After the 2007–2008 global meltdown showed the perils of what Warren Buffett termed “financial weapons of mass destruction,” bureaucrats and politicians have been galvanized into action. Governments long content to flash a green light to capital markets have unleashed watchdogs with their ears cocked for the faintest ticking of a financial time bomb.
Even now, after Washington has declared the recession over and a buoyant stock market in 2009 lifted the Dow Jones Industrial Average 19 percent, and financial exchanges in China, India and Russia to gains of 80, 81 and 128 percent, respectively, the new climate of scrutiny hovers over financial markets. Indeed, capital market players can expect to feel the fallout of the new regulatory focus for decades.
Politicians and regulators are pushing forward on multiple fronts. For instance, the Basel II framework (officially the International Convergence of Capital Measurement and Capital Standards: A Revised Framework) aims to create an international standard for banks’ capital requirements and risk profiles. The Financial Crisis Inquiry Commission (FCIC) appointed by the U.S. Congress assumes the role of crime scene investigator of global markets. The FCIC is empowered to piece together the causes of the epic financial unraveling. Congress created the FCIC to cast a spotlight on credit-rating agencies, regulatory failures and financial instruments such as credit-default swaps and collateralized debt obligations. The panel is tasked with compiling a detailed account of the global economy’s near-death experience.
Watching the watchdogs is the Financial Stability Board (FSB) based in Switzerland. The Group of 20 developed nations has assigned the FSB to keep tabs on global reform efforts—including the problem of banks that are “too big to fail”—and report back. Also taking leadership roles are the Bank for International Settlements, the World Bank and the International Monetary Fund (IMF).
As advisory and supra-national figures such as European Union financial services czar Michel Barnier gain clout, national regulators in the United States—such as the U.S. Office of the Comptroller of the Currency, a Treasury Department agency that charters and regulates national banks, and the Securities and Exchange Commission, which oversees equity and debt markets—retain key roles in pushing national reforms that could be adopted as regional or international standards. The Federal Reserve Board—which has been both vilified for enabling a housing bubble and praised for dramatic action to pull capital markets from the edge of the abyss—is seeking wider powers to monitor and regulate systemic risk, including authority over companies whose operations and capital flow across international borders.
Financial-industry reforms under consideration in various jurisdictions include the following:
- Curbs on the use of leverage and capital, a move designed to lessen the kind of domino effect that the demise of Lehman Brothers had on the global markets
- Strictures on derivatives markets, including registering over-the-counter derivatives
- Regulations on the marketing of mortgages and the packaging of them and other debt into securities
- Limits on the creation of new, exotic financial products
- Rules requiring hedge funds and private equity funds to divulge details of their operations
- Greater oversight over so-called dark pools, including proposals to open up the markets, and instant reporting of trades (although without identifying the trader intra-day)
- Scrutiny into credit-rating agencies, which failed to account for the risk investors shouldered on collateralized debt obligations and other structured products
- Creation in the United States of a Consumer Financial Protection Agency to shield retail investors
- Restrictions on high-frequency trading
- Tighter rules on credit-card solicitations
- Limits on short-selling
- A universal fiduciary standard for investment advisors and broker-dealer representatives
- Supra-national regulations—also known as harmonization—to keep pace with global capital flows
- Systemic risk management
- Routine stress testing of financial institutions
- Discretion to break up companies seen as systemic risks
- Demands for near-real-time reporting from financial firms