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Turf War by SEC, CFTC Advocates Expected in Financial Services Revamp

A financial services overhaul said to be under consideration by the Obama administration would elevate the Federal Reserve Board (Fed) to systemic risk regulator and create a new government agency to supervise banks, insurers and financial services firms. The proposed structure would leave most of the powers of current agencies intact, but calls to consolidate some of the powers of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) may lead to a turf battle in Congress.

The plan said to be under consideration by the administration comes as a report last week called for substantial changes to the financial regulatory system. The Committee on Capital Markets Regulation (CCMR), an independent, bipartisan group, has been working for more than a year on the proposals, which among other things recommended merging the SEC and the CFTC into a new agency, expanding the Fed's powers and setting rules for derivatives. The group, composed of academics, private sector members, former policymakers and regulators, issued 57 recommendations.

Treasury Secretary Timothy Geithner could heed some of those recommendations when he unveils an outline of proposed financial regulatory changes this month, and the House Financial Services Committee could begin hearings in mid-June, The Hill reported last Thursday. Geithner earlier this year offered some hints of what's ahead in testimony before Congress, in which he suggested the need to establish a systemic risk regulator to keep a watchful eye on all financial institutions (see NGI, March 30).

Plans to regulate some financial transactions already are in the works through agency directives and in Congress. Last month the Treasury Department, the SEC and the CFTC recommended a "series of comprehensive reforms" for over-the-counter (OTC) markets, which include provisions for central clearing (see NGI, May 18).

Sens. Carl Levin (D-MI) and Susan Collins (R-ME) in May introduced bipartisan legislation to give federal financial regulators immediate authority to regulate trillions of dollars in swap transactions that continue to be marketed and traded in the United States under the radar of government oversight (see NGI, May 11). And Rep. Bart Stupak (D-MI) introduced a bill to give the CFTC broad authority to regulate futures transactions involving energy commodities and to regulate credit default swaps (CDS) (see NGI, May 25). Another bill voted out of the House Agriculture Committee in February would require the CFTC to study and report on the effects of potential position limits on OTC trading.

Of the broad financial services reforms soon to be announced, Rep. Barney Frank (D-MA), who chairs the House Financial Services Committee, told CNBC last Thursday that "the suggestion that we're going to get to a unilateral bank regulator, something equivalent to the Financial Services Authority [in the United Kingdom] is simply wrong." Instead, Frank said the financial regulatory overhaul would be based on two issues.

"One, we are worried about the health of banks," he told CNBC. "Two, we are worried about systemic risk. That's why my own preference is for a dual-track regulation. One will be to continue to have existing prudential regulators" at the SEC and the CFTC, which Frank said "has a major role." At the same time, he said power needed to be created "somewhere, probably in a combination of federal regulators to deal with systemic risk."

The CCMR's recommendations, which were unveiled last Tuesday, call for the creation of two or three independent financial regulators to oversee the entire system: the Fed, possibly a new investor/consumer protection agency, and a new U.S. Financial Services Authority (USFSA), which would be composed of the CFTC, the SEC, the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Deposit Insurance Corp.

"The financial crisis came about because there were too many gaps in our regulatory system where products and markets operated in the shadows," said John L. Thornton, chairman of the Brookings Institution and co-chairman of the CCMR. The committee's recommendations, he said, have a dual goal: to unify the regulatory system and create a more transparent market.

Glenn Hubbard, dean of the Columbia Business School who co-chaired the committee, noted that "of the many causes of the financial crisis, one of the most significant was the failure of the regulatory system not only in the United States but around the world to address systemic risk."

The recommendations are sweeping, and many of them would take time, the committee members said.

"While the merger of the SEC and CFTC contemplated in the medium term by the Treasury's blueprint [toward financial regulatory reform] could be a transitional step, it should not be an end in itself; full consolidation within the USFSA (or independent consumer/investor protection enforcement agency) should be the ultimate outcome," the report noted.

In addition, the group recommends giving the Fed increased authority to regulate all systemically important institutions; it rejected proposals to create a systemic risk regulator composed of a college or council of financial regulatory bodies.

"We believe this important role should be retained by the Fed -- and the Fed alone," the committee said. "One regulator needs the authority and accountability to regulate matters pertaining to systemic risk."

A bigger role is recommended for OTC trades by centralized clearing organizations and exchanges. Focusing most of its attention on CDSs, the report said "the most prudent course is erring on the side of over-inclusiveness" of trades in a centralized clearing model. CDS trades that may not be standardized for clearing were recommended for reporting to a regulated system similar to the SEC's Trade Reporting and Compliance Engine for certain fixed-income transactions.

CCMR members also recommend adopting confidential reporting requirements for hedge funds. Although they support hedge fund registration, members said they don't believe hedge funds should be forced to publicly disclose proprietary information.

"We are optimistic that in the wake of the worst financial crisis in our lifetime, policymakers will embrace bold reform," said Hubbard.

Whatever the Obama administration's final plan, a turf battle is expected to ensue both in Congressional committees, which now have oversight over the federal agencies, and at the agencies themselves.

SEC Chair Mary Schapiro said in a speech last month that given the "various components of effective financial regulation, I have long been concerned about excessive concentration of power, which really means excessive concentration of point of view, in a single regulator." Instead Schapiro said she favors a hybrid plan suggested by the Federal Deposit Insurance Corp., which involves "a single regulator for systemically significant firms coupled with a systemic risk council to provide macro-prudential oversight of risk."

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