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ICI Recommends Capital Markets Regulator, Systemic Risk Regulator

In order to achieve meaningful reform of the financial services industry, Congress should create two key regulatory positions to oversee financial markets, according to a proposal last week by the Investment Company Institute.

"The financial crisis highlights the longstanding need for regulatory reform to develop a more effective framework for overseeing modern financial markets and mitigating risks to the financial system at large," said ICI President and CEO Paul Schott Stevens. "Such a framework should, among other things, close regulatory gaps, bolster regulatory expertise and improve interagency coordination."

One of the main suggestions of ICI's whitepaper, titled "Financial Services Regulatory Reform: Discussion and Recommendations," is to combine the functions of the Securities and Exchange Commission and the Commodity Futures Trading Commission.

The new capital markets regulator -which would likely have seven or nine appointed commissioners-would be responsible for the oversight of capital markets, market participants and financial investment products. This regulator would be the standard setter for registered investment companies as well as for money market funds.

This agency would be the first line of defense in anticipating market risks and addressing regulatory gaps in hedge funds, derivatives and municipal securities.

"We need to focus more on oversight and prevention," John Murphy, ICI chairman told MME. "Our laws need to be more aligned with the fast-changing pace of our industry."

"These are extraordinarily important issues, and the need is very great," said Karrie McMillan, ICI general counsel. While she acknowledged that Congress is extremely busy right now with other matters, "whatever their decision, it will require a very thoughtful and deliberative process, and we will have to live with the outcome for a very long time."

The U.S. hasn't seriously overhauled its financial regulatory system in more than 70 years, yet the nature of trading and investing has changed dramatically in recent years.

"As new, innovative financial instruments were developed, the lines between securities and futures often became blurred," ICI noted in the whitepaper. "The existing, divided regulatory approach has resulted in jurisdictional disputes, regulatory inefficiency and gaps in investor protection. With the increasing convergence of securities and futures products, markets and market participants, the current system makes little sense."

Regulatory reform is still in the early stages, and the ICI may refine its views as time goes on, but having the functions of the SEC and CFTC under one roof "will be very beneficial and will allow competing interests to be resolved by the same regulator," McMillan said.

"Our report recommends many ways to enhance the capital markets regulator position that could still apply even if the whole report isn't adopted," she said.

According to the whitepaper, the capital markets regulator would need to carry on the SEC's commitment to investor protection and law enforcement. The new agency would also need to be able to attract personnel with enough market experience to understand the complexity of today's marketplace.

"Government agencies have too much turnover," Murphy said. "We need tenured people in these agencies. The SEC shouldn't be a place where people build their resumes and move on."

The appointment of a multidisciplinary, capital markets advisory committee could help provide the capital markets regulator with valuable industry insight and perspective. Such a committee should be comprised of private sector representatives from all major sectors in the capital markets, the whitepaper said.

The ICI is also proposing the creation of a systemic risk regulator to provide greater overall stability of the financial system by monitoring domestic and international financial markets, identifying risks and practices that threaten that stability and acting to mitigate those risks.

Careful consideration should be given to make sure this new regulator doesn't stifle innovation or competition, displace primary industry regulators or impose unnecessary bureaucratic burdens, the ICI said.

"Despite its seeming appeal, such an approach could have very serious anticompetitive effects if the identified institutions were viewed as 'too big to fail' and thus judged by the marketplace as safer bets than their smaller, 'less significant' competitors," the whitepaper said. "Additionally, the systemic risk regulator should not be structured to simply add another layer of bureaucracy or to displace the primary regulator responsible for capital markets, banking or insurance."

In testimony last week to the Committee on Senate Homeland Security and Governmental Affairs, Robert Pozen, chairman of Boston-based MFS Investment Management, suggested the Federal Reserve should take on the role of systemic risk regulator.

"If the Federal Reserve Board is going to bail out a broad array of financial institutions and not just banks, it should have the power to monitor systemic risks so it can help keep institutions from getting to the brink of failure," Pozen said.

The ICI's whitepaper recommends that Congress consider consolidating the regulatory structure for the banking sector, authorizing an optional federal charter for insurance companies and enhancing interagency coordination and information-sharing efforts.

The President's Working Group on Financial Markets is the most logical mechanism to create this new regulatory structure, the whitepaper said.

"If a new, U.S. financial regulatory structure is to be successful in protecting the interests of our nation's savers and investors, there is a critical need for effective coordination and information-sharing among the financial regulators," the ICI said. "Stronger links between regulators and an overriding sense of shared purpose would greatly assist in sound policy development, prioritization of effort and cooperation with the international regulatory community."

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