Doubts Whether US Financial Reforms Will Be Adopted Globally

by Glen Shapiro, LawAndTax-News.com, New York

26 July 2010

Even though President Obama has signed into law the US financial reform bill passed by the Congress on July 15, it is recognised that it will take up to two years to put its measures into force and there is some doubt whether similar regulations will be adopted internationally.

The probabilities of the global adoption of the regulations in the Dodd-Frank Act, and the consequences to the US banking sector if they are not, formed part of the business of a hearing of the US Senate’s Subcommittee on Security and International Trade and Finance on July 20.

Federal Reserve Governor, Daniel K. Tarullo, giving his testimony on international cooperation and financial regulatory modernization, was of the opinion that “many elements of the Dodd-Frank Act align closely with the efforts of the G-20 leaders, the Financial Stability Board, and the Basel Committee.”

He referred, for example, to the provision of an authority to subject all financial firms that present outsized systemic risks to a common framework of supervision and regulation by the Federal Reserve, and the capacity to unwind or break apart major non-bank financial firms in an orderly fashion. Moreover, he said, the act strengthens the resiliency of the financial market infrastructure by mandating increased central clearing and transparency for over-the-counter derivative transactions; provides for the registration of advisers to hedge funds and other private investment funds; and improves the regulation of credit rating agencies.

At the same time, he said, “there are aspects of the Dodd-Frank Act that are unlikely to become part of the international financial regulatory framework. For example, the act generally prohibits US banking firms (and the US operations of foreign banking firms) from engaging in proprietary trading and from investing in or sponsoring private investment funds. The act also prohibits US depository institutions from entering into certain types of derivatives transactions.”

Tarullo added that: “In the US, activity restrictions have long been a part of the bank regulatory regime, serving to constrain risk-taking by banking firms and mitigate potential conflicts of interest generated by the combination of banking and certain other businesses within a single firm. Many other countries follow a universal banking model and are unlikely to adopt the sorts of activity restrictions contained in the act.”

His conclusion was that “not all elements of financial reform can be designed on a national level in a way that is perfectly consistent across countries. The characteristics of each country's financial system differ, sometimes significantly. Our challenge is to strike the right balance between achieving global consistency on the core reforms necessary to protect financial stability and provide a workably level playing field.”

The testimony of Lael Brainard, the US Under-Secretary of the Treasury for International Affairs, to the sub-committee on the same day, followed the same theme. “The challenge before us now is to ensure that the world's standards are every bit as strong as America's,” she said. “We must develop the most globally convergent financial protections the world has ever attempted. It is critical to level the playing field up.”

She was aware that “without internationally consistent standards, large financial firms will tend to move their activities to jurisdictions where standards are looser and expectations of government support are stronger. This can create a race to the bottom and intensify systemic risk throughout the entire global financial system.”

However, Brainard agreed with Tarullo that “while global convergence will be critical in areas such as capital and derivatives regulation, our international efforts in other areas may be equally well served by coordinating different approaches across nations, reflecting deeply rooted differences in national structures and institutions. In these cases, while we share common objectives globally, the mechanism that works best for other countries may not work best for the United States in seeking to advance our common objectives.”

While it is generally considered that it is too early to tell whether the provisions of the Dodd-Frank Act will have a serious effect on the international competitiveness of US financial institutions, much will therefore depend on the success, or not, enjoyed by the US in convincing its global counterparties to adopt similar regulations.

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