At the Federal Republic of Germany in Berlin, SEC Commissioner Daniel M. Gallagher delivered a speech regarding the impact of post-global regulatory reforms on financial markets, with a specific focus on what he referred to as “the trend towards so-called ‘regulatory harmonization.'”
According to Commissioner Gallagher, the legislative response to the 2008 global financial crisis, the Dodd-Frank Act, really had nothing to do with the crisis at all. The fact that Dodd-Frank was enacted before the completion of the Commission’s investigation of the causes of the crisis, Gallagher stated, is the most telling indication that Dodd-Frank was really just “a vehicle for ramming through the long-held ambitions of policymakers, bureaucrats, and special interest groups.”
According to Gallagher, prior to the global financial crisis, many U.S. and EU financial institutions were subject to national regulatory standards that were often duplicative and overlapping, and sometimes inconsistent. To find common ground, regulators worked toward regulatory harmonization, focusing on regulatory equivalence and substituted compliance. Gallagher noted that there have been some advances toward this sort of regulatory harmonization, such as the regulation of credit rating agencies and the SEC’s more recent implementation of Title VII of Dodd-Frank, which mandated regulation of the over-the-counter (“OTC”) derivatives market. However, Dodd-Frank greatly complicated the task of arriving at regulatory harmonization through its misprioritizations, such as the conflicts minerals and other “social disclosure” provisions.
Gallagher further stated that the post-crisis form of regulatory harmonization “has become a euphemism for forcing nations to accept a unitary set of regulatory standards created by international bodies that exist outside of the formal constitutional structures of nations.” He cited bodies such as the G20, the Financial Stability Board (“FSB”), and the International Organization of Securities Commissions (“IOSCO”) as organizations that have taken on an “opaque” character, attempting to claim regulatory powers that should reside in sovereign governments.
Commissioner Gallagher specifically noted the Financial Stability Oversight Council (“FSOC”) as an example of this sort of entity on a domestic level, stating that FSOC was given unintended regulatory powers, particularly “the authority to make a ‘recommendation’ to a member agency to engage in a particular rulemaking.” According to Gallagher, an example of this was the FSOC’s recommendation to the SEC with respect to money market mutual funds. He said that group like FSOC is particularly troubling, since it is a distinctly partisan body and its members are individuals handpicked by the President “who are under no obligation to represent their agency as a whole.” As a consequence, Gallagher stated, voices in the FSOC drown out those of the CFTC and the SEC, citing the FSOC banking regulator’s influence in the various Basel Accords as an example. Gallagher stated that he worries the current approaches to regulatory harmonization will result in capital markets and economies that are inefficient and that operate at less than their full potential.
Lofchie Comment: Commissioner Gallagher makes a number of arguments, all of them worthy of discussion.
As to the notion that Dodd-Frank has essentially nothing to do with the financial crisis, the recent “successes” of the CFTC demonstrate how little benefit Dodd-Frank provides. For example, the CFTC has now forced much of the plain vanilla interest rate swaps market through regulated clearing houses, with the result that the market now has somewhat greater transparency as to the pricing of interest rate swaps. But a lack of transparency with regard to interest rate swaps had nothing to do with the recent crisis. The problem was not that the market remained unaware of what interest rates were; the problem was that interest rates were, in retrospect, too low. Now that we know with some precision what swap interest rates are, how does that make the economy safer? Yesterday’s report by the Office of Financial Research said (at page iii): “The current financial environment, marked by low interest rates and low volatility, has spurred risk-taking, making markets and institutions more vulnerable to a sharp increase in interest rates, volatility, or both.” In short, knowing with added precision that swap interest rates are very low is not making the markets any safer. In fact, it is not clear what exactly has changed because of this new bit of knowledge.
A second observation that Commissioner Gallagher makes – that the Office of Financial Research established by Title II of Dodd-Frank is essentially a partisan agency – was not so obvious when the law was passed. OFR is largely made up of members of one party, unlike most other financial commissions that are made up of three members from one party and two from the other. As we commented in yesterday’s news report, it did seem that the report on U.S. financial regulation just issued by the OFR was disappointing with regard to the absence of any self-reflection. (Here is a link to the report and our comment on it.) By way of example, Form PF (which we understand was largely developed by OFR and is intended to provide information about hedge funds to OFR) has questions that, on their very face, are so badly written that it is obvious they cannot provide useful information to anyone, and certainly not information worth the cost of collection. But rather than focusing on ways that it might reexamine what it is doing, and on whether the information it is gathering is worth the cost, the OFR’s report is heavy with implicit self-praise that seems consistent with the production of a partisan agency. This is too bad, because political balance increases the likelihood of reasonable regulatory policy and oversight. The General Accounting Office is one example of that.
A third observation by Commissioner Gallagher – that there has been an overemphasis in the efforts to harmonize the global regulatory system – is problematic from a practitioner’s perspective. Current government regulation seems so arbitrary that it is impossible to expect companies to operate across borders when they are forced to comply with diverse sets of cumbersome rules. But it is hard to understand why we are forcing other countries to race alongside us. If the United States is convinced that its’ banks are made safer by complying with the Volcker Rule – a belief that (at least as the Volcker Rule was adopted by Congress) seems not to be shared by the banking regulators of any other country – then why exactly is it necessary that we force non-U.S. banks to operate according to a U.S. prescription?