14 December 2007

US looks to London for regulatory model

It was probably music to the ears of the City of London luminaries gathered in the ancient

Guildhall this week: a top US Treasury official explaining that his country's system of financial regulation might be broken. After all, London has delighted in watching as stock market listings have, at times, shunned the US in favour of foreign markets, with the City a beneficiary.

Yet David Nason, the Treasury's assistant secretary for financial institutions, had a serious message. The US is contemplating the biggest overhaul of its system of financial regulation since the passage of the 1999 Gramm-Leach-Bliley Act, which allowed banks to consolidate commercial and investment banking under one roof.

The US has watched as foreign markets have developed not only mature capital markets but also flexible yet sophisticated regulatory regimes that risk making the US system - with its hodge-podge of overlapping watchdogs and prescriptive rules - look hopelessly outdated.

"Our working assumption is that in this new globalised marketplace we are engaged in a race to the top to achieve the optimal regulatory structure for our financial services industry," said Mr Nason.

Hank Paulson, Treasury secretary, kicked off debate on the issue a year ago. Since then, four high-level reports have been published, littered with warning signs that the world's largest capital market is losing ground to London, Dubai and Hong Kong.

With the subprime crisis gripping the US Congress, the initiative has slipped from view in recent months. But Mr Nason's visit was designed to show it is alive and well - and that the US is looking at other regulatory models, such as the UK's Financial Services Authority with its "principles-based" system, which is considered to be more flexible.

The challenge for the Treasury is to come up with an alternative to the current system of five federal depository institution regulators, one federal securities regulator (the Securities and Exchange Commission), one federal futures regulator (the Commodity Futures Trading Commission) and a state-based insurance regulatory system.

The current system has its roots in the post-Wall Street crash era of the 1930s - a period closer to the American civil war than to today's world of sophisticated, cross-border financial transactions. The Treasury plans to produce a "blueprint" for reform early next year but there are already signs that proponents of reform are tired of talk and want action. The Financial Services Roundtable, a group of the 100 largest financial services companies, says the US is at a "tipping point" and reform is needed to maintain US competitiveness.

Last week the backers of the first of the four reports, the Committee of Capital Markets Regulation, issued a "second wake-up call". It found a record 56 foreign companies had delisted from US exchanges in the first 10 months of this year, compared with 30 in 2006. Hal Scott, a Harvard Law School professor and the committee's director, said it was particularly distressing that a year after the first report little had been done to address the problem. He dismisses the idea that the subprime crisis is to blame for distracting lawmakers: "Europe can multi-task," he said. "[EU markets commissioner Charlie] McCreevy and London continue to talk about regulatory reform while addressing the fallout from subprime."

Barney Frank, Democratic chairman of the House financial services committee, says he supports some rationalisation of the structure of financial regulation. But he argues that the problems exposed by the subprime crisis mean this is not a time for doing much beyond that. "There has been a change in tone. Twelve months ago we were talking about 'competitive deregulation' and the FSA was flavour of the month. That's changed now because of the subprime crisis," he told the Financial Times.

Karen Tyler, president of the North American Securities Administrators' Association, which represents state securities regulators, says that calls for "wholesale structural revision" have "fallen victim to their advocates' self-serving agendas" - a thinly veiled reference to Wall Street. Ultimately Congress is likely to take action only if it perceives there is a crisis. There is no sign of that yet. Mr Nason said that you "can't just snap your fingers and get Congress to change the system of financial regulation". Yet he is optimistic that the Treasury's blueprint may bring reform beyond the current administration.

© Graham Bishop