A New Foundation for Financial Regulation?

by Margaret E. Tahyar, Davis Polk & Wardwell,

Monday, June 22, 2009 at 07:48 PM EDT

(Editor's Note: This post is by Daniel N. Budofsky, John L. Douglas, Luigi L. De Ghenghi, Randall D. Guynn, Ethan T. James, Nora M. Jordan, Kyoko Lin, Arthur S. Long, Annette L. Nazareth, Lanny A. Schwartz, Margaret E. Tahyar, Robert Colby, and Reena Agrawal Sahni of Davis Polk & Wardwell LLP.

In our memorandum, available here, we describe the Obama Administration's White Paper on Financial Regulatory Reform. The White Paper is just the beginning of what is likely to be a legislative, regulatory and ideological marathon, despite the Administration's best efforts to achieve domestic political support before its publication. It is far less revolutionary than some either feared or hoped for and reflects an 'art of the possible' approach to regulatory reform by the Obama Administration. Ultimately the White Paper reflects a compromise designed to avoid as much as possible the most difficult regulatory, state and congressional turf battles.

As a result, the plan is notable as much for what it does not do as for what it does. It is not a once-in-a-lifetime regulatory overhaul. It does not propose a CFTC-SEC merger, it does not propose an optional federal insurance charter and it does not streamline the alphabet soup of financial regulatory agencies. If anything, it adds more regulators than it eliminates. Its key innovations involve expanded power for the Federal Reserve as the sole systemic risk regulator, with the creation of a Financial Services Oversight Council to mollify those who are concerned about the aggregation of power in the Federal Reserve; the long anticipated registration of advisers to hedge funds, private equity funds and venture capital funds; the regulation of OTC derivatives; the merger of the OTS and the OCC; the creation of a Consumer Financial Protection Agency with vast new powers delineated in such a way that future jurisdictional turf wars are inevitable; and the creation of a resolution regime for bank holding companies and Tier 1 FHCs. While the White Paper is an incomplete framework, one possible benefit is that it creates the skeleton of a 'twin peaks' structure, with a prudential and a business conduct regulator, into which other agencies could be merged in the future.

The Administration has set a goal of passing its reform package by the end of the year and promises that legislative text will soon be sent to the Hill. Naturally, the political reaction has already begun, with Republicans outlining their own plan and individual Senators and Congressmen proposing, or soon to propose, competing proposals and language.

Other stakeholders, both domestic and international, will also have a view and, in some cases, a voice. Indeed, the White Paper proposals are made at a time of parallel UK and European regulatory reform driven in part, as is the White Paper, by the G-20 proposals. The European Council of Ministers proposed its own plan this past week for which legislative text is expected in the fall, and the UK is expected to publish more details on its own version shortly. The era when financial regulation was purely a matter for domestic politics is over. More and more the domestic US financial regulatory agenda is being influenced by international fora, by an active EU regulatory structure which has created extraterritorial standards and imposed requirements of comparability and by the international and US domestic push for harmonization of standards across regulatory bodies.

The shifting dynamics of the regulatory reform proposals and the politics involved in any consolidation, reorganization or redistribution of regulatory responsibilities mean that it is too early to predict with certainty which proposals are likely to be enacted and in what form. In light of the many competing proposals and legislative texts, we believe that it is possible that some elements, such as the Consumer Financial Protection Agency, will be enacted separately and attached to other bills rather than as an omnibus package.

Our memorandum discusses the White Paper's proposals from a range of perspectives, domestic and international, and sets forth how the proposals may impact a range of institutions, financial and non-financial.

The memorandum is available here.

This article originally appeared on The Harvard Law School Forum on Corporate Governance and Financial Regulation.