us financial reform analysis

8/9/2019 US Financial Reform Analysis

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US Financial Reform

Material Changes or More ofthe Same?

Pre se n te d b y

,D a vid Ta te FR M


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Topics

Remedies for systemic risk

Derivative activities, proprietarytrading, securitizations

Initiative to control compensation

Consumer Protection Agency

Reform of Freddie Mac and Fannie

Mae Reforming Credit Rating Agencies

State rights vs. federal Preemption

issue


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Impact of Reforms

Type of Impact

Will it prevent anothereconomic/financial

meltdown? What impact will it

have on financialinstitutions viabilityand profitability

Broader impacts:consumerprotection, otherbusiness

opportunities

Conclusion

No cannot changehuman nature,

cannot manage allcomplex cause andeffects

Less profitable, morestable, slowergrowth in the shortrun

Minimal consumerprotection /

business


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Preventing the Next Crisis

You can pass a law against excess, andsomewhere down the road some excesswill appear at some point from some

direction, and no one will know it at thetime, and everyone will know it inhindsight

Goldman Sachs CEO Lloyd Blankfein


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US Political Process

Both Senate and House have passedfinancial reform legislation

A joint committee is formed to reconcile

the differences Timing of the process is dependent on

the complexity of the issues and thedifferences between the two versions

Outcomes can be unpredictable Also a few regulatory initiatives have

been proposed by the bank regulators


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Remedies for Preventing the NextCrisis

Increased Monitoring

Lender of Last Resort

Limitation on scope of activities Increased transparency

Adjusting compensation practices


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Increased Monitoring: OversightCouncil

Creation of a systemic risk regulator Nine member board consisting of all

financial regulators with Sec. ofTreasury as Chairman

Identify firms that pose systemic risk--

no free passes, hedge funds could betagged

$50 billion is recommended sizethreshold

Collection and consolidation of

information on risk positions andcompany interrelationships


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Expanded Fed Powers

Fed has power to force sale ordiscontinuation of high risk activitiesvia 2/3 vote of Board of Governors

Enforcement powers covering largefirms identified by Oversight council

Directs Fed to develop prudentialstandards for large firms covering the

following areas: Risk-based capital, leverage limits

Liquidity requirements

Risk management practices


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Orderly Resolution Authority

Create 3 judge panel with power to appointFDIC as receiver for troubled large firms

Must make determination within 24 hours ofrequest by Secretary of Treasury - Decisioncan be appealed to US Court of Appeals

Request from Secretary of Treasury must besupported by analysis form both the FDIC andBoard of Governors approved by 2/3 of itsmembers

additional steps for broker/dealer operations

insurance companies are referred to state courtsfor resolution

Study to be conducted to assess ability toliquidate large firms under bankruptcy codeand to determine how to promoteinternational coordination during liquidationof large firms


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Key Features of ResolutionProcess

Potential for future Bailouts FDIC can draw on Treasury funds to conduct

liquidation

FDIC to develop procedures for use of availablefunds

Potential for Confusion FDIC given power to adjust priority of unsecured

claims to minimize the loss

FDIC given power to enforce or repudiatecontracts including derivative transactions

Netting of exposure by counterpartiesdisallowed for 5 days following receivershipappointment

Need for Retribution Management responsible for failure must be

removed

Management and BOD can be held personally


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Lender of Last Resort& other Systemic Risk Safeguards

Tightens standards used by Fed forgranting loans to distressed firms

Use of 13(3) emergency powers to

grant liquidity funds to firms (used tosupport AIG) House bill eliminates emergency powers Senate bill requires development of

procedures and approval of Secretary

of Treasury Exempts banks from 10% concentration

limits in cases of acquisition of bankin default

Requirement to create living wills or


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Potential Impact of Reforms

Reforms create a cumbersome anduntested resolution process

Unlikely to create a zen-like calmamong investors during next periodof financial turmoil

Level of uncertainty could be even

greater during next financial crisis


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Hedge Fund Reporting Must provide systemic risk data to SEC

Data on assets and trading positions

Leverage

Counterparty risk exposure

SEC can conduct inspections to ensure accuracy of

submitted information SEC can obtain information about the identity, investments,

and affairs of their clients

Exempts venture capital fund, private equity fund, andfamily offices complete definitions to be developed by

SEC Requires following studies

Determine the feasibility of hedge fund selfregulation

Study of short-selling, esp. compliance with naked

short selling ban


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Next Reining inComplexity

CDOs CDS Z-traunch SwapsCMBS

You can catch more fish in murkywaters

Chinese proverb

, ,new wrinkle some innovative technique yet they


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Proprietary Trading RestrictionsVolcker Rule

Senate Bill contains the followingprovision

Requests a study to be performed within

one year Actual implementation would await

drafting of regulations

Regulations are likely to include thefollowing:

Apply restrictions only to banks withaccess to Fed Window

Banks could still execute trades forclients


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Limits on DerivativeActivities

Standard derivative contracts moved toexchanges

Non-standard contracts must be reportedand reviewed by systemic risk regulator

Derivative and swap transactions must bemoved outside of the bank

Adjustment in requirement likely duringreconciliation

At minimum, change is likely to allowactivity in an affiliate under holdingcompany

Provisions in this area take effect 180 days

from enactment no opportunity to adjust


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Impact of DerivativeClearinghouse

Provides transparency on size of marketand unusually large positions

Unanswered questions:

Appropriate level of capitalization Systemic risk of large margin calls, i.e.,

AIG would still have failed based oncall for increased collateralization oncredit default swaps

Does not eliminate the large losspotential of asymmetric risk contracts

that accept extreme tail risk Limitation on access to Fed lending

powers could increase risk of contagion

and systemic risk


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Securitization Activities

Requirement for retention of risk was stripped outof Senate bill in amendment process, could beput back in during reconciliation, or could beleft up to the regulators

FDIC proposed rule on retention of risk forsecuritization

5% retention for 1st yr put backs

Rating agency compensation must be partiallydeferred

Prudential rules for loans held on books will applyto loans securitized

Recent accounting rules create greatertransparency by requiring gross-up of exposurefor certain sercuritizations


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Rules on Compensation

Requires all companies to submit forshareholder vote a resolution coveringany material changes In

compensation Mortgage brokers cannot be

compensated based on differences inloan rates

Regulatory initiative to create standardsdesigned to promote alignment ofcompensation and risk managementincentives

Stock options vs cash compensation


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Consumer ProtectionAgency

Creates independent agencydedicated to consumer protection

Broad coverage: banks and credit

unions, all mortgage relatedbusiness, debt collectors, creditbureaus

Some details still under debate Exemption of some small businesses?

Independent rule-making authority?

Source of funding?


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Credit Rating Agencies

Regulated by new government officewithin SEC

Power to suspend and revoke rating

agency license by type of security Annual inspections conducted, which will

be made public

Can prescribe methodology standards

Enhance transparency and internalindependence

Requires separation of sales and ratings

functions


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Other Requirements forNRSRO

Requires credit rating agency toreport any potential illegal activitiespursued by clients

Meet standards for employeequalifications

Studies to be conducted

How to reduce reliance of ratingswithin financial regulations

Review alternate paradigms for

compensation of credit ratings


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Government SponsoredEntities (GSEs)

Cost of supporting GSEs is politicalAchilles heal for Democrats andObama administration

Reform bill requires Treasury tocomplete a report by Jan. 31, 2011

Potential Options

Smaller specialized governmentagencies similar to FHA, VA

Privatize core of operations or gradual

liquidation


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Problems that Remain

No clear standards for internationalcooperation during times of crisis

Most financial institutions and other largecorporations rely heavily on short-term

funding sources Constant innovation and complexity of

products prevents accounting industryfrom developing rules to give accuratepresentation of financial status

Short-term investor prospective eliminatesincentive for in-depth analysis required toadequately evaluate large financialinstitutions

How do we estimate risk within individualfinancial institutions


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Potential Next Crisis

Sovereign Debt

Reliance on short-term fundingremains dilemma for both finance

and non-finance companies Difficult for China to avoid bubble

Trade friction between slow growth

free market economies of US &Europe versus government directedeconomies of Asia esp. China.


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Potential Opportunities

If limits are imposed on GSE lending it willprovide greater opportunities for privatelending organizations

Banks and Wall street firms could re-engage

in securitization market with lower riskloans

Potential reemergence of private mortgageinsurance companies

Enhanced opportunities for community andregional banks due to tougher regulationof large banks and fewer number of largebanks

Proprietary trading opportunities will shiftto firms outside of banks hed e funds,

P ti f St t B ki


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Preemption of State BankingLaws

All federal banks charters enjoy some level ofpreemption rights

Preemption allows for more efficient operation

Prevents states attorney generals from suing banks

Defining level of preemption via court cases Watters vs. Wachovia rule that operating

subsidiaries are covered by preemption

Cuomo vs. clearinghouse allows state attorneygenerals to bring suit against national banks

Last minute amendment to Senate Bill (Carper

amendment) Attorney generals can sue banks, but only for

violations of regulations written by the ConsumerFinancial Protection Bureau

House members may fight to limit preemption rightsduring reconciliation

White house states publically that it wants to limitreem tion, but is allowin democrats to reinstate


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Best Guess Result

Preemption will be preserved withsome carve out for state attorneygenerals

Language is likely to be sufficientlyambiguous and will generateadditional legal challenges

Why did big banks and Wall


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Why did big banks and WallStreet firm not see the dangers

of the bubble?We are so accustomed to disguiseourselves to others that in the endwe become disguised to ourselves.

17th century author Francois de LaRochefoucauld

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