europe is going through now. That is great 
they are doing it. It worked well for us. But there are some 
disturbing reports that maybe they will not be quite as 
transparent as we might like because of what the results might 
    Ms. Brainard. The international architecture that we are 
developing should go some distance in advancing our convergence 
agenda. So beneath the level of political commitment, we are 
elaborating the set of structures importantly among which is 
the Financial Stability Board, which is helping coordinate the 
activities of a number of different entities, not just on 
negotiations, which are the critical first step to make sure 
that national jurisdictions adopt convergence standards, but 
also with a follow-on, very important mechanism for 
implementation, for cooperation, and for peer pressure, if you 
    So with regard to the area of enforcement, one of the best 
mechanisms for enforcement that we have is transparency and 
market discipline, and the IMF will participate, as will the 
FSB and other entities, in making assessments of every 
jurisdiction's regulatory framework. And we have just gone 
through this here in the U.S. It is like a very detailed 
physical check-up, very uncomfortable but very good for the 
system. And so we will be working with the IMF and the 
Financial Stability Board to ensure that other countries are 
not only adopting those standards in rhetoric but are 
implementing them in reality.
    Chairman Bayh. Thank you. And why don't we continue? And I 
do not want to drag out--I just wondered if each of you would 
just respond to my question, and I will turn to my colleagues, 
because this is a longer dialogue. But if peer review is the 
best we can do and peer pressure and sort of reputational risk, 
well, I guess that is better than nothing. But a skeptic might 
say that the IMF has issued reports about countries' fiscal 
policies and a variety of other practices over the years, and 
they have been honored primarily in the breach. And you are 
right, market transparency and market pressure is probably the 
best discipline, but markets sometimes can wait pretty late. 
Look at the Greece phenomenon. I mean, markets have reacted to 
that, but it is only when the imbalance has got to the point 
where we have got a crisis on our hands, and we are trying to 
avoid that.
    So I guess I would--I am all in favor of peer review, but 
if we can put a little teeth in the peer review, that would be 
even better.
    Ms. Casey. Thank you, Chairman Bayh. Just to add on to 
Lael's comments, as she has noted, there is always going to be 
arbitrage opportunities given the global nature of our markets 
and the use of capital flows.
    I think that to the degree that you have agreement along 
regulatory principles or common approaches to regulation at the 
international level, which is ultimately complemented by 
increased cooperation and coordination among key regulators and 
supervisors, you improve the chances of minimizing those 
arbitrage opportunities.
    I think what is also important, and which I think has been 
reflected in the articulation of some of these common 
regulatory approaches by the G-20, is that the policy 
objectives themselves necessarily need to be considerate to the 
interest of improving market efficiency, stability, and 
integrity, and that they do not necessarily unduly impede 
capital formation and growth, and that further in the 
implementation phase by regulators, which is very critical to 
whether or not those objectives are achieved, that regulators 
are also sensitive to implementing the rules in a manner that 
they, again, do not unnecessarily create market disincentives 
to achieving those goals or dampen market growth.
    As was just noted, with respect to the focus on enforcement 
and compliance, that has been one of the lessons, I think, to 
the crisis you have pointed to, to some of the examples of the 
effectiveness of previous efforts in the past on the 
international level. And I think that the efforts of the FSB 
and existing standard setters, such as IOSCO, have got an 
intense focus now on implementation and compliance. So what you 
will see--again, you mentioned peer reviews. There is no 
question that that does have an element of--a political element 
as well, but I think that to the degree that you have 
regulators who by their very nature are voluntarily engaged in 
these organizations like IOSCO, they bring both the capability 
to meet those commitments and the consensus that was ultimately 
achieved in supporting those principles. So you do have that 
vested interest in seeing that those rules are adopted and that 
they are adopted consistently across jurisdictions.
    So I do think that enforcement is--or assessment and 
implementation and enforcement of principles is a key focus 
coming to the crisis. But there is no question that ongoing 
cooperation and coordination as jurisdictions undertake to 
implement these new rules and regulations will be critical to 
whether or not you continue to have significant arbitrage 
    Chairman Bayh. Thank you very much, Ms. Casey.
    I was just saying, Mr. Tarullo, I would appreciate your 
answer, and then I am going to turn to Senator Corker for his 
round of questioning.
    Mr. Tarullo. OK. Just a couple of complementary 
observations, Mr. Chairman.
    One, as I mentioned, there are an awful lot of things going 
on internationally right now, and we have Federal Reserve staff 
participating in dozens of working groups in these various 
international organizations. I do think it is important for the 
principals and the agencies to zero in on what we think the 
priorities ought to be, to devote ourselves to trying to get a 
good set of standards or understandings, and then to do what is 
necessary to make sure that those standards or understandings 
are realized.
    In that respect, I, as you can tell from my introductory 
remarks, think that capital standards are among the most 
important things and among the things most susceptible to 
effective convergence around the world.
    I mentioned in my prepared testimony that along these lines 
I have long felt--this long predates my arrival at the Federal 
Reserve--that we need to have a different kind of mechanism for 
monitoring the implementation of complicated capital standards. 
Markets are just not in a position to judge whether an internal 
model has been properly validated and is thus assigning the 
proper risk weights to particular kinds of exposures. If the 
markets cannot do it, then we need to make sure that there is 
some transparency, and my sense is that that is going to need 
to be provided internationally.
    So after we get these capital standards agreed upon, what I 
am looking forward to is a discussion in international fora of 
how we can make sure that everyone has assurance that these 
standards are being properly implemented.
    Chairman Bayh. Very good. I would just only end this round 
by saying I understand, Ms. Brainard, this is a journey, and we 
are not going to get this done all at one time. There are a lot 
of things going on. There are countervailing concerns in 
addition to the stability we seek in the financial markets. I 
think you are exactly right, Mr. Tarullo, about the capital 
standards. So one of the points I am driving at here is I think 
some of us will look at their willingness to adopt meaningful 
capital standards, even if they pinch domestically a little 
bit, look at the stress tests. I understand that may cause some 
domestic heartburn, but are they transparent, are they 
meaningful as a test of their seriousness over time in getting 
us to meaningful standards that really truly have some 
enforcement mechanism. I am sure that some in Germany, thinking 
back to the time when they surrendered the Deutsche mark, wish 
they had focused a little bit more on enforcement of standards 
and some of these kind of things. Perhaps they did not, and now 
they are reaping the results of that. So let us learn from some 
of these lessons. Thank you for your responses, all of you.
    Senator Corker.
    Senator Corker. Thank you, Mr. Chairman, and I thank each 
of you again for being here.
    I read an analysis yesterday in the Financial Times talking 
about the bill that was just passed, the Dodd-Frank bill, and 
the final analysis was so many pages, so little content. And 
what that means, of course, is over the next 18 months, 
regulators--the Fed, SEC, Treasury--will be engaged in all kind 
of rulemakings. We have G-20 happening, we have Basel after 
that, and so, really, a world of instability as it relates to 
banking, which no doubt will help continue the malaise that the 
world is feeling right now as it relates to growing.
    But on those things where there was prescriptive language 
in the Dodd-Frank bill, Governor Tarullo, what are those things 
that people are most complaining about as you meet 
internationally? What are those things that they have most 
concern about?
    Mr. Tarullo. I would say, Senator, the things that I have 
most heard about are the Volcker Rule and the Lincoln amendment 
and the degree to which they will apply internationally and to 
foreign firms in the United States. There is also some concern 
about the Collins amendment.
    I think that in all of those cases, those concerns were 
communicated directly to members of the conference committee. I 
heard more about them before the conference committee met than 
I have since, so I await hearing the degree to which those 
concerns were allayed in the course of the conference.
    Senator Corker. So, obviously, the Collins amendment had to 
do with capital. Do you think we ought to have minimum capital 
requirements internationally?
    Mr. Tarullo. I do, Senator. As I said a moment ago, while 
there are a variety of regulatory mechanisms that are tailored 
to the legal and financial system characteristics of a 
particular country, I think capital is a sine qua non of a 
well-functioning, stable financial system. And although, of 
course, there are going to be some differences--tax law and 
accounting standards make a difference--it is possible to 
converge around a set of strong capital requirements which try 
to implement a particular goal, the goal being the one Under 
Secretary Brainard referred to that was in the G-20 communique 
and that we at the Fed had articulated in a slightly different 
way: that these large financial institutions be able to weather 
a very stressed financial environment and still have sufficient 
capital at the end of that event to be functioning as 
successful financial intermediaries. That has been our aim 
domestically in thinking about capital and has informed the 
positions that we have been taking along with the FDIC and the 
OCC internationally on capital.
    Senator Corker. Should goodwill on mortgage servicing count 
as capital?
    Mr. Tarullo. In my view, goodwill should not.
    Senator Corker. What about mortgage servicing?
    Mr. Tarullo. Mortgage servicing rights are one of a number 
of elements of a balance sheet of a firm that do reflect some 
loss absorption capacity. That is what we want capital to be. 
We want capital to be loss-absorbing, which is why our focus 
has been common equity.
    The concern, of course, is that if you have something like 
a minority investment in an affiliate, that investment does not 
protect the entire financial firm, only the affiliate, and thus 
it should not be counted the same way as a dollar of common 
equity at the holding company level.
    Mortgage servicing rights, again, are not the same as an 
asset already on the balance sheet, but they are an expected 
stream of earning which have performed well in the past. And so 
our approach has been to say that they should count for 
something, but----
    Senator Corker. Is that on a multiple?
    Mr. Tarullo. Sorry?
    Senator Corker. Is that on a multiple of that?
    Mr. Tarullo. On a multiple of the----
    Senator Corker. Servicing.
    Mr. Tarullo. No. I think our approach has been that all of 
these sorts of things, whether they are minority investments or 
deferred tax assets or mortgage servicing rights, should be 
applicable but limited. They should only account for a limited 
portion of your capital needs. And I think we are on the way to 
achieving that.
    Senator Corker. Internationally?
    Mr. Tarullo. Internationally, yes.
    Senator Corker. Let me ask all three of you this: I have 
doubts, especially when I hear the reaction of people around 
the world to what we have done, what the country has done with 
Dodd-Frank, you know, the concerns about the Lincoln amendment, 
concerns about the Collins amendment, concerns about Volcker--
which, by the way, are just so easily gotten around. I mean, 
let's face it. Somebody in Kansas just picks up the phone and 
deals with the arm of a non-U.S. bank that is based here, you 
know, they just transfer them over to somebody in another 
place, and it seems like it is relatively easy to get around 
much of this. But let me ask you, if you all found that you had 
great difficulty in getting other countries, especially those 
that we compete so much with, if you found difficulties in 
getting them to agree to whatever component of the Dodd-Frank 
bill that, you know, they just would not agree to 
internationally, would each of you come back asking us to make 
    Mr. Tarullo. I will start because this has been something 
that we have been thinking about. We in the United States have 
had a particular approach to financial regulation going back 
decades. Our approach was really set in the Depression, 
building on the National Banking Act when we added Glass-
Steagall and the Federal Deposit Insurance Act. We have always 
had significant activities restrictions on our insured 
depository institutions to a much greater extent than many 
banking systems in the rest of the world. And I do not think 
that has stopped us from having a very healthy banking system 
in this country for many decades.
    Senator Corker. I know we are going to run out of time, and 
I really do not want a historic perspective. The question is: 
If we ended up being out of synch with the rest of the world in 
areas that made us not competitive that we felt like were not 
really--you know, let's face it. I mean, politics overcomes 
substance when these bills hit the floor. Some of these things 
are passed just for people to make a name for themselves. They 
do not necessarily have anything to do with stability. If we 
found some of those that really were not making our country 
more secure as it relates to our financial system, the question 
is, without a historic perspective, would you come back and 
talk with us about those so that we might make changes if it 
did not have anything to do with the security of our financial 
    Mr. Tarullo. Sure. If we observe that there were provisions 
that did not seem to be enhancing financial stability and at 
the same time were creating competitive problems for U.S. 
industry, of course we would. I just want to make the point 
that different ways of doing things and different kinds of 
regulation do not in and of themselves mean that we are going 
to have the kinds of problems to which you alluded. That is why 
I was referring to history.
    Senator Corker. Thank you.
    Ms. Brainard. Senator, could I just respond to that 
    First of all, I think it is important to recognize that 
this is historic legislation that will increase and strengthen 
the competitiveness of the overall U.S. economy by making it 
much less prone to excessive investments in areas that are not 
particularly productive, that other countries are going to want 
to move in this direction because it will improve the strength 
    Senator Corker. Well, we do not really know that yet.
    Ms. Brainard. ----resilience of our financial system.
    Senator Corker. I mean, those are great talking points, but 
we will know that----
    Ms. Brainard. Can I just----
    Senator Corker. ----over the next 18 months.
    Ms. Brainard. ----mention, Senator Corker, so in the G-20 
there is actually language welcoming the strong financial 
regulatory reform bill in the U.S. in the Toronto summit. And 
many of the countries participating in the G-20 have, in fact, 
been waiting to see the final outlines of U.S. financial 
reforms because they want to move in that direction and emulate 
the systems that we are putting in place.
    As we were saying earlier, there are some areas----
    Senator Corker. But the question is, if they do not 
emulate, will you come back and talk with us? That is the 
    Ms. Brainard. In those areas where we absolutely must have 
international convergence, we will ensure, like in the area of 
capital standards, that we come to a global set of high-quality 
rules. As Dan was suggesting, there are other areas that have 
to do with our national banking system and its history where we 
might want to go a different way and where it will create no 
difficulties for us internationally by continuing to have some 
of the structures that our consumers have been used to for 
decades. So in those areas where we must have international 
rules, we will absolutely pursue them and ensure that the U.S. 
standard, high standard, is the world standard.
    Ms. Casey. I would say yes, we would absolutely come back 
and highlight any major divergences that would have a 
significant adverse impact. I think in particular with respect 
to areas like OTC derivatives, we continue to engage very 
closely with our counterparts in Europe, for example, where 
they continue to give contemplation to achieving the G-20 
objectives of mandatory clearing and trade reporting and, where 
appropriate, exchange trading or platform trading. And I think 
those key components are going to be really critical, so I know 
that we do continue to engage reactively now that we have the 
passage of Dodd-Frank and the expectation of the President's 
signature soon bringing it into law. But as the law recognizes, 
international cooperation and consistent implementation in this 
area will be particularly critical to achieving the broader 
objectives. So I think that that will be a key area I think we 
are going to have to work very carefully on, and, of course, to 
the degree that Congress, which I believe is very important, 
needs to monitor the implementation, you will be able to 
identify these issues as we go forward.
    Senator Corker. Thank you.
    Chairman Bayh. Thank you very much.
    Senator Warner.
    Senator Warner. Thank you, Mr. Chairman.
    The first couple questions I want to address to Governor 
Tarullo and Secretary Brainard, and, Commissioner Casey, I will 
come back with a couple specific ones for you as well.
    We have spoken quite a bit here about capital standards. 
Another piece--at least in my process of getting educated about 
the crisis--was the leverage rates. If I have heard once, I 
have heard dozens of times, you know, Canada made comments 
about the fact that their lack of problems because of their 
rates on--their restrictions on leverage. There was a proposal 
in the House bill to put a restriction on leverage. I believe 
the blended rate left it--or the conference report left it to 
you all. Within Basel or elsewhere, are there other discussions 
about trying to reach some international court on leverage as 
    And then let me also follow up again--this is perhaps more 
for Dan than others. You know, there is still lots of 
consternation about the whole question of defensive ring 
fencing in bankruptcy and/or resolution. I was just reading 
again recently some of the Europeans complaining about what 
happens in the Lehman crisis when Lehman went down and how 
assets left. And, you know, one of the fears I have going 
forward with these interconnected international institutions is 
making sure that we have got, again, preferably through 
bankruptcy but as last resort resolution some process so that 
assets are not fleeing quickly from one jurisdiction to the 
other in the event of an unwind. So leverage and then questions 
around bankruptcy and/or liquidation.
    Mr. Tarullo. With respect to leverage, Senator, there are 
more than discussions. There are proposals within the Basel 
Committee right now. The meeting last week addressed the issue 
of the leverage ratio. I would say at this juncture that there 
is a reasonable prospect of an agreement upon a leverage ratio. 
I do not know that that will immediately become a so-called 
``Pillar 1 requirement,'' which is to say just an articulated 
rule; but it may at the beginning be a so-called ``Pillar 2'' 
or ``supervisory requirement,'' which would hopefully then 
migrate into Pillar 1 after there is experience with it.
    I share your view that a leverage ratio is an important 
complement to a risk-based capital ratio. The leverage ratio 
gives one a clean, unvarnished view of leverage. Of course, its 
shortcoming is it does not take into account the different 
risks associated with the assets, but that is why I think they 
have to be done in tandem.
    Senator Warner. Secretary Brainard, do you want to mention 
anything on that as well?
    Ms. Brainard. Just with regard to the leverage, we have, 
since Pittsburgh, had agreement internationally that the risk-
weighted capital framework would be supplemented by a simple 
leverage ratio which is a sort of supplementary backstop, if 
you will, to cut through some of the complexity, and as 
Governor Tarullo was suggesting, it may take some time for that 
to become a mandatory part of the framework. But there is 
commitment among the G-20 to migrate it to a mandatory part of 
the framework, and we are very much supportive of that.
    Mr. Tarullo. Did you want to go to----
    Senator Warner. Yes, 1 second, please. Let me just extend 
the question a little bit, too. There has been some 
conversation I have heard that there might be agreement on the 
front end in the event of bankruptcy and/or resolution to, in 
effect, choose a jurisdiction ahead of time in terms of what 
rules will apply. I would like you to comment on that. And you 
used the term ``the debt bail-in,'' which I imagine--I 
interpreted it as a conversation at the international level 
about this contingent debt that would convert to equity. I 
hope, though, it would be preassigned. I would think we would 
have real problems in our country--I would have real problems 
if there was going to be kind of an arbitrary taking of debt 
that would be converting it to equity if investors were not 
prewarned on that. But you might want to clarify that for me as 
    Mr. Tarullo. Sure. With respect to several of the things 
that you mentioned in the resolution arena, the idea of a firm 
being able to choose its locus for insolvency declaration and 
Administration, I think, is one that is well off on the 
horizon. It would require the kind of harmonization of and 
comfortableness with deference to one another's bankruptcy 
systems, which in the financial area in particular does not 
exist right now.
    With respect to ring fencing, I think you are exactly 
right, Senator. It is hard to have a conversation about 
international insolvency internationally without the term 
``Lehman'' recurring through the conversation. This is the 
event that, in the case of the U.K., seared itself onto their 
minds in thinking about the potential for international 
    The difficulties of the kind of lawyer's dream of a 
comprehensive international system that is completely 
harmonized in legal terms not being achievable has meant that 
we are paying more attention to trying to do things in advance 
which would diminish the need for, and the incentive to, ring 
fence. So that is why the recovery and resolution plans, the 
kind of living will exercise that you alluded to, is important 
because it allows supervisors to see what the sources of 
liquidity are. It can also entail the rationalization of the 
corporate structure of these firms. The day Lehman failed, it 
had 3,000 separate legally incorporated entities. They were not 
all there for business purposes. And if one can force earlier a 
business rationalization of the structure of a firm, again, you 
make it easier to deal with. That is why the payment system 
obligations are also important to try to standardize.
    So a lot of these work groups that we are in right now are 
actually trying to get to the point where the incipient 
insolvency of a firm would not raise the prospect of all those 
assets fleeing immediately and, thus, would result in a 
somewhat more deliberate response.
    On the debt bail-in that I mentioned, I avoided the term 
``contingent capital'' only because that term has now embraced 
so many different things that it sometimes can be confusing.
    The proposal to which I was referring actually has several 
variants, but the basic idea seems to be that there would be 
contractual obligations for certain kinds of debt which would 
act like debt on the balance sheet of the firm in normal times, 
but which could be converted to equity in order to avoid an 
insolvency situation and thus could maintain the firm as a 
going concern.
    There are, as I say, several variants which all raise the 
question of, well, what would the trigger be, what would the 
amounts be. There are a lot of technical issues that have not 
been worked out, but I think the concept is one that is 
appealing enough because of its aim to internalize the 
potential cost of insolvency that we want to continue working 
on it even though at this juncture there is not a proposal 
which specifies the details in a way that we think answers all 
the questions.
    Senator Warner. Let me make one comment, and I want to get 
to one question for Commissioner Casey. One is, and I agree 
with Senator Corker that a lot of this bill was turning over to 
the regulators to try to figure things out, but they are going 
to be tough. I mean, if you want to prevent the use of 
resolution, and only as a last resort, and we want a preferred 
bankruptcy regime, making sure that the living wills and/or 
funeral plans are really closely examined, particularly as 
regards to the international implications, will be one of the 
ways that you would prevent, I would think, resolution having 
to be used. A comment.
    Second, I think, whether it is your term debt bail-in or 
contingent capital, getting that trigger right so it doesn't 
become a self-fulfilling prophecy that that action means the 
firm is going down, but if it is some kind of cascading effect 
rather than a waterfall, in figuring out that trigger early 
enough on that it is a warning shot but not a death warrant is, 
sitting up here, the policy goal.
    I want to, and again, I know my time is about up, but 
Commissioner Casey, one of the things that I have been still 
very concerned about are the events of May 6 when we saw the 
precipitous drop in the markets and we, to my knowledge, at 
least, still don't know how much of that was caused by computer 
error, lack of trip wires, or within this world of high-
frequency trading firms using some of these tools to 
potentially manipulate the market. It seems to me as we move, 
particularly in your area, to a much more global marketplace of 
these exchanges, this is an area that desperately needs not 
just the United States sorting it through, but sorting it 
through in an international framework, and I wonder if you 
could, recognizing that we still don't have all the answers to 
May 6, how we kind of sort through to get an answer, put 
appropriate trip wires in place. I still have grave concerns 
about the investments around high-frequency trading, that it is 
not just all about liquidity, that there are attempts to gain 
market advantage, how you are looking at that in the 
international context.
    Ms. Casey. Well, thank you, Senator Warner. As you note 
with respect to the events of May 6, we don't have particular 
forensic answers with respect to exactly what happened, but 
based on the preliminary efforts of the joint SEC-CFTC Advisory 
Committee, which has been empaneled to actually give 
consideration to exactly what happened and then report back to 
the SEC, potentially with recommendations on additional changes 
that might need to be undertaken, that we do understand that is 
a confluence of events and we are trying to sort through them 
to fully appreciate the dynamics of how those events affected 
that day.
    I would say that, with respect--and, of course, we have 
taken several measures in the near term to address the 
potential recurrence of such an event. With respect to the 
international dimension, as you note, there is no question that 
that is also informing our consideration of these issues. And I 
would tell you also that we have a great deal of collaboration 
and consideration with our foreign counterparts on similar 
concern, because they obviously took note of what happened here 
and were significantly interested in appreciating what happened 
and what the implications might be on their markets.
    With respect to the role of high-frequency trading, as 
well, I would note that that also has been a topic of 
discussion and consideration by the Joint Committee, and I 
would say more generally the Commission is undertaking a 
broader review of the role that high-frequency trading plays in 
our market given the significant volume that it accounts for in 
terms of trading. And so that more comprehensively, we are 
giving consideration to and necessarily inform what additional 
changes, if any, are appropriate in the coming years.
    But I would say that the international component is not 
lost and that it is absolutely well understood, again, the 
global nature of how our markets operate and the fact that you 
can have contagion throughout the markets when you have an 
event like this.
    Chairman Bayh. Thank you, Senator Warner.
    Let us start our second round here. Mr. Tarullo, I would 
like to start with you. In your testimony, you note that it is 
unlikely that our counterparts abroad will follow a universal 
banking model, or that follow a universal banking model will 
adopt the kind of restrictions included in the Volcker Rule. To 
what degree or extent do you anticipate this will leave our 
financial institutions at a competitive disadvantage, if that 
turns out to be the case?
    Mr. Tarullo. Senator, there are a couple of different 
questions there. To what degree might some of our regulated 
financial institutions have some limits on how they can compete 
in some areas? I think there is little doubt but that that is 
going to be the case, and I think that, indeed, was 
contemplated and intended by the Congress, that the protection 
of insured depository institutions was of sufficient importance 
and the need to insulate taxpayer funds from having to back up 
trading losses was a fundamental policy decision that was made.
    As I was alluding to earlier, I think that the U.S. 
financial system has historically moved things around. We 
developed public capital markets much more quickly and 
comprehensively than other countries precisely because we 
didn't allow banks to do a number of things that banks in other 
countries could do.
    So I think it is difficult to say in advance whether the 
outcome of all of this will be more expertise, development of 
new approaches, development of new markets within the United 
States, or whether it will be a case in which some of our large 
institutions say, they can't compete with what some of the 
universal banks are doing.
    Based on history, I don't think there is any particular 
reason to believe that they are going to be at a competitive 
disadvantage since, if you do look at history, the most 
important characteristic of a financial institution is how safe 
is it, how sound is it, and do investors and counterparties 
believe that it is safe and sound. The kind of effort that you 
have made with this bill, I think, indicates to markets that 
there won't be public bailouts forthcoming and thus 
institutions are going to have to stand on their own, and if 
they have to stand on their own, then they need to operate in a 
safe and sound fashion, and if they do, they will have 
advantages in the markets.
    Chairman Bayh. Thank you, Mr. Tarullo.
    A somewhat similar question for you, Ms. Casey. If our 
global counterparts adopt significantly different standards for 
how we treat the end users of derivatives, what will the 
consequence of that be for our financial markets?
    Ms. Casey. I think that it could have significant 
implications with respect to the competitiveness of our firms, 
potentially. I think with that in mind, though, I would note 
that in the OTC derivatives space, a tremendous amount of 
cooperation and coordination has been undertaken with respect 
to how we give consideration to the framework that we hope that 
most jurisdictions will follow.
    I do know that this is, again, with respect to our 
engagement with Europe, in particular, these issues are 
currently being contemplated and so our engagement with them as 
we take the legislative requirements forward through our 
implementation of the rules, it will be critical to understand 
how that is going to marry up with what Europe does, as well.
    Chairman Bayh. Even if you get a fair amount of 
convergence? I mean, as long as there is just one significant 
outlier out there, won't this kind of activity just offload 
    Ms. Casey. I think that with respect to, again, the 
significant disadvantages that may come with the cost of 
financing, depending on how the definition might be 
interpreted, I think that we just have to be sensitive to what 
the playing field is with respect to our foreign counterparts 
and various other jurisdictions. But I would just note that, 
again, in the OTC space with respect to implementing the 
legislation, which we will do, it will be critically important 
that we also closely monitor how other jurisdictions take their 
rules forward.
    Chairman Bayh. Good. One last question for you, Mr. 
Tarullo, in the area of capital standard setting and 
particularly the, I think, what is referred as the 
countercyclical capital standard setting, where as I understand 
it we would look for a growing gap between the growth of 
private credit and the growth of GDP to perhaps indicate there 
was some excessive growth in credit and that then require firms 
to begin building up their capital during the good times to 
help get them through the difficult times. It makes sense in 
theory, but as we discovered here even with our own Fed, as 
bright and well intended as it was, it is kind of hard to start 
taking away the punch bowl when the party is in full swing, 
although in theory that is what needs to be done.
    And so my question is, I noted that there was going to be--
it was going to be left up to individual nations to decide when 
this was going to be triggered and implemented. Isn't that a 
possible significant practical loophole in what is 
theoretically a pretty sound approach?
    Mr. Tarullo. That is a proposal that we have some questions 
about, the countercyclical buffer. I think we are enthusiastic 
about the so-called ``fixed buffer,'' which would just be a 
specific amount of capital that would need to be held, but that 
falling below that amount would not occasion the same 
consequences that falling below minimum capital levels would.
    The countercyclical buffer, as you suggest, Senator, is one 
that implicates the issue of variable credit and GDP growth in 
different countries. So you either have to have a one-size, 
global-size-fits-all, which has obvious difficulties, or you 
need to calibrate it to particular countries. And if you 
calibrate it to particular countries, then you either have to 
have a fixed calibration at the outset, which is just like a 
rule, or you have to give discretion.
    The problem with a fixed calibration is that the measure 
you noted that is in the proposal of credit growth to GDP would 
not have done such a good job at seeing the early stages of the 
subprime and housing problems. So it doesn't look to us like a 
particularly efficacious metric.
    Whether there are other metrics that would be possible, we 
are certainly open to them. But this is one of those very good 
ideas that is conceptually very appealing but whose practical 
implementation--a little bit like contingent capital that 
Senator Warner was referring to--has a lot of technical 
    Chairman Bayh. The devil is always in the practical 
details. Thank you, Mr. Tarullo.
    Senator Corker.
    Senator Corker. Thank you, Mr. Chairman. Again, thank you 
all for being here.
    I believe that each of you and the people you work with are 
going to do the best you can to make sure that we end up 
internationally in the best place that we should be. I believe 
    I am slightly skeptical about our ability to do that. I 
watch with interest as the currency issue that is of great 
concern here in our country with China. I watch the 
Administration try to deal with Europe on their view of what 
ought to happen with issues regarding stimulus and they say, 
absolutely not. We are doing just the opposite. And I would 
say, I wished we were following their lead in that regard.
    But, Madam Secretary, as it relates to that issue, because 
this would be under your purview, the fact that Europe is 
taking a markedly different position as it relates to austerity 
and balancing budgets and those kinds of things than we are, 
what kind of discussions is that generating inside Treasury 
    Ms. Brainard. So I think that in Toronto, there was 
actually a lot of agreement around the table about steering a 
path forward, given where we are in the recovery, still at a 
rather nascent stage, still needing to provide public support 
for the hand-off to the private sector. There was broad 
agreement around the table that there is still a need to 
support the economy, to support recovery, to follow through on 
the stimulus plans that all members of the G-20 have 
    At the same time that we all, and this has been very 
important to President Obama, articulate a medium-term path of 
fiscal consolidation that will put public finances on a very 
sound footing, in fact, those two things are very carefully 
intertwined, that the more confidence there is in the longer 
term fiscal consolidation path, the more able we are to support 
recovery now. The better we support recovery now, the better 
our growth prospects will be contributing in turn to fiscal 
    So there was a lot of agreement around the table, and in 
fact, the U.S. plans going forward are fiscal consolidation 
plans are among the steepest and most rapid of the G-20 
economies, in fact, of the G-7 economies. Germany is actually 
bringing its stimulus down at a slightly slower pace than the 
U.S. is starting in 2011. So we, I think, got to a good place 
with our partners in the G-20 in terms of working together to 
make sure that this recovery really gets onto sounder footing, 
and then working together to make sure that we move forward to 
put our fiscal finances here in the U.S. more broadly on a 
sound footing while ensuring that there is a broader plan for 
rebalancing of growth so that other countries stimulate the 
global economy through their demand to a greater extent than we 
saw in previous years and we grow through exports and through 
our competitiveness.
    Senator Corker. Thank you.
    Commissioner, you know, we typically have--you were here 
for a long time and you know, candidly, more about the inner 
workings here than I do, I am sure. We typically have a hearing 
like this--my friend Evan Bayh is leaving us soon, which I 
regret, but we will have a hearing and then----
    Chairman Bayh. Absence always makes the heart grow fonder.
    Senator Corker. We have a hearing and then there is really, 
you know, it kind of goes away. We don't focus on it. As a 
matter of fact, I would say that not only did the regulators 
miss a lot of things during this last crisis, candidly, we 
didn't do our work in this body properly as it relates to 
    So as it relates to the things that each of you are working 
on with G-20, with Basel, what is it we should do here to 
ensure that the work is being carried out in a way that we can 
say grace over and that we keep ourselves fully informed?
    Ms. Casey. Well, as you note, these hearings serve an 
important function of giving us an opportunity to bring you up 
to date on some of the work that we are engaged in and the 
progress that is being made in some of the key areas that we 
are working on.
    I think, also, another mechanism that works, and again is 
completely a function of the interest of the committee or 
particular members, are informal briefings, which I think do 
occur quite regularly, and I would anticipate, given the sheer 
amount of implementation rulemakings the Commission would be 
engaged in that we would also be spending a tremendous amount 
of time being responsive to the Congress in understanding how 
those rules are going forward. So I do think informal 
mechanisms, in terms of briefings at the staff level, can also 
be very effective in monitoring what we do.
    And I think, also, that will be complemented by the fact 
that with respect to the rules that we are going to be required 
to adopt under the law, it is going to be a very transparent 
process with respect to putting forward our rules in a notice 
and comment period and, again, being very clear about the 
direction that the Commission is going in implementing them.
    With respect to, again, the international components, I 
think to the degree that we can help the Subcommittee 
understand how that is consistent or inconsistent with other 
efforts that are being taken internationally, we can put that 
in a context as we proceed in implementing the new law.
    Senator Corker. Thank you.
    Mr. Tarullo. Senator?
    Senator Corker. Yes, sir?
    Mr. Tarullo. Can I just add one thing on that point, 
because I know exactly what you mean about the phenomenon of a 
hearing and then you wonder sometimes what happens thereafter. 
But I can think of a couple of important instances in which 
this Subcommittee's oversight actually had an impact.
    In 2005 and then again in 2006, Senators Sarbanes and 
Shelby, who reversed chair and ranking roles during that period 
but were together on the issue, held oversight hearings on 
capital standards and on Basel II. And although those hearings 
came at the end of that process, when the basic framework had 
been agreed on, my own observation as someone who testified at 
both of those hearings as an academic and then observed from 
outside was that those hearings and the fact that Senators 
Sarbanes and Shelby were clearly together in their concerns had 
an impact on the implementation of Basel II here in the United 
States, specifically in some of the safeguards that were 
included in the regulations.
    So although sometimes it may not be so obvious sitting on 
that side of the dais, I think there is enormous utility to a 
Congressional committee focusing on a particular ongoing issue 
and just forcing us to come up and explain why we have made the 
decisions that we have and where the implementation is.
    Senator Corker. Thank you for that.
    Let me ask you, and I will stop with this last question, I 
think, some mention has been made in this hearing and I know a 
big part of the debate as we passed, as this legislation was 
passed, dealt with resolution. I think Senator Warner made a 
very good contribution to that. I know a lot of people worked 
on it. From my perspective, judicial checks that should have 
been in place didn't end up making it in place and I think 
Senator Warner would agree with that.
    But the big, glaring, huge issue that wasn't dealt with was 
really causing the Bankruptcy Code to work more fully for 
highly complex bank holding companies, and there was just a 
tremendous resistance toward that occurring. It also was in a 
different committee of jurisdiction, and around here, it is 
unfortunate for the American people. You know, it is the same 
reason the SEC and the CFTC exist. It is shame. They shouldn't 
both exist. We all know that. There is not a person in this 
room that believes they should both exist, and yet they exist 
because of committee jurisdictions, and that is a flaw that has 
to do with all of us as politicians, if you will. And so I will 
throw that back on us.
    But back to the issue of bankruptcy, I don't think--I think 
what we have done with the Dodd-Frank bill is we have added a 
tool to the tool kit that could be abused. There could be some 
crony capitalism. I don't think there are enough checks. I 
mean, I look at Treasury, and Madam Secretary, I mean, Treasury 
and the Feds come out a winner, obviously, but the Treasury has 
got tremendous powers now, powers that I think all of us, I 
mean, the country has resisted giving Treasury. It now has 
those, and I am sure with people like you and others, it will 
be handled responsibly.
    But a lot of things occurred in this bill except really 
dealing with this bankruptcy issue, and as we met with 
sophisticated folks who deal in international problems like 
this, it just became more and more glaring as an omission. So I 
would just ask, what is it we needed? I don't think--and we 
have added a tool to the tool kit. I don't think we by any 
means have come close to dealing with the too big to fail issue 
because of the international relationships that exist. What is 
it, and that is hard work. That is maybe more difficult than 
much of what you all will be working on over the next year and 
a half. What is it, though, we need to begin doing to try to 
create a regiment that will work internationally?
    Mr. Tarullo. As I said earlier, Senator, and I think is 
implicit in your question, we are not any time in the 
foreseeable future going to converge around a single legal 
mechanism which is operative and effective across 
jurisdictions. We are not going to have the equivalent of an 
international treaty that says everybody is going to now change 
their bankruptcy law to conform in precisely these particulars 
and here are the debtor and creditor rights.
    So in that world, I think what we have to try to do is to 
ease in advance the kinds of concerns that arise, as Senator 
Warner was saying earlier, when people see that there may be a 
problem and thus they have the instinct to ring fence.
    So I actually do think that the so-called ``living wills'' 
have a lot of efficacy as supervisory tools domestically, just 
forcing firms to plan and think well about their ongoing 
operations, including liquidity, but also internationally, 
because they force us all, meaning U.S. banking agencies and 
our counterparts abroad, to think through what the impact of 
the highly stressed and potentially insolvent status of an 
internationally active institution would be, and then in a very 
practical way, allow us to start trying to tackle those 
    That is where those four work streams that I alluded to 
earlier came from on things like payment systems. It is people 
actually thinking practically, what would be the impact of a 
high degree of stress on this kind of firm. Ah, here is where 
it is. Let us see if we can relieve some of that stress.
    So I think if we continue to do that, and if other 
countries begin to implement resolution mechanisms that have 
some of the same features as we do, then over time we may be 
able to converge around a set of practices which are 
sufficiently common that we could handle an international 
    But I would not disagree with you for a moment. I think we 
have a good ways to go before we get there.
    Senator Corker. So if I hear you, though, you would 
advocate that other countries adopt a similar resolution 
mechanism, not necessarily that we all develop more 
sophisticated Bankruptcy Code to work for highly complex 
entities like that.
    Mr. Tarullo. I think the domestic choice that a country 
makes as to whether it is going to have a special part of its 
bankruptcy law devoted to financial institutions or whether it 
is going to have something that it calls a resolution mechanism 
is less important than the resolution mechanism or the special 
bankruptcy chapter having the kinds of provisions that are 
being elaborated right now in the Basel Committee work, or FSB 
work, to say these are the kinds of things that we need to be 
able to do. These are the kinds of decisions that we need to be 
able to make, things like bridge banks, in order to contemplate 
a successful resolution.
    And the last thing I would say, Senator, is the FDIC is 
going to work with the law that has been passed and the 
resolution mechanism that they have and try to implement that 
in the best way possible. One of the elements of that best way 
possible is to try to get some compatibility, not harmonization 
necessarily but compatibility with what other major financial 
centers are doing.
    Senator Corker. Can I ask another question or do you need 
to go? I am going to just ask one more. As you look at the 
Dodd-Frank bill and you are out dealing with your international 
counterparts, is there anything that each of you wish was in 
the bill that is not?
    Chairman Bayh. We should have given the witnesses--we 
should have put some sodium pentothal in the water, Bob, before 
asking that question.
    Senator Corker. And forget even the international 
component, just from where you sit. I personally thought that, 
looking at any bill this size, there are going to be some good 
things in it, and there are some good things in this bill. I 
also thought, on the other hand, there was a lot of overreach 
in areas that have nothing whatsoever to do with financial 
regulation and the country will figure that out over time. But 
it also was a tremendous missed opportunity to address some of 
the core issues that, as a country, we needed to address.
    That was my own view, and it obviously is on public record 
now. I felt that, overall, the bill was a net negative because 
of that, OK. And I guess it was so close to it, I just knew 
what it could have been as a bill and it wasn't and that was 
disappointing. But over time, we are going to have some 
opportunities to correct unintended consequences and we will be 
dealing with this and I look forward to dealing with people on 
both sides of the aisle to do that.
    But from your perspective, what are some of the things that 
you wish were in the bill but are not?
    Mr. Tarullo. Senator, by and large, my sense is that, as 
you and the Chairman have both indicated, there is a lot of 
open textured language and authority in the bill in the 
Systemic Risk Council and in the constituent agencies of it. So 
if we think that there is something lacking, there is often an 
avenue for trying to develop the necessary authority.
    I think one problem, and I am not saying the bill doesn't 
have the ability to address this, but the way I have looked at 
the financial crisis and our financial system is that we have 
had three kinds of problems. We have had domino-effect type 
problems, counterparty problems, where the failure of one firm 
could induce the failure of another.
    We have correlation problems, whereby a big negative effect 
on assets affects everybody's balance sheet and leads to 
distress sales that drive down asset prices further and get the 
negative spiral going. And we have had contagion problems, 
where the problems in one institution, because of information 
asymmetries, lead to runs on other institutions.
    I think that there is an enormous amount in the bill that 
addresses the first problem of domino or counterparty effects, 
and it is going to be up to us to elaborate capital, liquidity, 
and other kinds of regulations that will successfully address 
the second and third issues.
    And I would also say that we have two kinds of phenomena 
out there. We have the too big to fail phenomena, which we just 
needed to address and we need to continue to address. But we 
also have what I think of as the parallel strategies problem. 
So let us hypothesize. You have 30 or 35 midsize financial 
institutions who are all engaged in the same kind of activity, 
all relying on the same sources for their liquidity, and a 
problem arises in that market. You are going to have a systemic 
issue just as surely as if you had a challenge to one of the 
two or three largest firms in the country. And I don't think we 
have really come to grips with that kind of issue yet.
    We are not extending capital and liquidity requirements to 
all big financial firms, only to those that own banks and/or 
those that are regarded as in and of themselves systemically 
important. So the Council is going to have to do a good bit of 
monitoring to see whether activities and parallel strategies 
migrate into the unregulated sector because I think that is at 
least a possibility going forward.
    Ms. Casey. Just briefly, you touched on one of the primary 
reforms I had hoped for, which was sort of structural, which 
would have been a merger of the CFTC and the SEC, which, again, 
I think would have resulted in enhanced efficiencies, I mean, I 
think despite our best efforts to work very collaboratively 
together, which we are doing and will do. But there is a lot in 
the bill for the SEC and our mission, so I think I guess that 
is the one I would highlight that would have been more 
fundamental to reforming our oversight of the markets.
    Ms. Brainard. Senator, I think Members of this Committee 
just should feel enormously proud of this legislation. I think 
that it will put in place protections that address every 
component that contributed to the financial crisis, and I think 
it does what good legislation does. It creates a full and very 
clear framework of high quality standards for U.S. financial 
markets, but leaves a lot of work to regulators, supervisors, 
in terms of implementation going forward. It ends too big to 
fail. It will end taxpayer-funded bailouts. It will provide the 
greatest set of consumer protections that this Nation has seen. 
It gives regulators and supervisors the tools they need to 
constrain the kind of reckless risk taking that went into the 
crisis. And it is going to create a safer, more transparent 
derivatives market.
    So I think if you look at this bill against the principles 
that have been agreed internationally in the G-20 and the 
Financial Stability Board, this bill hits every single one of 
those core priority objectives and really does set the standard 
internationally. And now I think we all have our work cut out 
for us to make sure that other financial jurisdictions come to 
the same standards.
    You asked earlier what Members of this Committee could do. 
We engage a great deal, not just multilaterally but also 
bilaterally, especially with the Europeans, and I know Members 
of this Committee have engaged with European Parliamentarians, 
but as they work through in the critical areas of hedge funds, 
where we need to make sure our firms have nondiscriminatory 
access as they work through end user exemptions in OTC markets, 
I think engagement with the European Parliament is another 
avenue for continuing our joint efforts to bring those 
standards up.
    Senator Corker. Madam Secretary, I might disagree with a 
few of the points you just made, but I would say you are as 
well coached, well prepped, well talking pointed as any person 
that has ever come before this Subcommittee.
    I wish you all well, and as you move ahead, I look forward 
to working with all three of you----
    Chairman Bayh. Any person who is not a Supreme Court 
nominee? Bob, is that what you meant to say?
    Senator Corker. There you go. I thank you all for your 
service and certainly for coming here today. Thank you.
    Chairman Bayh. Thank you, Bob.
    I just have--you have been very patient. I just have a 
couple quick questions, and you don't need to go on at great 
    I note that estimates show that $5 trillion in bank debt 
may be coming due in 2012. At least that is the figure that has 
been supplied to me. That seems like a lot for the system to 
adjust in any one period of time. Does this present a possible 
systemic risk, Mr. Tarullo, and if so, what are we doing to 
prepare for that? Most of it is European, but a big slug of it 
is here in the United States, as well.
    Mr. Tarullo. So----
    Chairman Bayh. Trying to digest that much debt in the 
banking sector, what is that going to mean to credit 
availability elsewhere and that kind of thing?
    Mr. Tarullo. Senator, the capital position of our large 
firms in the United States, I think, has been substantially 
enhanced over the last year as a result of the stress tests and 
the capital increases that we required. And I think right now, 
the funding capacities of those large institutions are actually 
quite strong. Obviously, the European situation created some 
stresses, but at this juncture, I don't think we have any 
reason to believe that our institutions will not be able to 
access capital markets very successfully.
    Chairman Bayh. Let me ask you this. What about some of the 
European institutions? Obviously, our markets react here when 
they have adverse developments there. They have got some 
sovereign debt problems they are trying to work their way 
through and it seems to me this may be a potential problem for 
us. Is this the sort of thing we are collaborating with our 
counterparts in Europe on?
    It leads me to my second question. These stress tests are 
coming up in a matter of days.
    Mr. Tarullo. Right.
    Chairman Bayh. Do you think they should be made public in 
their entirety, and if that is not what the Europeans decide to 
do, what does that tell us about their seriousness in really 
making some difficult decisions to get to the root causes of 
this problem over the longer term?
    Mr. Tarullo. Well, my understanding is that the intention 
of the Committee of European Banking Supervisors is to post the 
results of the stress tests in both aggregate and individual 
bank form on Friday. They have a rather elaborate timing 
sequence that they actually laid out in a press release. I 
don't know, Senator, the degree of detail that will accompany 
those releases, but I do think that the European authorities 
understand the importance of transparency in conducting a 
successful set of stress tests.
    Chairman Bayh. Good. Hopefully, they will keep ambiguity to 
a minimum.
    Just two more quick questions, one on behalf of Chairman 
Dodd, who could not be with us today. My final question on my 
behalf to all of you is, as you know, some of the Europeans are 
moving forward with bank assessments, taxes, whatever we want 
to call it. It doesn't look like at least in the immediate term 
we are going to be doing that in our country. This is sort of 
the reverse of a couple of questions you were being asked 
earlier. If the Europeans move forward with that tax, we don't, 
what is that going to do to the competitive balance of the 
financial institutions here and there? Does anybody want to 
take that on?
    Ms. Brainard. So I think there have been a lot of 
conversations, as you know, within the G-20 about whether to 
adopt a consistent financial fee across the jurisdictions and 
the agreement that we reached in Toronto, I think, was a good 
one and it is that all of the members of the G-20 essentially 
agreed that taxpayers should never bear the burden of any 
extraordinary interventions into the financial system, that 
financial institutions should. And that, of course, is 
reflected in the Dodd-Frank legislation. And that is, I think, 
a basis for creating a level playing field.
    And so to the extent that different jurisdictions have 
different burdens to compensate in terms of extraordinary 
Government interventions, there may be different levels of need 
for assessments on financial institutions, but our general 
conclusion from those discussions is that as long as the 
general principle was recognized and that those fees are 
imposed in a way that respects a level playing field, that 
different jurisdictions were going to have different needs to 
impose those levies at different times.
    Chairman Bayh. Thank you very much, Ms. Brainard.
    On behalf of Chairman Dodd, who could not be with us here 
today, let me ask you the following question. Governor Tarullo 
and Commissioner Casey stressed the importance of strong 
Congressional oversight. Secretary Brainard, will Treasury be 
responsive to this Subcommittee's request for testimony from 
Secretary Geithner to explain the recent International Economic 
and Exchange Rate Policy Report? I think we are talking about 
the China currency issue here. So far, Treasury has not been 
responsive. That is channeling Chairman Dodd.
    Ms. Brainard. Treasury is always very responsive to this 
Subcommittee and will continue to be.
    Chairman Bayh. Do you care to put a time line on that?
    Ms. Brainard. I don't actually know discussions about 
dates, but will be very happy to get back to you or to Chairman 
Dodd on that request.
    Chairman Bayh. Very good. Thank you.
    My final observation, I hope your take-away from this when 
you go to the international forums in which you work with our 
counterparts is that you can tell them that the Congress is 
serious about convergence. We think that is important over time 
to avoiding a repetition of what we have been through, and that 
we are also serious about enforcement mechanisms. At the 
beginning, understandably, we will rely upon sort of soft 
enforcement, but over time, you need to have real teeth if we 
are going to truly take our aspirations and translate them into 
better financial stability reality. I think that is the point 
of the hearing today, and I am very grateful to each of you in 
your capacities for promoting that objective. It really is 
doing our country a great service, and I know that sometimes 
progress is not as fast as we would like in international 
forums, but it is essential and I just want to express my 
appreciation for your work in that regard and also for your 
courtesy and your time here today.
    Thank you all very much. This hearing is adjourned.
    [Whereupon, at 11:50 a.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]

       Under Secretary of the Treasury for International Affairs,
                       Department of the Treasury
                             July 20, 2010

    Chairman Bayh, Ranking Member Corker, and Members of the 
Subcommittee, thank you for the opportunity to discuss our 
international financial reform agenda.
    The historic passage of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act lays the foundations for a sounder and more 
resilient financial system. Thanks to the leadership of President 
Obama, Secretary Geithner, and Chairmen Dodd and Frank, and to the hard 
work of this Subcommittee, this legislation enacts the most far-
reaching reforms of our financial system that this country has seen 
since the Great Depression.
    The challenge before us now is to ensure that the world's standards 
are every bit as strong as America's. In the wake of the most globally 
synchronized financial crisis the world has ever seen, we must develop 
the most globally convergent financial protections the world has ever 
attempted. It is critical to level the playing field up--while 
protecting against future financial crises and promoting economic 
    While implementation will take some time, we are determined to move 
quickly to provide clarity and certainty about the basic rules. We will 
do so with great care recognizing the complexity of the challenges, but 
with a sense of urgency commensurate with the critical importance of 
achieving international convergence and consistency.
    Today, I will discuss our international regulatory reform agenda, 
focusing on the importance of achieving international convergence to 
high-quality standards that address too big to fail and extend the 
perimeter of regulation, and establishing a global architecture that 
will prevent future crises.
Setting High-Quality Standards
    You have now acted with legislation to address the fundamental 
weaknesses in the U.S. financial system. The Dodd-Frank bill does just 
what good legislation should do: it creates a clear, full framework of 
high-quality standards for U.S. financial markets. Now that we have 
achieved this goal at home, why do international standards matter for 
U.S. households, workers, and firms?
    Financial firms, markets, and transactions are more interconnected 
than ever before, and the breadth and depth of these linkages require 
us to coordinate across borders if we are to protect America's economic 
and financial well-being. Without internationally consistent standards, 
large financial firms will tend to move their activities to 
jurisdictions where standards are looser and expectations of Government 
support are stronger. This can create a race to the bottom and 
intensify systemic risk throughout the entire global financial system.
    As the crisis demonstrated, significant market disruptions in one 
market can have a significant impact on other markets. Therefore, our 
financial reform agenda will not be complete until we achieve a level 
playing field with high-quality standards across the world's major 
financial centers covering the most globally mobile activities.
    But while global convergence will be critical in areas such as 
capital and derivatives regulation, our international efforts in other 
areas may be equally well served by coordinating different approaches 
across nations, reflecting deeply rooted differences in national 
structures and institutions. In these cases, while we share common 
objectives globally, the mechanism that works best for other countries 
may not work best for the United States in seeking to advance our 
common objectives.
Addressing Too Big To Fail
    The recent financial crisis demonstrated clearly that some 
financial firms are so large and interconnected that their failure 
could pose a threat to overall financial stability. The crisis also 
made clear that the existing framework for constraining the risk of 
large, interconnected financial firms and our Government toolkit for 
managing their failure were profoundly inadequate. That is why our 
reform efforts are tackling head on the moral hazard problem associated 
with firms perceived to be ``too big to fail,'' by increasing the 
incentives of these firms and their shareholders, creditors, and 
counterparties to manage and discipline their risk-taking and by 
reducing the threat they pose to the system. Internationally, our 
efforts are focused on the largest and most consequential economies in 
order to reinforce our domestic reform efforts.
Constraining Risk-Taking by Major Financial Firms
    In the lead-up to the recent crisis, major financial institutions 
around the world held too little loss-absorbing capital relative to 
risky assets; used excessive leverage to finance their operations; and 
relied too much on unstable, short-term funding. The resulting 
distress, failures, and Government intervention imposed steep and 
unacceptable costs on households, workers, and businesses that are 
still felt today.
    The lesson is clear: more and higher quality capital must be at the 
core of our efforts to ensure a more resilient financial system less 
prone to failure.
    It is equally clear that we must focus our regulation of these 
firms on protecting the stability of the financial system as a whole--
not just the solvency of individual firms--and that the new standards 
on capital must be global in reach. For the past two decades, there has 
been broad recognition that the high mobility of bank risk-taking in 
response to small differences in regulatory capital requirements 
demands convergence of capital rules for globally active firms across 
major financial centers. And that is truer than ever today when 
considerations of safety and soundness are paramount.
    That is why, in Toronto last month, the G-20 Leaders agreed on the 
need to increase the quality, quantity, and international consistency 
of banks' capital with the goal of ensuring that financial institutions 
hold enough common equity to withstand without Government intervention 
stresses of the magnitude seen in the last crisis. President Obama and 
other G-20 leaders set the goal of reaching a comprehensive agreement 
by the time of their next summit, in Seoul in November.
    The Basel Committee on Banking Supervision (BCBS)--which is 
responsible for setting capital standards--is working hard to meet this 
deadline. Efforts are underway to establish common definitions of 
capital and risk weights and to determine the necessary amount of 
capital and an appropriate liquidity ratio for a more resilient system, 
along with specifying appropriate transition periods. The U.S. banking 
regulatory agencies have been key players in advancing this work in the 
Improving Market Discipline Through Enhanced Disclosures
    Improving market discipline on major financial firms is an 
important complement to prudential supervision and regulation by 
governments. This in turn requires increasing the quantity and quality 
of information available to market participants about major financial 
    Stress tests are one important source of information that can help 
to identify sources of significant risk and assess the resilience of 
individual financial institutions in adverse scenarios. While 
controversial at the time, the decision to subject large U.S. financial 
institutions to stress tests through the Supervisory Capital Assessment 
Program (SCAP) and to fully disclose the results at the aggregate and 
bank levels marked a turning point in global financial markets by 
reducing uncertainty and restoring confidence in our financial 
institutions. Since that time, U.S. banks have raised more than $150 
billion in high-quality capital.
    In the coming days, the Committee of European Banking Supervisors 
will release bank-by-bank stress test results for the large cross-
border European banking groups as well as a number of smaller banks. 
While there is no one-size-fits all approach to stress testing, this 
European effort--with the appropriate assumptions and disclosures--
could play a helpful role in dispelling uncertainty about the financial 
conditions of individual financial institutions in Europe and in 
strengthening transparency and bank balance sheets, as SCAP did in the 
United States.
Strengthening Shock Absorbers and Market Infrastructure To Reduce the 
        Risk of Contagion
    In the years leading up to the crisis, a parallel banking system 
emerged, populated by highly leveraged nonbank financial firms that 
relied on short-term borrowing to finance the purchase of long-term 
assets. This parallel banking system had none of the Government-
provided shock absorbers that protect the banking system--deposit 
insurance, a lender of last resort, and guaranteed payment systems.
    In turn, the traditional banking system had important exposures to 
this parallel banking system with its risks of asset bubbles, runs, and 
collapse. Banks provided credit to, and engaged in large amounts of 
over-the-counter (OTC) derivative transactions with, the major 
securities firms and other nonbank financial institutions. Banks also 
provided payment, clearing, and settlement services to the parallel 
banking system. In significant part because of these exposures, the 
collapse of the nonbank financial sector during the crisis threatened 
the safety and soundness of the banking system itself.
    In particular, the build-up of risk in OTC derivatives markets 
became a major source of contagion during the crisis. To reduce risk 
from the web of bilateral derivatives trades between the major 
financial firms, U.S. financial reforms require clearing of 
standardized OTC derivatives through well-regulated central 
counterparties; exchange trading of standardized derivatives to promote 
transparency, price discovery, and liquidity; and supervision and 
regulation of all derivatives dealers and major market participants, 
including conservative capital and initial margin requirements on all 
non-centrally cleared derivatives. Moreover, trade repositories will 
provide regulators with information about standardized and customized 
transactions so that they can assess the potential for derivatives 
trades to transmit shocks through the financial system.
    In light of the globalization of these transactions, we are now 
working internationally to make sure others take comparable steps. In 
this regard, we are working especially closely with the EU to make 
certain that critical OTC derivative market infrastructure is subject 
to oversight in line with the standards adopted by the G-20 and FSB, 
and that appropriate cooperative oversight frameworks are established 
to address the information needs of supervisors and regulators.
Providing Better Tools To Resolve Major Financial Firms While 
        Safeguarding the System
    Another key element of our approach to constrain risk-taking and 
tackle moral hazard consists of making the system safe for failure. The 
Dodd-Frank legislation helps to achieve this objective by providing for 
a special resolution authority for the Federal Government to use in 
times of distress when the failure of a major financial firm could pose 
a threat to the broader system. Modeled on the FDIC process, this 
resolution authority closes a gap that severely limited the Federal 
Government's options during the crisis.
    We have worked within the G-20 to secure a commitment to robust 
resolution authority consistent with the recommendations of the BCBS, 
which has identified improvement of national resolution systems, better 
cross-border crisis management mechanisms, and convergence of national 
laws as key priorities.
    In addition, G-20 Leaders have agreed that major financial firms 
should be required to prepare and regularly update credible plans for 
their rapid resolution in the event of severe financial distress--so 
that governments and stakeholders are better prepared to accomplish an 
orderly unwinding of the firm in the event that crisis strikes. 
Regulators in the United States and the other G-20 countries are 
working through the FSB and the BCBS to implement this requirement in 
an internationally coordinated fashion.
    Finally, it remains vital that the financial sector, not taxpayers, 
bear the burden of risks imposed on the system as a whole. In Toronto, 
G-20 Leaders agreed on the principles that financial institutions--not 
taxpayers--should bear the burden of extraordinary support provided in 
crisis to the financial sector, that any fees be based on risk imposed 
on the system, and that such fees be undertaken in a manner that allows 
for broad international adoption. This is a significant achievement.
Tying Compensation to Long-Term Value Creation
    We recognize that excessive compensation in the financial sector 
both reflected and encouraged excessive risk-taking. Our response has 
been decisive. Last year, G-20 Leaders endorsed the Financial Stability 
Board's (FSB's) Principles for Sound Compensation Practices, which aim 
to align compensation with long-term value creation, deter excessive 
risk-taking, and create a level international playing field. The FSB 
has since reviewed implementation of these important principles, found 
that substantial progress had been made but that more work remains to 
be done, and indicated that it will follow up with a further review 
next year.
    Our work domestically supports these principles. The Dodd-Frank 
legislation gives shareholders a say in the compensation of senior 
executives at the companies they own, and it requires independence of 
the compensation committees of corporate boards. The Federal Reserve 
has conducted a review of incentive compensation practices at large 
banks and, along with other U.S. banking regulators, issued supervisory 
guidance on sound incentive compensation policies. These efforts are in 
addition to the SEC's recent enhancement to rules on compensation 
disclosure and Treasury's appointment of a Special Master to ensure 
that the pay packages of executives at firms that received exceptional 
Government assistance promote long-term value creation and avoid 
incentives for excessive risk.
Extending the Perimeter of Regulation
    Of course, effective restraint of risk-taking in the financial 
system depends in the first instance on Government having the authority 
to subject firms that present outsized risks to the stability of our 
financial system to a common framework of supervision and regulation. 
All firms, products, and institutions that could pose significant risks 
to the system should be regulated--thereby extending the perimeter of 
    A well-functioning financial sector also depends on supervision 
addressing risks to the stability of the system as a whole, not just 
the risks arising from individual institutions. Prudential supervision 
has historically focused on the safety and soundness of individual 
firms, an approach that can fail to detect emerging threats to 
financial stability that may cut across many institutions. The new 
Financial Stability Oversight Council of financial regulators will help 
fill gaps and supplement existing approaches to supervision with 
assessments of the potential impact of the activities and risk 
exposures of major firms across financial institutions, critical 
markets, and the broader financial system.
    While supervisory and regulatory institutions vary across 
jurisdictions, there is broad recognition within the G-20 of the need 
for supervision to be consolidated and to address risks to the system. 
European policymakers are now creating a macro-prudential supervisory 
function--the European Systemic Risk Board--to assess systemic risks 
and vulnerability, as well as issue risk warnings.
    We are also working with our partners in the G-20 to address other 
areas that require broader international consistency, including credit 
rating agencies and hedge funds. The Securities and Exchange Commission 
is leading work with our international partners in the G-20 and the 
Financial Stability Board to develop stronger oversight of the credit 
rating agencies in order to eliminate conflicts of interest, reduce 
reliance on ratings, and improve disclosure.
    The perimeter must also be extended to ensure stronger oversight of 
hedge funds--an area where international consistency is at a premium. 
We have worked to ensure international agreement on the same approach 
that the United States has adopted: requiring all advisers to hedge 
funds (above a threshold) to register and report appropriate 
information so that regulators can assess whether any fund poses a 
threat to overall financial stability by virtue of its size, leverage, 
or interconnectedness and to impose heightened supervisory and 
prudential standards on entities that do.
    As the EU works to establish similar requirements under their 
Alternative Investment Fund Managers Directive, we are working to 
ensure that the EU provides U.S. managers and funds with 
nondiscriminatory access to the EU market on par with that of EU-based 
managers--in the same way that U.S. rules treat all advisors and funds 
operating in the U.S. equally regardless of their origin.
Strengthening the International Architecture for Financial Cooperation
    Building a resilient financial system at home will require strong 
financial reforms around the world. For that reason, we have been 
working to strengthen and extend the global architecture for financial 
cooperation--fostering high-level political commitment to implement key 
reforms where global consistency and cooperation is most critical; 
extending international regulatory, supervisory, and standard-setting 
cooperation to include key emerging markets; and working intensively 
through strengthened bilateral channels.
Building Stronger Global Cooperation
    Owing in large part to President Obama's leadership, the G-20 has 
become the premier forum for global economic cooperation. By working 
with our partners in the G-20, which represents 85 percent of global 
economic output, we have pursued global economic stability and growth, 
and built high-level political commitment to the core tenets of our 
financial reform and repair agenda.
    To help coordinate the formulation and execution of strong and 
consistent rules across key financial jurisdictions, last spring, G-20 
Leaders agreed to reestablish the FSB with a strengthened mandate and 
expanded membership. The FSB is a critical part of our collective 
efforts to identify vulnerabilities in the global financial system, 
promote financial stability, and encourage coordinated and 
comprehensive regulatory standards through peer review. The FSB brings 
together representatives from 25 major jurisdictions, including all 
major global financial centers, along with international regulatory, 
supervisory, and standard-setting bodies. The FSB is working closely 
with the BCBS to coordinate international efforts to strengthen bank 
capital and liquidity standards, and to devise policy recommendations 
for winding down large, interconnected financial institutions. 
Currently, the FSB and BCBS are preparing recommendations on this set 
of issues for the next G-20 Leaders Summit in November.
    To promote effective and timely implementation of national 
regulation and supervision in activities where international 
consistency is at a premium, and to provide safeguards against 
jurisdictions with lax standards, we are also working to build 
effective systems of surveillance and peer review.
    The International Monetary Fund (IMF) is central to this effort, 
and it has expanded its multilateral and bilateral surveillance 
analysis to identify emerging macroeconomic and financial risks, and to 
recommend actions needed to address those risks. It also has 
contributed work on financial risk fees, alternative approaches to 
cross-border resolution, and supervisory effectiveness. The IMF's 
Financial Sector Assessment Program (FSAP) is a voluntary, 
comprehensive, and in-depth analysis of a country's financial sector, 
and has been strengthened to reflect lessons learned from the crisis, 
including regular coverage of systemically important countries and more 
candid and transparent assessments.
    Peer reviews will be increasingly integral to collective efforts to 
raise international standards in the areas of prudential supervision, 
antimoney laundering and counterterrorism financing, and tax 
information exchange. The three responsible international bodies--
respectively, the Financial Stability Board, the Financial Action Task 
Force, and the Global Forum on Transparency and Exchange of Information 
for Tax Purposes--have each launched a rigorous process for peer review 
of compliance in their relative areas.
Building Stronger Bilateral Cooperation
    Finally, we are also building stronger bilateral mechanisms for 
regulatory and supervisory cooperation and coordination with major and 
emerging financial jurisdictions. We have recently elevated our 
Financial Market Regulatory Dialogue with the EU to ensure greater 
consistency and nondiscriminatory approaches as rules are being 
rewritten on both sides of the Atlantic on key areas such as 
derivatives and hedge funds. Treasury, in cooperation with U.S. 
regulators and supervisors, is also strengthening financial policy 
dialogues with China, Japan, India, Mexico, Canada, and Australia, 
recognizing that cross-border coordination is more important than ever 
to ensure the integrity and resilience of our financial system.
Looking Ahead
    In conclusion, as we prepare for historic financial regulatory 
reform to be enacted into law in the United States, we must work to 
level up the playing field across all major and emerging financial 
centers internationally. By pursuing and implementing high-quality 
standards, addressing the moral hazard associated with too big to fail, 
extending the perimeter of regulation, and establishing a stronger 
international architecture to prevent future crises, we will enhance 
the soundness and resilience of our own financial system to better 
serve America's households, workers, entrepreneurs, and corporations 
for generations to come.
    We appreciate the leadership of this Committee on these key 
challenges, and we look forward to working with Congress as we engage 
with our international partners, challenging them to match the strength 
and sweep of American reforms.
    Thank you.
            Commissioner, Securities and Exchange Commission
                             July 20, 2010

    Chairman Bayh, Ranking Member Corker, and distinguished Members of 
the Subcommittee, thank you for inviting me to testify about 
international cooperation to modernize financial regulation.
International Cooperation: From Policy to Principle to Standard
    I am pleased to have the opportunity to testify before you on 
behalf of the Securities and Exchange Commission on this very important 
topic. As I stated in my testimony before the Subcommittee last 
September, international cooperation is critical for the effectiveness 
of financial regulatory reform. \1\ At that time, I described the 
existing mechanisms for international cooperation in securities market 
regulation and key securities regulatory reform issues being pursued 
through such mechanisms. The various mechanisms I described in 
September all remain active and relevant today. I therefore would like 
to use this opportunity to comment on some of the entities and venues 
in which we cooperate, and update the Subcommittee on progress in 
certain key areas.
     \1\ See, http://www.sec.gov/news/testimony/2009/ts093009klc.htm.
    At the same time that Congress has been considering the scope and 
specifics of regulatory reform in the United States, discussions have 
been taking place in the G-20, the Financial Stability Board (FSB), 
International Organization of Securities Commissions (IOSCO), and other 
forums as to the nature of regulatory reforms that might be desirable 
in the wake of the crisis and how best to coordinate such regulatory 
responses internationally. Effective international coordination begins 
with a coherent articulation of and commitment to policies designed to 
address the weaknesses identified in the crisis. Those policies, in 
turn, must be reflected in sound principles developed to guide national 
regulatory authorities' regulation, such that national authorities can 
move forward in a coordinated fashion to consider and implement those 
principles in their own standards and regulations.
Articulating International Policy
    The G-20 has proven helpful in forging a broad consensus about what 
major issues should be addressed by the individual G-20 members in 
seeking to avoid and to mitigate at least some of the risks the global 
financial system may continue to face.
    In addressing such broadly identified risks, not all jurisdictions 
will follow the same or even similar approaches. While the G-20 is an 
excellent vehicle for discussion of the highest-level policy objectives 
for financial regulation, regulatory objectives are just that--
objectives. Different jurisdictions are likely to use different 
approaches in pursuit of those objectives, depending on their own legal 
and market structures. In this respect, I would note that the relevant 
provisions of the Dodd-Frank Wall Street Reform and Consumer Protection 
Act are broadly consistent with the international principles 
articulated in the key areas of hedge funds, OTC derivatives and credit 
rating agencies, and provide the Commission with the requisite 
authorities to craft regulations consistent with these principles.
    In addition, because not all jurisdictions are members of the G-20, 
and even in those jurisdictions that are, not all important actors are 
represented--legislatures, for example--national deviations from the G-
20 consensus are possible. On issues relating to regulatory arbitrage 
or market competitiveness, it is unlikely, however, that a significant 
divergence from the G-20 consensus would go unnoticed.
    At the G-20 Summit in Toronto, the Leaders pledged to act together 
to achieve the commitments to reform the financial sector made at the 
Washington, London, and Pittsburgh Summits. This reform agenda rests on 
four pillars, consisting of a strong regulatory framework, effective 
supervision, resolution of financial institutions in crisis and 
addressing systemic institutions, and transparent international 
assessment and peer review. The G-20 has tasked the FSB and other 
organizations with certain responsibilities in these areas, supported 
their ongoing work, and set forth timelines for completion of some of 
this work.
    Currently, I represent the Commission in the FSB alongside the 
other U.S. Government participants, including the Federal Reserve Board 
and the Department of the Treasury. Although the SEC is a independent 
Federal agency, 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 has been 
highly effective and is accomplished through extensive and informal 
communication between the staffs of our agencies as well as the Office 
of the Comptroller of the Currency, the Commodity Futures Trading 
Commission, and the Federal Reserve Bank of New York.
    The Commission continues to support the efforts of the FSB, which 
includes officials from across the spectrum of financial regulation. It 
is useful as a discussion forum to review broad trends affecting the 
financial systems. Through FSB discussions, some gaps in regulation can 
be more readily identified and remedial action prioritized. The G-20's 
focus on these results also is helpful in ensuring that the pace of 
reform is maintained and that a clear and coherent international 
framework emerges.
    While the FSB is useful in discussing and coordinating these 
efforts, the real work associated with building international 
regulatory-level consensus and coordination rests with international 
technical bodies such as IOSCO. The members of these organizations have 
both the expertise and regulatory authority to establish a coordinated 
approach to common regulatory problems. For these reasons, we cannot 
underestimate the importance of efforts at the level of international 
bodies like IOSCO, where policies, including many of those agreed to by 
the G-20 and the FSB, can be forged into principles to guide securities 
    As a securities regulator, the SEC has long been active in IOSCO as 
member of the Technical Committee and Executive Committee. As 
mentioned, I recently completed a 2-year term begun by former SEC 
Chairman Chris Cox as Chair of the Technical Committee. During this 
period, IOSCO has taken important steps in advancing approaches to 
regulation in the areas of credit rating agencies (CRAs), hedge funds, 
over-the-counter derivatives, securitization and short selling. IOSCO 
recently agreed to reorganize its internal structure as part of an 
ongoing strategic review, as well as to strengthen the organization's 
role in forging an international consensus on issues where the 
potential for regulatory arbitrage or conflicts are real concerns. \2\
     \2\ During its 35th Annual Conference, held in June this year, 
IOSCO reformulated its strategic mission and goals for the next 5 
years, in order to take into account IOSCO's increased role in: 
maintaining and improving the international regulatory framework for 
securities markets by setting international standards; identifying and 
addressing systemic risks; and advancing implementation of the IOSCO 
    IOSCO is the leading forum for securities regulators to discuss 
regulatory issues and concerns and to move these issues from broader 
agreement on policy to an articulation of particular principles that 
should guide regulation across global capital markets. The crisis has 
highlighted the need for enhanced cooperation in international 
regulation, and IOSCO has continued to focus on raising standards for 
international cooperation and coordination among securities regulators. 
This past year's focus on cooperation relates to enforcement as well as 
in supervisory oversight of market participants whose operations cross 
borders in the globalized market place.
Principles of Securities Regulation
    The IOSCO Objectives and Principles of Securities Regulation (IOSCO 
Principles) have, since their adoption by the organization in 1998, 
served as the key international benchmark for the regulation of 
securities markets. They are recognized by the international community 
as one of ``Twelve Key Standards'' for a sound financial system. \3\
     \3\ The objective of the IOSCO Principles is to encourage 
jurisdictions to improve the quality of their securities regulation. 
They are used not just by developing markets interested in creating a 
regulatory structure for an emerging financial market, but also by the 
World Bank, the International Monetary Fund, and other international 
financial institutions in conducting their financial sector assessment 
programs and similar regulatory assessment exercises.
    In the wake of the recent financial crisis, IOSCO's Executive 
Committee charged its Implementation Task Force to revise the IOSCO 
Principles to take into account the emerging consensus regarding 
regulatory concerns raised by the recent crisis. At the annual meeting 
last month in Montreal, the Presidents' Committee approved revised 
IOSCO Principles, which include eight new principles as well as a 
number of revisions to existing principles.
    The new principles address concerns regarding systemic risk in 
markets, recognizing the vital importance of this concept, and 
emphasize the need to review the perimeter of regulation to address 
other market practices highlighted during the global financial crisis.
Enforcement Cooperation
    In May 2002, IOSCO developed the Multilateral Memorandum of 
Understanding Concerning Consultation and Cooperation and the Exchange 
of Information (MMoU), a nonbinding multilateral enforcement 
information-sharing and cooperation arrangement that describes the 
terms under which any signatory can request information or cooperation 
from any other signatory as part of an investigation of violations of 
securities laws or regulations in the requestor's jurisdiction. The 
MMoU serves as an international benchmark for securities regulators 
interested in acquiring the powers necessary to cooperate fully in the 
fight against securities fraud and financial crime. The MMoU has also 
greatly expanded the number of securities regulators who have the 
ability to gather information and share information with the SEC for 
enforcement investigations and proceedings.
    IOSCO completed a milestone this past January when 96 percent of 
the eligible membership of 115 securities regulatory authorities met 
the requirements needed to become signatories to the MMoU, or have made 
the necessary commitment to seeking national legislative changes to 
allow them to do so in the near future. This represents a virtually 
complete commitment on the part of the international regulatory 
community to meet the minimum standards expected of regulators with 
respect to cooperation in the enforcement of securities laws. In order 
to pursue full implementation of the IOSCO MMoU, the IOSCO President's 
Committee passed a new resolution in June of this year requiring all 
IOSCO members with primary responsibility for securities regulation in 
their jurisdictions to become full (Appendix A) signatories by January 
1, 2013.
Supervisory Cooperation
    Recognizing the increasing need to collaborate in the oversight of 
firms and markets that are increasingly global, the Technical 
Committee, in June 2009, established a new Task Force on Supervisory 
Cooperation. This Task Force, led by the SEC and the French Autorite 
des marches financiers, was tasked to develop principles on cooperation 
in the supervision of markets and market participants whose operations 
cross international borders. This effort is particularly relevant to 
IOSCO's ongoing work related to broker-dealers and exchanges as well as 
hedge funds, credit ratings agencies and other elements of the 
securities markets infrastructure. In May 2010, IOSCO published 
Principles Regarding Cross-Border Supervisory Cooperation, which 
included a report and sample Supervisory Memorandum of Understanding to 
assist securities regulators in building and maintaining cross-border 
cooperative relationships with one another.
Hedge Funds
    In June 2009, IOSCO's Technical Committee published a report, 
``Hedge Funds Oversight,'' which sets out six high-level principles for 
regulation of the hedge fund sector. \4\ A task force under the 
direction of the Technical Committee has since expanded its efforts to 
provide a coordinated basis for hedge fund oversight by developing a 
common template to help regulators identify the types of information 
that could be gathered to assess possible systemic risk arising from 
the hedge fund sector. This template contains a list of broad proposed 
categories of information (with examples of potential data points) that 
regulators could collect for general supervisory purposes and 
potentially to help in the assessment of systemic risk (including, for 
example, product exposure and asset class concentration, geographic 
exposure, liquidity information, extent of borrowing, credit 
counterparty exposure, risk issues).
     \4\ The Final Report is available at: http://www.iosco.org/
Short Selling
    In the last few years, many jurisdictions, including the U.S. and 
EU member states, have been considering the implementation of 
regulatory controls to govern the short selling practices of market 
participants. \5\ The SEC participates in the IOSCO Short Selling Task 
Force formed during the depths of the financial crisis to effect 
coordination among member states with respect to short selling 
regulations. Pursuant to its mandate, the task force developed four 
principles for the effective regulation of short selling \6\ and aims 
to identify opportunities for greater convergence in the implementation 
of, and assessment of the effectiveness of, these principles. As IOSCO 
member jurisdictions are still in the process of implementing and/or 
conducting consultations with respect to new short selling measures, 
including transparency measures, \7\ the task force chair is organizing 
a workshop for members to continue monitoring developments in short 
selling regulation through an exchange of experiences, allowing members 
to better understand each other's short selling regulations and 
     \5\ For example, the SEC has adopted several rules and regulations 
relating to the short selling of securities by regulated entities. On 
June 23, 2004, the Commission adopted Regulation SHO, which was 
designed primarily to address concerns regarding potentially abusive 
``naked'' short selling and persistent fails to deliver securities. As 
adopted, Regulation SHO included a close-out requirement that required 
broker-dealers to purchase securities to close out fail to deliver 
positions in certain securities with large and persistent fails to 
deliver. The Commission subsequently amended the close-out requirement 
in the fall of 2008 such that fails to deliver in all equity securities 
must be closed out immediately after they occur. This amendment, among 
other actions taken by the Commission, has significantly reduced the 
number of fails to deliver securities. In addition, the Commission also 
adopted a ``naked'' short selling antifraud rule in October 2009 which, 
among other things, makes it unlawful for individuals to submit an 
order to sell an equity security if they deceive others about their 
intention or ability to deliver the security, and such person fails to 
deliver the security on or before the settlement date. In February 
2010, the SEC adopted an alternative uptick rule (Rule 201) which 
imposes restrictions on short selling if a security has triggered a 
circuit breaker by experiencing a price decline of at least 10 percent 
in one day. At that point, short selling would be permitted if the 
price of the security is above the current national best bid. The 
implementation date for this short sale price test is November 10, 
    With respect to the European Union, on June 14, 2010, the European 
Commission published a consultation paper on short selling addressing 
the scope of securities covered under a short selling regime, increased 
transparency of short positions, restrictions on ``naked'' short 
selling and credit default swap transactions, possible short selling 
exemptions and emergency powers relating to short selling. A formal 
European Commission proposal is scheduled for adoption in September 
2010. In addition, on March 2, 2010, the Committee of European 
Securities Regulators (CESR) submitted a proposal to the European 
Institutions recommending the introduction of a pan-European two-tier 
disclosure regime for net short positions. Further, in October 2009, 
the United Kingdom's Financial Services Authority (FSA) published a 
feedback report detailing the responses it received on a February 2009 
discussion paper regarding short position disclosure. In the report, 
which made no changes to its current short position disclosure regime 
that has been in effect since 2008, the FSA advocated for the adoption 
of the CESR proposed disclosure regime and indicated it is awaiting the 
outcome of the CESR proposal before amending the current FSA short 
position disclosure policies.
     \6\ These principles state that (1) short selling should be 
subject to appropriate controls to reduce or minimize the potential 
risks that could affect the orderly and efficient functioning and 
stability of financial markets; (2) short selling should be subject to 
a reporting regime that provides timely information to the market or to 
market authorities; (3) short selling should be subject to an effective 
compliance and enforcement system; and (4) short selling should allow 
appropriate exceptions for certain types of transactions for efficient 
market functioning and development.
     \7\ The Commission has also worked with several Self Regulatory 
Organizations (``SROs'') to improve public disclosure regarding short 
sales. Specifically, the SROs have made the following short sale 
information publicly available to all investors: the aggregate short 
selling volume in each individual equity security for that day; and, 
information regarding individual short sale transactions (without 
identifying the parties to the transaction) in exchange-listed equity 
securities. In addition, the Commission increased the frequency of its 
publication of data regarding fails to deliver for all equity 
Examples of the Layers of International Coordination
    Credit rating agencies and over-the-counter (OTC) derivatives 
provide illustrative examples of the interaction of the various levels 
of cooperation--involving the G-20, FSB, IOSCO, and national and 
regional authorities.
OTC Derivatives
    In March 2010, IOSCO, the Committee on Payment and Settlement 
Systems (CPSS) and the European Commission formed a working group to 
analyze and suggest policy options to further the objectives agreed 
upon at the September 2009 G-20 Leaders' Summit in Pittsburgh to 
improve the OTC derivatives markets. \8\
     \8\ The Pittsburgh Leaders' Statement states, ``All standardized 
OTC derivative contracts should be traded on exchanges or electronic 
trading platforms, where appropriate, and cleared through central 
counterparties by end-2012 at the latest. OTC derivative contracts 
should be reported to trade repositories. Noncentrally cleared 
contracts should be subject to higher capital requirements. We ask the 
FSB and its relevant members to assess regularly implementation and 
whether it is sufficient to improve transparency in the derivatives 
markets, mitigate systemic risk, and protect against market abuse.''
    Separately, IOSCO and CPSS issued in May 2010 two consultative 
reports containing proposals aimed at strengthening the OTC derivatives 
market. \9\ One report presents guidance for central counterparties 
that clear OTC derivatives products, and the other presents a set of 
considerations for trade repositories in OTC derivatives markets and 
for relevant authorities over trade repositories. These are examples of 
how experts from IOSCO, the Basel-based committees, and national 
authorities are collaborating to ensure a coordinated approach as 
regulatory reforms in our respective jurisdictions evolve, in a manner 
responsive to the objectives laid out in policies developed by the G-
20. \10\
     \9\ See, http://www.iosco.org/news/pdf/IOSCONEWS182.pdf.
     \10\ From the U.S., representatives of the Commission, the Federal 
Reserve System and the Commodities Futures Trading Commission 
participate on the working group.
Credit Rating Agencies
    At the London Summit, G-20 Leaders agreed that regulatory oversight 
regimes of credit rating agencies (CRAs) should be established by the 
end of 2009. The G-20 Leaders took as a starting point the IOSCO CRA 
Code of Conduct Fundamentals (Code Fundamentals) first adopted in 2004. 
Following this commitment, national and regional initiatives have been 
taken or are underway to strengthen oversight of CRAs. In the U.S., the 
SEC has adopted or proposed amendments to its rules on nationally 
recognized statistical rating organizations (NRSROs) in order to foster 
accountability, transparency, and competition in the credit rating 
industry as well as to address conflicts of interest at NRSROs, 
including through enhancements to their disclosure requirements. The 
recent regulatory reform legislation also seeks to further strengthen 
oversight, ensure greater transparency and address conflicts of 
interest at NRSROs.
    Many other G-20 countries have also introduced or are on the way to 
introducing new regulatory oversight framework for CRAs. In the 
European Union regulation introducing oversight and supervision of CRAs 
entered into force in December 2009; and the Committee of European 
Securities Regulators (CESR) issued guidance in June 2010 on various 
topics including the registration process and supervisory practices for 
CRAs. In Japan, the final version of a cabinet order and cabinet office 
ordinances were published in December 2009, following the June 2009 law 
that introduced a new regulatory framework for CRAs. The new 
regulations became effective in April 2010.
    While these national developments build on the IOSCO Code 
Fundamentals, attention is needed to ensure international coordination. 
The SEC, Financial Services Agency of Japan and CESR-members have been 
engaged in ongoing discussions to address issues relating to cross-
border transferability of credit ratings and any other significant 
inconsistencies or frictions that may arise as a result of differences 
among their new CRA regulations.
    These discussions have been facilitated by the work of Standing 
Committee 6 of IOSCO's Technical Committee (which is chaired by SEC 
staff). In May 2010, IOSCO issued for public consultation a report 
reviewing CRA supervisory initiatives in several of its member 
jurisdictions in order to evaluate whether, and if so how, these 
regulatory programs implement the four principles set forth in the 2003 
IOSCO paper Statement of Principles Regarding the Activities of Credit 
Rating Agencies.
    In response to the FSB and G-20 recommendations to review the use 
of ratings in the regulatory and supervisory framework, steps are being 
taken to reduce official sector use of ratings. The Basel Committee, 
for instance, is working to address a number of inappropriate 
incentives arising from the use of external ratings in the regulatory 
capital framework. National and regional authorities, including the 
SEC, have also taken steps to lessen undue reliance on ratings in rules 
and regulations or are considering ways to do so. As guidance to assist 
this work, the FSB has collected information on the measures taken both 
at international and national levels, and is discussing the development 
of high-level principles for use by authorities in reducing their 
reliance on ratings.
Bilateral Cooperative Arrangements
    In addition to our collaborative efforts with our counterparts in 
IOSCO, the Commission is pushing ahead in developing much stronger and 
more extensive supervisory cooperation arrangements with a number of 
jurisdictions. These types of arrangements improve our abilities to 
share information at the operational level, to essentially ``compare 
notes'' with our counterparts abroad and share information about the 
entities we regulate. This combined emphasis--engagement with and 
strengthening of the international standard-setting bodies, and forging 
closer bilateral ties with our counterpart regulators overseas--is 
necessary for the high-level objectives of the G-20 to be implemented 
in any meaningful fashion, and in ways that do not lead to regulatory 
    On June 14, 2010, the SEC, Quebec Autorite des marches financiers 
(AMF) and Ontario Securities Commission (OSC) announced a comprehensive 
arrangement to facilitate their supervision of regulated entities that 
operate across the U.S.-Canadian border. The arrangement, in the form 
of a memorandum of understanding, provides a clear mechanism for 
consultation, cooperation, and exchange of information among the SEC, 
AMF, and OSC in the context of supervision. The memorandum of 
understanding sets forth the terms and conditions for the sharing of 
information about regulated entities, such as broker-dealers and 
investment advisers, which operate in the U.S., Quebec, and Ontario.
    I anticipate that there will be additional arrangements of this 
sort in the future. Certain provisions of the Dodd-Frank bill will 
facilitate supervisory cooperation between U.S. authorities and our 
foreign counterparts by further enabling and protecting information 
sharing with foreign authorities. \11\
     \11\ Section 929K, ``Sharing Privileged Information With Other 
Authorities'', indicates that the Commission shall not be deemed to 
have waived any privilege applicable to any information by transferring 
that information to, among others, any foreign securities authorities 
or foreign law enforcement authorities. This extra protection for 
shared information can be expected to strengthen the volume and types 
of information that the SEC can comfortably share with our foreign 
counterparts, for the benefit of investors. Section 981, Authority to 
Share Certain Information with Foreign Authorities, allows the Public 
Company Accounting Oversight Board (PCAOB) to share information with 
its foreign counterparts without the information losing its status as 
privileged and confidential in the hands of the Board. To receive 
information from the PCAOB, a foreign counterpart will need to provide 
assurances of confidentiality, a description of its applicable 
information systems and controls and of its relevant laws and 
regulations. The PCAOB will have the discretion to determine the 
appropriateness of sharing. This information sharing will enhance the 
PCAOB's ability to effectively oversee firms that audit multinational 
public companies.
Initiatives in Other Areas of International Interest
    Ultimately, while bodies such as the G-20 and FSB play an important 
role in the international policy dialogue, it is critical that 
regulatory bodies such as the Commission have control over their own 
agendas and the ultimate outcomes of their regulatory and standard-
setting work consistent with their national authorities and mandates. 
Regulators and supervisors have specific goals for regulation--which 
may differ 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 primary regulators, where the 
technical expertise resides, to develop regulatory approaches in their 
areas of concern, 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.
    I would like to briefly describe initiatives in two areas where 
regulators and standard setters must bear in mind the international 
repercussions of their work, but ultimately must make decisions that 
comply with the demands of their unique mandates.
Convergence in Accounting Standards
    Continuing a policy established over three decades ago, the 
Commission unequivocally supports efforts of the Financial Accounting 
Standards Board (FASB) and the International Accounting Standards Board 
(IASB) (collectively, the Boards) to reduce disparities in financial 
reporting standards through their convergence agenda. The Boards 
formalized their efforts to remove differences in key areas of their 
respective accounting standards in a 2006 memorandum of understanding.
    In the Leaders Statement issued at the September 2009 Summit in 
Pittsburgh, the G-20 ``call[ed] on our international accounting bodies 
to redouble their efforts to achieve a single set of high quality, 
global accounting standards within the context of their independent 
standard setting process, and complete their convergence project by 
June 2011.'' In the wake of the G-20 Statement, the IASB and FASB have 
been working aggressively toward completion of their eight remaining 
joint projects. \12\ To provide greater visibility into and 
accountability for their processes, in November 2009, the Boards issued 
a joint statement that set forth milestones for each remaining major 
convergence project. The Boards will issue quarterly reports on 
progress on those projects until they are completed. Two such quarterly 
reports have been issued to date.
     \12\ In addition, the Boards are collaborating on a number of 
other projects.
    The Boards' most recent progress report, issued on June 24, 
provided the details behind a modified approach to its work plan, 
announced in general terms on June 2. The modification reflects a 
prioritization of the major projects in the memorandum of understanding 
to permit a sharper focus on the issues and projects for which the 
Boards believe the need for improvement in their respective standards 
is the most urgent. For these projects, the modified strategy retains 
the target completion date of June 2011 or earlier. Included among 
these is the financial instruments project, the importance of which was 
accentuated during the financial crisis.
    Another revision to the project plan will result in phased 
publication of exposure drafts and related consultation on standards 
under development. Many stakeholders expressed concern that they may 
not be able to provide high quality input to each project, given the 
large number of major exposure drafts previously planned for 
publication in the second quarter of this year, in order to finalize 
standards by mid-2011. A more rationalized pace of proposed standards 
for comment is expected to increase the input provided to the Board, 
which in turn should contribute to the development of sustainable final 
    The Boards' modified strategy has the full support of the 
Monitoring Board of capital market authorities, which oversees the 
IASB's trustee body. SEC Chairman Mary Schapiro issued a statement upon 
announcement of the modified plan, expressing support for the 
adjustment. Both Boards are obligated to develop high quality 
accounting standards that improve the transparency and usefulness of 
financial reporting in the interest of investors. At their most recent 
summit in Toronto last month, the G-20 Leaders' statement urged the 
Boards to complete their convergence project by the end of 2011.
    The Commission staff continues to develop its analysis of the 
appropriate role of the accounting standards set by the IASB, 
International Financial Reporting Standards (IFRS), in financial 
reporting for U.S. issuers, as directed by the Commission in a February 
2010 Statement in Support of Convergence and Global Accounting 
Standards. The staff's work is designed to position the Commission in 
2011 to make a determination regarding incorporating IFRS into the U.S. 
financial reporting system for U.S. issuers.
Equity Market Structure
    Last year, the Commission began an in-depth evaluation of the U.S. 
equity market structure. The Commission embarked on this review to 
ensure that the U.S. equity markets remain fair, transparent and 
efficient in light of new technology and trading strategies. To date, 
the Commission has proposed several rules related to the equity market 
structure that would:

    Establish a consolidated audit trail system to help 
        regulators keep pace with new technology and trading patterns 
        in the markets. \13\
     \13\ SEC Release No. 34-62174 (May 26, 2010), available at http://

    Generally require that information about an investor's 
        interest in buying or selling a stock be made available to the 
        public, instead of just to a select group operating with a dark 
        pool. \14\
     \14\ SEC Release No 34-60997 (November 13, 2009), available at 

    Effectively prohibit broker-dealers from providing their 
        customers with unfiltered access to exchanges and alternative 
        trading systems and ensure that broker-dealers implement 
        appropriate risk controls. \15\
     \15\ SEC Release No 34-61379 (January 19, 2010), available at 

    Create a large trader reporting system to enhance the 
        Commission's ability to identify large market participants, 
        collect information on their trades, and analyze their trading 
        activity. \16\
     \16\ SEC Release no 34-61908 (April 14, 2010), available at http:/

    Each of these proposals is currently pending before the Commission, 
and the Commission has received helpful comment from the public on 
these proposals.
    In addition, to help generate thought and provide the Commission 
with insight on the current landscape of the U.S. equity markets, the 
Commission issued a concept release in January of this year. \17\ The 
Commission followed on this Concept Release this past June by holding a 
Roundtable on Equity Market Structure. \18\ The Concept Release covers 
three broad categories. First, it asks about the performance of the 
U.S. market structure in recent years, particularly from the standpoint 
of long-term investors. Second, it seeks comments on the strategies and 
tools used by high frequency traders, such as colocation services. 
Finally, it asks about dark liquidity in all of its forms, including 
dark pools, alternative trading systems (ATSs), over-the-counter market 
makers, and undisplayed order types on exchanges and ECNs.
     \17\ Concept Release on Equity Market Structure, SEC Release No. 
34-61358 (January 14, 2010), available at http://www.sec.gov/rules/
     \18\ See the SEC Press Release announcing the agenda and panelists 
for the Market Structure Roundtable, available at http://www.sec.gov/
    While the Concept Release is focused on analyzing the changes of 
the U.S. equity market structure, the Commission did request comment on 
the impact of globalization on U.S. equity markets. Specifically, the 
Commission asked the following questions:

  1.  How does global competition for trading activity impact the U.S. 
        market structure?

  2.  Should global competition affect the approach to regulation in 
        the U.S.?

  3.  Will trading activity and capital tend to move either to the U.S. 
        or overseas in response to different regulation in the U.S.?

  4.  How should the Commission consider these globalization issues in 
        its review of market structure?

    The SEC is not alone in its interest in evaluating equity market 
structure. These topics are currently being evaluated in other 
jurisdictions. For example, the EU is currently in the process of 
reviewing the Market in Financial Instruments Directive (MiFID) in 
light of new technology. \19\ In May of this year, the U.K. Financial 
Services Authority issued its regulatory agenda for the U.K. markets, 
which highlights many of the market structure issues that the 
Commission is considering, such as dark pools of liquidity and new 
trading platforms. \20\ In addition, IOSCO is evaluating certain market 
structure issues, such as dark pools and direct market access.
     \19\ See, e.g., ``CESR Call for Evidence, Micro-Structural Issues 
in the European Equity Market'', CESR Ref No. 10-142 (April 1, 2010), 
available at http://www.cesr.eu/
index.php?page=consultation_details&id=158. See also, ``CESR Technical 
Advice to the European Commission in the Context of the MiFID Review--
Equity Markets'', CESR Ref No. 10-394 (April 2010), available at http:/
/www.cesr.eu/index.php?page=consultation_details&id=16. In its call for 
evidence, CESR requested comment on issues related to high frequency 
trading; sponsored access; colocation services; fee structures; tick 
size regimes; and indications of interest.
     \20\ See, ``The FSA's Markets Regulatory Agenda'', (May 2010), 
available at http://www.fsa.gov.uk/pubs/other/markets.pdf.
    Beyond the formal bilateral regulatory dialogues and international 
financial and regulatory bodies in which the Commission and its staff 
participate, we have a long-standing commitment to assist in the 
development and strengthening of capital markets globally. Securities 
commissions and stock exchanges are increasingly requesting the 
expertise and experience of SEC staff in dealing with insider trading, 
market manipulation, pyramid schemes, corporate governance, inspections 
and compliance, antimoney laundering, and a host of other market 
development and enforcement issues. Utilizing a faculty of senior SEC 
and industry officials, and seasoned practitioners, the technical 
assistance program has provided training to nearly 2,000 regulatory and 
law enforcement officials from over 100 countries. Such technical 
assistance helps build good relationships with our regulatory 
counterparts abroad. We often need the assistance of our counterparts 
abroad in cross-border enforcement matters and, increasingly, in cross-
border supervisory matters. Increasingly, we find that they are 
pursuing the same wrongdoers that we are, so sharing our best 
regulatory and enforcement practices redounds directly to our benefit.
    Through its flagship International Institutes, bilateral dialogues, 
and regional training programs, we seek to improve market development 
and enforcement capacity around the world. This past April, we held our 
20th annual International Institute for Market Development. The 
International Enforcement Institute is held each fall. Earlier this 
month, the Commission hosted its second annual Institute on Inspection 
and Examination of Market Intermediaries.
    As is described above, the Commission is continuing its pursuit of 
efforts to improve securities market regulation in the wake of the 
financial crisis. Increasingly, our success will depend on 
international consensus on fundamental objectives of securities 
regulation--investor protection; the promotion of fair, efficient and 
transparent markets; and the reduction of systemic risk. As regulators, 
it is essential that we bear these principles in mind, as they will 
help us support the strength of our own capital markets. Our markets 
are made better not simply by international consensus on principles, 
but also on our implementation and enforcement at the national level of 
common objectives agreed upon at the international level.
        Member, Board of Governors of the Federal Reserve System
                             July 20, 2010

    Chairman Bayh, Ranking Member Corker, and other Members of the 
Subcommittee, I appreciate the opportunity to testify today on 
developments in international regulatory reform and U.S. Government 
priorities for international regulatory cooperation.
    When you held a hearing on this topic in the fall, I gave an 
overview of the Federal Reserve's role in international cooperative 
activities and reviewed some pertinent recent developments. In my 
testimony today, I will begin by enumerating the goals that should 
inform U.S. participation in international regulatory and supervisory 
activities. Then I will turn to some of the issues you identified in 
your invitation letter as being of interest to the Subcommittee in this 
hearing: the Federal Reserve's role in the international financial 
reform efforts--including our work on the Basel III reforms, cross-
border crisis management and resolution, and incentive compensation--
and a preliminary assessment of the likely effect of the Dodd-Frank Act 
of 2010 on international financial reform. Finally, I will close with a 
few thoughts on the future role of the Financial Stability Board (FSB) 
and other international regulatory bodies as we move from the design of 
financial regulatory reforms to implementation of the new framework.
Goals for International Cooperation in Financial Regulation and 
    Before discussing some of the very important initiatives that are 
under way, I think it important to specify what I believe should be the 
U.S. goals for international cooperative efforts.
    First, to increase the stability of our financial system through 
adoption of strong, common regulatory standards for large financial 
firms and important financial markets. As events of the past few years 
have shown, financial stresses can quickly spread across national 
borders. Global financial stability is a critical shared goal.
    Second, to prevent major competitive imbalances between U.S. and 
foreign financial institutions. A core set of good common standards 
will reduce opportunities for cross-border regulatory arbitrage, even 
as it promotes financial stability. This goal is particularly 
noteworthy as the United States tightens its domestic prudential 
    Third, to make supervision of internationally active financial 
institutions more effective through a clear understanding of home and 
host country responsibilities and adequate flows of information and 
    Fourth, beyond the supervision of individual institutions, to 
exchange information and analysis in an effort to identify potential 
sources of financial instability and to take action to help mitigate 
the buildup of risks in international financial markets, particularly 
those potentially posing systemic risks.
    Embracing these goals does not, of course, answer the often complex 
questions raised in specific initiatives, such as the degree to which 
rules should be standardized and the degree to which national variation 
or discretion is warranted in pursuing shared regulatory ends. But I do 
think it is useful to keep all of these goals in mind as we pursue our 
international agenda. Our task as U.S. regulators is to work to ensure 
that, together, the various international financial organizations 
produce reforms and practices that are consistent with U.S. interests 
and legal requirements.
The Federal Reserve's Role in International Financial Reform Efforts
    As a central bank with significant supervisory responsibilities, 
the Federal Reserve actively participates in both (1) central-bank-
focused groups that monitor developments in global financial markets 
and promote sound and efficient payment systems and (2) supervisory 
forums, such as the Basel Committee on Banking Supervision (Basel 
Committee), which promotes high global standards for banking 
supervision and regulation. We also actively participate in the FSB, 
which is coordinating many of the initiatives undertaken in response to 
the financial crisis and is directly communicating with the Group of 
Twenty (G-20).
    Our contributions to these groups take advantage of the synergies 
between our central banking functions and our supervisory 
responsibilities. Our contributions combine our economic research, 
knowledge of financial markets, and regulatory policy experience. 
Interestingly, in the wake of the financial crisis, we see some other 
countries, notably the United Kingdom, moving back toward a more 
significant involvement of the central bank in supervision, presumably 
for these same reasons.
Basel III
    The Basel Committee is working toward new global standards for 
minimum bank capital levels and a new liquidity requirement--a project 
that has become known as Basel III. This undertaking is central to the 
first and second goals for international cooperation that I noted 
earlier. The Basel Committee aims to complete this task by the November 
G-20 leaders meeting in Seoul. The Federal Reserve has devoted 
considerable resources to this important global initiative, and we note 
that international bank supervisors continued to make progress at the 
Basel Committee meeting last week.
    We agree with the yardstick set forth last month by the G-20 
leaders in Toronto--that minimum capital requirements should ``enable 
banks to withstand--without extraordinary Government support--stresses 
of a magnitude associated with the recent financial crisis.'' \1\ Our 
view is that large institutions should be sufficiently capitalized so 
that they could sustain the losses associated with a systemic problem 
and remain sufficiently capitalized to continue functioning effectively 
as financial intermediaries. Meeting this standard will require a 
considerable strengthening of existing requirements, both with respect 
to the amount of capital held and to the quality of that capital. As to 
the former, it is particularly important that the risk weightings 
associated with traded instruments be substantially increased. As to 
the latter, the crisis confirmed what many of us have long believed--
that common equity is by far the best measure of a firm's loss 
absorption capacity. During the crisis, regulators, counterparties, and 
market analysts all looked to levels of common equity as the key 
measure of a firm's durability in the face of extraordinary financial 
stress. We have conducted extensive analysis to inform our judgments on 
the specific rules needed to implement this standard. In this respect, 
the stress tests we conducted last year as part of the Supervisory 
Capital Assessment Program have been very useful in assessing the 
amount of capital needed to survive a financial crisis without unusual 
Government support.
     \1\ G-20 (2010), ``The G-20 Toronto Summit Declaration'', 
Financial Sector Reform, item 18, G-20 Toronto Summit held June 26-27 
in Toronto, Canada, http://g20.gc.ca/toronto-summit/summit-documents/
    Since the Basel Committee published its proposals in a number of 
consultative documents, the Federal Reserve and the other U.S. Federal 
banking agencies have been working together for a Basel III framework 
that produces a strong set of globally consistent capital and liquidity 
requirements that will promote financial stability and a level playing 
field for internationally active banks. We have assessed how various 
proposals would, or would not, achieve that aim. We have also 
considered carefully how to structure the transition to the new 
requirements so as to minimize their effect on the economy as a whole 
and to allow adequate time for firms to adjust their capital accounts.
    Although adopting a robust, common set of capital and liquidity 
rules for internationally active banks is critical, it is neither 
practical nor desirable to negotiate all details of financial 
regulation internationally. It is important that the United States 
preserves the flexibility to adopt prudential regulations that work 
best within the U.S. financial and legal systems. Within a common set 
of agreed-upon global standards, each jurisdiction will want to tailor 
some of its rules and supervisory practice to national conditions and 
preferences. Along these lines, there have been recent discussions 
within the FSB on the possibility of formalizing consultations among 
member countries to examine how each member is using its own mix of 
instruments to achieve particular safety and soundness ends.
    The Basel Committee has a number of initiatives and work programs 
related to capital requirements that go beyond the package of measures 
that we expect to be completed by the fall. These efforts include, 
among others, ideas for countercyclical capital buffers, contingent 
capital, and development of a metric for capital charges tied to 
systemic risk. Each of these ideas has considerable conceptual appeal, 
but some of the difficulties encountered in translating the ideas into 
practical rules mean that work on them is likely to continue into next 
Cross-Border Crisis Management and Resolution
    Like stronger capital and liquidity requirements, improved 
resolution regimes for both banks and systemically important nonbank 
financial companies are a critical element of the domestic and 
international agenda to contain systemic risk. Internationally, the FSB 
is seeking to enhance cross-border cooperation both in making advanced 
preparations for handling severe stress at specific firms and in 
dealing with financial crises when they occur.
    The FSB is developing concrete policy recommendations for the G-20 
Summit in November. Specifically, the FSB is working to identify common 
principles and key attributes for effective national resolution 
regimes, including a menu of resolution tools for authorities to draw 
upon in light of the varying circumstances that may be associated with 
distress at a particular firm. Among these are restructuring and wind-
down measures for firms that will be closed down, such as arrangements 
for providing temporary funding or the ability to establish a bridge 
bank to take over essential functions. There is also considerable 
interest at the FSB in developing a resolution tool that could 
facilitate a restructuring of a firm's own capital and liquidity that 
would allow it to continue operating as a going concern. Specifically, 
the FSB is exploring whether there could be a viable mechanism for 
converting debt into equity through terms set out in the debt 
    Another aspect of the FSB's work focuses on four technical areas 
that may affect cross-border recovery or resolution: (1) practices for 
booking trades in one legal entity and then transferring the market or 
credit risk of the trade to a different location or legal entity; (2) 
the use of intragroup guarantees and related cross-border implications; 
(3) the critical nature of global payments operations, such as cash 
payments or securities settlement; and (4) the adequacy of a firm's 
management information systems and service level agreements. The FSB is 
exploring ways to mitigate challenges related to these four areas.
    Firm-specific crisis management working groups composed of home and 
host supervisory authorities are working to identify specific issues 
and barriers to coordinated action that may arise in handling severe 
stress at identified firms. This process should culminate in recovery 
plans--developed by the individual firms--that outline options for an 
institution to recover from a severe distress without extraordinary 
official sector actions, and resolution plans--developed by the 
official sector--intended to identify options that would result in an 
orderly wind-down.
    Domestically, we have formed crisis management groups to cover the 
key internationally active U.S. banking organizations. In addition to 
the Federal Reserve, the groups include representatives from the Office 
of the Comptroller of the Currency, Federal Deposit Insurance 
Corporation, Securities and Exchange Commission, and relevant foreign 
supervisors and central banks. The firms are each internally 
identifying and assessing their options and strategies to lower risk in 
the event of stress, including selling portfolios or business lines, 
restructuring liabilities and implementing contingency funding plans. 
The objective is to ensure that each firm has a concrete and viable 
plan to reduce riskiness, ensure the continuity of critical financial 
services, preserve liquidity, and make up cash flow shortages under 
severely adverse conditions. They are individually working with their 
own crisis management group to isolate key impediments to recovery and 
are focusing on work that should be undertaken in the near term to 
enhance recovery options. These plans will have to be dynamic to ensure 
they remain relevant and appropriate in light of changing business and 
economic conditions.
    Despite the progress that is being made through the FSB work and 
domestic efforts, comprehensive solutions to cross-border crisis 
management difficulties will not be easy to achieve. Enhancing cross-
jurisdictional synchronization of resolution options and recovery 
processes would be a meaningful step in the right direction. At least 
for the foreseeable future, a focus on regulatory coordination and 
supervisory cooperation and planning before a large firm's failure 
becomes a real possibility is likely to yield the greatest benefit.
Incentive Compensation
    In the last 2 years, compensation has been a regular topic of 
discussion at meetings of international regulatory groups, culminating 
in the FSB's agreement last year on principles to guide incentive 
compensation. \2\ The principles specify that compensation practices at 
major financial institutions should properly account for risk, that 
boards of directors and risk managers at such firms should ensure they 
do so, that supervisors should provide effective oversight, and that 
firms' disclosures should be sufficient to inform stakeholders about 
compensation and risk.
     \2\ See, Financial Stability Board (2009), FSB Principles for 
Sound Compensation Practices (Basel, Switzerland: FSB, September), 
    In addition to these principles, a number of specific projects are 
in progress or have recently been completed by international regulatory 
working groups. The FSB conducted a peer review of G-20 nations' 
progress toward implementing the principles, which found that progress 
is being made but more work is needed. Other projects include work by 
the Basel Committee, expected by end-2010, on practices that would 
improve the soundness of risk-taking incentives, and a proposal for 
disclosure of compensation information under Pillar 3 of Basel 2.
    While the views of national supervisory authorities have in many 
respects converged on such matters as the sources and effects of 
incentive problems and some methods for better aligning the risk-taking 
incentives of employees at major financial institutions with the 
interests of shareholders and the financial system, different nations 
have taken different approaches in implementing the FSB principles.
    We have adopted an approach that requires large financial 
organizations to establish and maintain internal governance and 
management systems to implement principles for assuring that incentive 
compensation arrangements are risk-appropriate. These principles, and 
the process by which we proposed that they be implemented, were issued 
by the Federal Reserve for public comment in October. The final 
supervisory guidance, which was jointly issued with the other banking 
agencies, was released last month. \3\ We chose a principles-based 
approach because of the substantial variation in the actual incentives 
and risks associated with the thousands of executives and other 
employees within and among banking organizations. Our view continues to 
be that a uniform or formulaic approach to all such employees would be 
neither efficient in motivating and compensating employees nor 
effective in preventing excessively risky activity, particularly among 
nonexecutives such as traders.
     \3\ See, Board of Governors of the Federal Reserve System, Federal 
Deposit Insurance Corporation, Office of the Comptroller of the 
Currency, and Office of Thrift Supervision (2010), ``Federal Reserve, 
OCC, OTS, FDIC Issue Final Guidance on Incentive Compensation'', joint 
press release, June 21, www.federalreserve.gov/newsevents/press/bcreg/
    In contrast, this month the European Parliament approved a 
directive that has the potential to lead to a number of formula-based 
restrictions on employee compensation at financial services firms 
operating in the European Union (EU). \4\ This approach is consonant 
with views expressed by some EU members to the effect that formula 
setting--for example, putting a floor on the portion of an employee's 
salary that must be deferred--is the surest way to produce changes in 
bank practice. However, many of the details are left to be set by the 
European Commission, the Committee of European Bank Supervisors, and 
other entities.
     \4\ More information on this directive is available on the 
European Parliament Web site at www.europarl.europa.eu/sides/
    While both approaches have merit, we believe the option we have 
chosen is likely to be more successful in promoting risk-appropriate 
compensation practices. As already noted, we fear that a formula-based 
approach applicable to all covered employees may spawn efforts to 
circumvent the rules through creative new compensation practices, 
whereas our requirement that the banks internalize sound principles for 
incentive compensation and apply them to all such arrangements places a 
continuing responsibility on the firms themselves. Of course, 
considerable oversight is needed to ensure that a principles-based 
approach is implemented rigorously. We have already conducted an 
extensive horizontal review of compensation practices at 25 large U.S. 
financial holding companies and have sent detailed assessments to each 
firm commenting on their proposals for implementing the principles.
    It may well be that over time the two approaches will converge 
somewhat. For example, we may determine on the basis of experience with 
many firms that there are certain best practices that should at least 
presumptively be applicable to certain classes of employees. Similarly, 
the EU may find that more attention to internalization of the 
principles and customization of appropriate practices is necessary, 
particularly as applied to nonexecutive employees. We intend to 
continue information sharing and discussions through the FSB and the 
Basel Committee. For now, though, there is indeed a difference in 
approach, one that illustrates the point I made earlier that there need 
not be complete harmonization in all prudential regulation and 
supervision, even where there is agreement on basic goals.
Effect of the Dodd-Frank Act
    Of course, concurrent with the efforts of the Federal Reserve and 
other U.S. agencies to advance the goals of international regulatory 
reform, the U.S. Congress has debated and passed the Dodd-Frank Act, 
creating a comprehensive package of domestic financial reforms.
    Many elements of the Dodd-Frank Act align closely with the efforts 
of the G-20 leaders, the FSB, and the Basel Committee. For example, the 
act provides the Federal Government with the authority to subject all 
financial firms that present outsized systemic risks--regardless of 
whether they own an insured depository institution--to a common 
framework of supervision and regulation by the Federal Reserve. In 
addition, the act creates a special resolution regime that gives the 
Government the capacity to unwind or break apart major nonbank 
financial firms in an orderly fashion with less collateral damage to 
the system. Moreover, the act strengthens the resiliency of the 
financial market infrastructure by mandating increased central clearing 
and transparency for over-the-counter derivative transactions and 
stronger prudential regulation of bank and nonbank derivatives dealers. 
The act also provides for the registration of advisers to hedge funds 
and other private investment funds, improved regulation of credit 
rating agencies, and more-consistent oversight of systemically 
important financial market utilities.
    At the same time, there are aspects of the Dodd-Frank Act that are 
unlikely to become part of the international financial regulatory 
framework. For example, the act generally prohibits U.S. banking firms 
(and the U.S. operations of foreign banking firms) from engaging in 
proprietary trading and from investing in or sponsoring private 
investment funds. The act also prohibits U.S. depository institutions 
from entering into certain types of derivatives transactions. In the 
United States, activity restrictions have long been a part of the bank 
regulatory regime, serving to constrain risk-taking by banking firms, 
prevent the spread of the market distortions caused by the Federal bank 
safety net to other parts of the economy, and mitigate potential 
conflicts of interest generated by the combination of banking and 
certain other businesses within a single firm. Many other countries 
follow a universal banking model and are unlikely to adopt the sorts of 
activity restrictions contained in the act.
    Similarly, the Dodd-Frank Act expands the existing 10 percent 
deposit cap in U.S. law by preventing the Federal Reserve from 
approving a material acquisition by a financial firm if the resulting 
firm would have liabilities that exceed 10 percent of the total 
liabilities of the broader U.S. banking system. Other countries with 
more concentrated banking systems are unlikely to impose this type of 
concentration limit on financial firms in their jurisdiction.
    Again, not all elements of financial reform can be designed on a 
national level in a way that is perfectly consistent across countries. 
The characteristics of each country's financial system differ, 
sometimes significantly. Our challenge is to strike the right balance 
between achieving global consistency on the core reforms necessary to 
protect financial stability and provide a workably level playing field, 
and at the same time providing the flexibility necessary to supplement 
the common standards with elements tailored to national financial 
systems, legal structures, and policy preferences.
Current and Future Focus of International Regulatory Groups
    As my testimony makes clear, the international regulatory groups 
remain focused on responding to the crisis. The FSB is pursuing 
financial reform and working with the relevant standard-setting bodies 
to ensure that detailed proposals are developed in a timely manner. In 
some cases, the importance of the issues and the drive to respond 
quickly to the crisis have led to a proliferation of international 
working groups whose mandates may overlap. While this reaction is 
natural in the wake of a crisis, we will need to rationalize the 
activities of these groups as our focus shifts from policy development 
to implementation. So, too, we will need to ensure that the relatively 
new members of these groups are fully and effectively integrated into 
their activities, including in leadership positions.
    It is also important that we not lose sight of the third and fourth 
goals I suggested for our international cooperative efforts. While much 
of the effort in the international groups has recently been focused on 
negotiating rules and principles to reform financial regulation, it 
would be unfortunate going forward if negotiations were to become the 
dominant mode of international financial cooperation. We would not want 
to crowd out the other valuable aspects of international regulatory 
cooperation, including sharing supervisory perspectives on 
internationally active financial institutions and analyzing latent 
risks to financial stability.
    The FSB itself has a valuable role to play by bringing together the 
international standard-setting bodies and key national authorities 
responsible for financial stability in the G-20 member jurisdictions. 
Its role might usefully be conceived as roughly paralleling the role to 
be played by the Financial Stability Oversight Council in the United 
States under the Dodd-Frank Act. The FSB can facilitate discussion and 
analysis of emerging risks to financial stability that cut across 
sectors or across the jurisdiction of more than one regulator. Because 
it consists of senior officials from finance ministries, regulatory 
agencies, and central banks, it is well positioned not only to identify 
cross-cutting risks or regulatory gaps, but also to take action to 
address those risks.
    Finally, I believe that it will be important for standard-setting 
bodies such as the Basel Committee to enhance monitoring of the 
implementation of the sometimes complex agreements reached 
internationally. Where it is difficult for market analysts and other 
outside observers to determine if, for example, Basel III capital rules 
are being vigorously implemented and enforced, the international 
standard setters must themselves develop appropriate monitoring 
mechanisms. These mechanisms must go beyond examining whether 
international standards have been duly incorporated into domestic law 
to consider whether financial institutions are complying with those 
    Thank you for again giving me the opportunity to share our thoughts 
on the evolving issues in international financial cooperation. I would 
be pleased to answer any questions you may have.