The Investors’ Working Group (IWG) has urged the US Government to set up an independent authority to monitor the activities and risk exposures of dominant financial institutions and advise regulators on ways to mitigate current and emerging risks in the financial system.
The IWG recommendation to create a Systemic Risk Oversight Board (SROB) is prominent amid a bold set of near-term measures proposed by the IWG to check systemic risks to the health of the financial system in a report entitled “US Financial Regulatory reform: The Investors” Perspective.
Formed in February, the IWG is a non-partisan panel of senior investment professionals from the Council of Institutional Investors and the CFA Institute Centre for Financial Markets Integrity. Its original aim is to represent investors” views in the debate over reforming the US financial system.
The SROB would accrue data to monitor emerging and current systemic risks to the financial system, and would be informed by the Financial Crisis Inquiry Commission’s investigations into the origins of the meltdown.
The board represents an alternative to the creation of a systemic risk regulator, proposed by the Obama Administration, and the “college of cardinals” model of oversight favoured by some lawmakers, which would see a collection of existing federal regulators tackle systemic risk.
“The IWG views both approaches with scepticism,” the IWG paper states, arguing the ultimate power available to a council of existing regulators would be inhibited because none would have the authority of a final say, and any outcomes could be hamstrung by jurisdictional disputes.
The Administration’s proposal, which places the Federal Reserve Board as a systemic risk regulator, was also problematic, mainly because the Fed is already responsible for determining monetary policy and managing the large US payments system, among other tasks.
And in the eyes of the IWG, the Fed also has some answering to do.
“Its credibility has been tarnished by the easy credit policies it pursued and the lax regulatory oversight that let institutions ratchet higher their balance sheet leverage and amass huge concentrations of risky, complex securitised products.”
Plus, the heavy influence that banks exert upon the Fed’s governance, and its refusal to police mortgage underwriting practices or define suitability standards for mortgage lenders, also make it an unsuitable choice, the paper argues.
Some other near-term regulatory reforms are also suggested. Firstly, now that a light-tough approach to regulation has been met by disaster, agencies should no longer be starved of funding.
The paper points out that the Securities and Exchange Commission’s budget was flat in the last four years as the number of market participants it monitored increased by 32 per cent to 30,000 entities.
Shortcomings in the regulatory architecture, such as the lax monitoring of over-the-counter derivatives and credit rating agencies, should be remedied, and investment managers, including those operating private pools of capital, should be forced to register with the SEC.
Regulators should be empowered to wind down or restructure ailing non-bank investment companies that are systemically significant – similar to the authority given to the Federal Deposit Insurance Company to deal with failed banks.
The group also believes that originators of asset-backed securities should put some skin in the game, and that investors should be more prepared to challenge business executives who are driving excessively risky strategies.
In the long term, the “hodge-podge” of financial regulators and key institutions must be reformed. The government should aim to build a more rational and less-conflicted financial system, and to achieve this, the following steps should be considered:
-Appoint a systemic risk regulator, with appropriate scope and powers
-Draw up regulations to prevent the financial services industry from becoming dominated by a few giant and unwieldy institutions
-Strengthen capital adequacy standards for all financial institutions
-Carefully curb proprietary trading activities of banks to ensure their primary function is to take deposits and make loans
-Consolidate federal bank regulators and market regulators.