The Banking and Strategy Initiative

Financial regulatory reform: A new paradigm for Banking is yet far

The new reforms

OTC derivative are a $450 trillion industry and after the reforms are passed, the only knowledge public would be where one of the biggies is on at least one side of the transaction. No banker is basing his price on your swaps to what the other bank did..they are but only to probably engage you with themselves next time ( and that is not shopping for discounts as you would either)

Everyone is still paying the bankers more and then you find the price on record for only the bigger deals as the registered biggies typically will have a minimum ticket size to waste their resources on. Also, these regulations are myopic in that the dealmakers and advisors are able to buy/sell insurance against/for the deal in a matter of minutes after each such deal. None of Goldman Sachs or AIG are anyways paying for the deal. I do not want to sound negative but you must know the facts and during its passage in the Senate thru 2010 you just might.

What Hank Palson started and what Lehman’s Fuld would claim now, would come back uglier and bigger next time. When the Oversight Council points out to another Bear next time, the counterparties of that Bear will hold significant mileage as that drama unfolds. In a market there are two parties to each deal, and here there are many inter-connected deals that can solve or create the problem, to put it simply and then when an Oversight council meets a Greenberg will come up and demand his way for knowing how the Council works.

MANAGING SYSTEMIC RISK

* Establishes inter-agency Financial Services Oversight Council, with staff and funding, chaired by Treasury secretary
* Council can tighten regulatory screws on firms that are in distress or judged to pose a threat to financial stability
* Council members include Federal Reserve, Securities and Exchange Commission, Commodity Futures Trading Commission, Federal Deposit Insurance Corp, other bank supervisors
* Firms’ debt-to-equity ratio can be capped at 15-to-1, credit exposure to unaffiliated companies limited to 25 percent of capital stock, among balance-sheet strengthening steps
* Firms can be ordered to hold contingent capital, or long-term hybrid debt convertible to equity in emergencies
* In extreme cases, firms can be ordered to restructure, restrict executive pay, sell businesses, or otherwise break up
* Treasury secretary must approve order to divest more than $10 billion in assets; president, more than $100 billion
* Risky firms must undergo annual “stress tests” and submit “living wills” on how firms could be unwound quickly
* For first time, Federal Reserve monetary policy subjected to audits by congressional watchdog

SENATE OUTLOOK: Senate bill proposes stronger inter-agency council, smaller role for Federal Reserve in managing risks

DEALING WITH TROUBLED FIRMS

* In emergencies, FDIC can back debts of solvent firms, up to $500 billion, drawing on Treasury borrowings, fees to firms
* FDIC can liquidate insolvent firms through bankruptcy or orderly receivership, like FDIC now dismantles failing banks
* Fully secured creditors in FDIC dissolutions can have up to 10 percent of their claims treated as unsecured claims
* “Systemic dissolution fund” of $200 billion helps pay for FDIC actions, drawn from fees charged to firms with more than $50 billion in assets, and Treasury borrowings
* Fees paid by banks into FDIC’s existing Deposit Insurance Fund become risk-based, cutting small banks’ fee burden
* In financial emergencies, Fed can extend loans to a wide variety of businesses up to a total of $4 trillion

SENATE OUTLOOK: Senate bill proposes paying for dissolutions of troubled firms after the fact

SUPERVISING BANKS, SECURITIZERS

* Office of Thrift Supervision abolished and its operations merged into Office of Comptroller of the Currency
* Lenders must retain 5 percent of credit risk of loans securitized for sale onto secondary debt market

SENATE OUTLOOK: Senate bill proposes more radical bank supervisor centralization, similar securitization reform

REGULATING OTC DERIVATIVES

* Over-the-counter derivatives go through clearing and exchanges or equivalent facilities where possible
* Swaps not cleared centrally must be reported to swap repository or to regulators
* “End users” of swaps, such as airlines and agribusinesses, can be exempted from central clearing
* Regulators can set position limits on swap trading and on security-based and commodity-based derivatives
* Financial firm clearinghouse stakes capped at 20 percent

SENATE OUTLOOK: Senate has competing bills, main bill has narrower end user exemptions than House

More ‘critique’

However, the basics look fine with a cap of Debt Equity of 15-1, making everyone a scheduled bank ( earlier), asking for provisions of contingent capital, and getting the Fed reserve a more focussed role rather than everything. “Stress Tests” and “Living Wills ” have already been around, the top global banks share these within the bank and whether they will ever be made public for their impact is a matter of conjecture. Especially as it might not be prudent to discuss risk policies threadbare in the public domain and as always, you would need to provide the banks to cnduct their businessuniquely per their positioning with their clients.

Solvent debt contracts can be saved by FDIC probably even today. The $500 billion tab helps them discover the FDIC address a little sooner, but unlikely it will happen the weekend they are still solvent. Doesn’t work like that when you have to eject from a jet fighter on fire, never. Some respite for secured creditors, that should have just brought down

PROTECTING INVESTORS, CURBING PAY

* SEC standards for brokers and investment advisers harmonized, mandatory investor-broker arbitration curbed
* SEC’s budget doubles, enforcement powers strengthen
* Investors get annual, nonbinding votes on executive pay, while pay plans encouraging excessive risk can be prohibited

Managing performance pay is going to be a herculean effort for the new Oversight Council, in its mandatorily advisory role, but the CFPRA from Dodd is a clear winner…Retail Banking ( Cards, Loans and Mortgages ) is something easy to tackle and where America would be watching it everyday and if that itself turns around this bill would have brought US back to the rails.

CREATING CONSUMER WATCHDOG

* Consumer Financial Protection Agency (CFPA) created to regulate mortgages, credit cards, other financial products
* Fed, other existing agencies stripped of consumer protection duties, which would go to CFPA
* Exempted from CFPA oversight are auto dealers, retailers, accountants, tax preparers, real estate agents
* States can have tougher rules than CFPA, but federal regulators can block state laws in some circumstances
* Banks with less than $10 billion in assets need not have full-scale CFPA exams, but must follow agency’s rules

The above, along with measures in the CARD bill however will face significant opposition from Moneycenter banks. The regulators will have to cap interest rates further and also tackle the Bankers’ flights of fancy with overdraft charges that have been hiked recently and interest rates on credit cards that have been hiked recently.. once the profits are in, more focussed regulatory action is plausible against the rampant malpractice

Last but not the least, getting Hedge Funds, Credit rating agencies and regulators would be even tougher now, and this start could not have gone any further at this point either. It’s anyone’s guess where that might lead us and the only way to find out would be to let them come out and show what they would be playing. the Oversight committees and other regulators will have to sit in on the verdict till 2012

REGULATING HEDGE FUNDS, CREDIT RATING AGENCIES

* Hedge funds, private equity firms, offshore funds must register with SEC, while venture capital firms and funds with less than $150 million in assets exempted

* SEC gets new oversight over credit rating agencies, which exposed to more investor lawsuits

MONITORING INSURERS

* Federal Insurance Office (FIO) set up to monitor insurance industry for first time, but not regulate it

* FIO cannot preempt state insurance laws except in limited circumstances, preserving state-level regulation

This regulation package is not going to work unless America wants it to work. And asking A service firm to not pay its employees from profits is unlikely to work after some time. But it has to be done over the next 2-3 years, this regulation itself may just be political fodder for 2010 from here. We bankers are the ones that know the products, the risk and the profits. And we are all in it together.

A special thanks to Kevin Drawbaugh and Leslie Adler for putting together the bill summary. Must have been a horrible weekend.

Banking regulation in India and China might influence global regulation more as bankers retract from multi tiered deals later on, but as of now it is the US example that is the important one for Europe and rest of the sinking world to fathom. European regulation has always been seemingly faster, higher and stronger on risk regulation but to no avail. Even the terms of the Competition commission in dealing with the monopolistic markets from new consolidation are a little touch and go and european banks in particular have more pain to follow as they stick to their ‘specially created isolated time warp’ for regulatory reporting and accounting that neither follows the US model nor shows any signs of resilience or realism.

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