March 21, 2007
Nazareth on Competitiveness
Excerpts from Remarks Before the Council of Institutional Investors by Commissioner Annette L. Nazareth:
Any serious examination of competitiveness issues and unnecessary regulatory cost also will have to focus on our U.S. regulatory structure. This "elephant in the room" has been largely ignored in the recent debate as there has been greater focus on "quick fixes." But our regulatory structure has been virtually unchanged since the 1930s. When one considers the enormous changes that have occurred in the nature of our markets, the market intermediaries, and in the products that they sell, is it any wonder that we have inefficiency, uncertainty and duplication in our regulatory oversight? Indeed, we are witnessing increasing instances of proposed products and services that fall on the jurisdictional seams of the various regulatory agencies. If these activities simply raised questions of "who is in charge," I could understand a lack of broad public interest in the debate. But when the question is "what law applies and what protections do U.S. investors have," then we should all have an interest.
The Chamber report, to its credit, broached the subject of SEC-CFTC consolidation. This topic has traditionally been viewed as virtually unachievable, due largely to the interests of the separate committees in Congress that oversee the two agencies. As you undoubtedly know, we may well be the only jurisdiction in the world that oversees securities and futures activities in two separate agencies. Through financial innovation we now have financial futures and securities options that bear striking resemblances to each other from an economic standpoint. Yet these products are regulated under very different regimes. Among the more important distinctions, securities options and other securities are subject to insider trading prohibitions. Futures subject to exclusive CFTC jurisdiction, on the other hand, are not subject to insider trading prohibitions, even though some of the new products designed to duplicate the OTC credit default swaps market could be used as vehicles for insider trading. These types of issues are arising with increasing frequency as the futures and options exchanges seek to create new exchange-traded products. It is particularly troubling when jurisdictional murkiness provides opportunities to create products that avoid the protections of the securities laws. At some point Congress will need to address these fundamental jurisdictional and policy issues. And dare I note that the issues of potential SEC-CFTC consolidation pale in comparison to the challenges, but also the potential cost savings and efficiencies, that could result from consolidation of even a few of the many federal banking regulators?
I also believe more effort should be made to develop prudential regulatory approaches. There has been much discussion recently about the benefits of principles versus rules-based regulation. Many commentators believe that our rules-based regulation in the U.S. adds unnecessary cost and stifles innovation. I believe that this is a false dichotomy. All regulation should be derived from over-arching principles, but rules can provide guidance and specificity that the marketplace desires. Indeed, Callum McCarthy, the Chairman of the UK's Financial Services Authority ("FSA") has noted that even the FSA, that pillar of principles-based regulation, has hundreds of pages of rules. So in my view the focus should not be on rules versus principles, but rather on a move toward more prudential approaches to regulation. The bank regulators have implemented a prudential regulatory model with success for many years. Although not well known by many in the industry, for two years the SEC also has implemented a highly successful program of consolidated financial supervision. Known as the Consolidated Supervised Entity, the program enables us to work in very close collaboration with our five largest U.S. investment bank holding companies to monitor their risk management capabilities. The program is notable for at least two reasons that distinguish it from the traditional SEC supervision. First, the program emphasizes a prudential approach to supervision. The staff involved in this program meet with the five firms on a regular and periodic basis to review risk management controls and liquidity. Second, the supervision is at the holding company level, and includes not only the regulated but also the unregulated entities. Thus for such firms, the SEC has a wholistic view of the risk management and the business of these firms. Thus enabled, we can effectively carry out our charge of insuring adequate risk controls and liquidity throughout the organization.
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