Inside the Obama Administration's Road Map for Financial Regulatory Reform

The Obama plan would turn the Fed into a systemic risk regulator, push derivatives onto electronic platforms and force hedge funds to register with the SEC.

Grappling with the worst financial crisis since the Great Depression, the Obama administration is prepared to overhaul the U.S. financial regulatory system. The administration has proposed a broad range of reforms that could bring steeper capital requirements for banks and brokers, transparency to the derivatives market and tighter controls on hedge funds.

Treasury Secretary Timothy Geithner laid out the administration's road map for financial reform in an 85-page white paper unveiled in mid-June. Broad in scope and general in its language, the paper calls for "promoting robust supervision and regulation of financial firms" and "giving government the tools for managing financial crises."

The sweeping set of rules could impact almost every corner of the industry, including the banking, brokerage, hedge fund and retail broker sectors. If enacted into laws, the proposed guidelines would tighten the regulation of hedge funds, push standardized OTC derivatives onto centralized clearing houses, set up data reporting warehouses, and raise the capital and margin requirements on dealers trading derivatives and asset-backed securities.

Among the key changes in the proposal is bestowing on the Federal Reserve new authority to supervise too-big-to-fail financial institutions. Under the plan the Fed would become the systemic regulator, gaining the power to unwind non-bank holding companies, which would be categorized as Tier 1 financial holding companies (FHCs). The plan also calls for setting up a new Consumer Financial Products Protection agency to oversee mortgages, credit cards and annuities. For the alternative investment industry, it would require hedge funds and private pools of capital (including private equity funds and venture capital funds) to register as advisers with the Securities and Exchange Commission. And brokers that provide investment advice to retail clients could be held to a fiduciary standard to harmonize the regulations with those of investment advisers (see related sidebar).

Strength in Numbers?

"Stronger capital [requirements] is probably the most important aspect of the plan," comments Paul Zubulake, a senior analyst with Aite Group. While increased capital requirements may reduce the risk of institutions failing, the downside, Zubulake asserts, is that tighter capital and regulatory requirements will stunt economic growth. "If firms are required to hold some capital back, that is going to retard them from taking risk," he says. "On the other hand, the reforms are positive since there were some holes in the capital requirements on the derivatives side."

One of the major goals of the reforms is to give regulators transparency into interconnected financial institutions that pose a systemic risk to the global financial system. But while the proposals beef up the Federal Reserve's role as a systemic risk regulator, there's been mixed reaction to the plan to give the Fed more power. "[The Fed already] is responsible for monetary policy and unwinding the massive portfolio [of toxic assets] that it developed," Zubulake relates. "To give them more authority and more of a regulatory burden is not efficient."

The plan also would create the Financial Services Oversight Council, chaired by the Treasury, to identify emerging risks in firms and market activities. But, Zubulake contends, creating an additional layer of bureaucracy to detect systemic risks is not the solution. "Promoting robust supervision sounds great, but they want to create another bureaucracy," he says.

What's missing from the plan, Zubulake argues, are details on what technologies the regulators will need to monitor the financial institutions. "To me the biggest type of problem is what type of technology is going to be used to gather the information -- again, no one is talking about how are they going to handle the job that they are going to be creating," he comments.

"They're developing a council to identify the systemic risks. In theory you would want to consolidate the regulatory agencies as a first step and to streamline them and get them on the same technology," Zubulake continues. "The issue is: How do you get a consolidated risk position for a regulator to observe, and how is that going to progress and how long is that going to take?"

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio