Speech by SEC Commissioner:
Remarks at the Center for the Study of International Business Law at Brooklyn Law School Breakfast Roundtable
Commissioner Elisse B. Walter
U.S. Securities and Exchange Commission
New York, New York
October 9, 2009
Introduction and International Cooperation
Good morning, and thank you, Roberta, for that wonderful introduction. I am delighted to participate in the first Brooklyn Law breakfast roundtable for the 2009-10 academic year. Before I begin, I'd like to express my gratitude to and admiration for Roberta. I first met Roberta when she was an SEC Commissioner and I was a staff member. For many of us, Roberta served as a role model for several reasons. I'd like to highlight just a couple. First, she was a staffer who became a Commissioner, as many of us aspired to do. In fact she was the first female Commissioner of the SEC. And, for the women on the staff, when we became discouraged with juggling work and family, we looked to Roberta as a shining example of someone who had not only survived but thrived. I continue to be in awe of her energy, intellect, and humanity. And it is an honor to speak here at a Brooklyn Law event, which I understand was among the small group of legal institutions that admitted women and minorities in the early 1900s. Before I get too much further, though, I of course need to give you the standard disclaimer that the views I express here today are my own and do not necessarily reflect the views of the Securities and Exchange Commission or my fellow Commissioners.
This morning, Roberta has asked me to provide you with some highlights of the international initiatives currently developing with respect to financial regulation, but I hope that time will permit you to raise other current topics with me.
With respect to international matters, first I think it is important to emphasize the Commission's commitment to cross-border cooperation. This has become more important to the Commission's mission in recent years due to the increasingly global nature of financial markets.
Let me stop there for a moment. During the nearly two decades I spent as a Commission staff member, our international efforts were essentially a separate program — in effect you did your day job and then you also handled some international matters. Nothing could be further from the truth today. Frequently, problems cannot be solved without collective international action or at least consciously parallel multi-national action. But, even when that is not the case, everything the Commission considers today must be placed in its global context. In adopting each and every rule, or otherwise taking policy positions, the Commission must go beyond domestic boundaries in considering the impacts of its action, intended and unintended.
The global nature of our business environment highlights the importance of international cooperation and coordination and particularly of organizations that transcend national and continental borders. In my view, we regulators must actively participate in international organizations, as well as multilateral and bilateral discussions, to foster communication, coordination, and cooperation among national regulators, if we are going to do our best to assure investor protection. And, if we fail to have a global view, we will create opportunities for jurisdictional regulatory arbitrage, giving financial institutions the option to seek to do business in jurisdictions with the lowest standards. Only coordinated action can prevent a race to the bottom in regulatory standards. As President Obama recently said, "what we need instead is a global race to the top."
Currently, U.S. regulators meet with regulators from other nations in a number of different forums. To name just a few alphabet soup entities, these include:
International Organization of Securities Commissions ("IOSCO");
Basel Committee on Banking Supervision ("Basel Committee");
Senior Supervisors Group ("SSG," which is comprised of senior financial institution supervisors from Canada, France, Germany, Japan, Switzerland, the United Kingdom, and the United States); and
Financial Stability Board ("FSB"), which as I will explain, has succeeded the Financial Stability Forum ("FSF").
I am pleased to report that for years the Commission has been actively working to achieve international coordination and consistency in regulatory policy and implementation, through such multilateral, regional, and bilateral mechanisms.
Let me briefly highlight some of the Commission's ongoing involvement in promoting rising levels of cooperation in the international regulatory community.
First, there is IOSCO. The SEC was a founding member of IOSCO in 1983 and has maintained a leading role in the organization, with SEC Commissioner Casey currently serving as the chair of IOSCO's Technical Committee.
The Commission is also actively involved in the Financial Stability Board, both as a direct member and through representation by IOSCO. As you may be aware, at the G20 Leaders Summit this past April, the decision was reached to establish the FSB as the successor to the Financial Stability Forum and expand its membership to include all G20 countries.
The FSB now serves as a key mechanism for the Commission to engage internationally on broad financial market issues, which include encouraging the development of strong regulatory, supervisory, and other policies in the interest of financial stability. Each country has delegates to the FSB representing the financial policy maker, central bank, and regulatory authorities. And, the organization's work has been expanded by the G20 to include identifying and overseeing actions to address financial system vulnerabilities and to advise on and monitor industry best practices in meeting regulatory standards.
The Commission is also represented in the Joint Forum on Financial Conglomerates, which was established by the Basel Committee on Banking Supervision, IOSCO, and the International Association of Insurance Supervisors (IAIS), to deal with issues that cut across the banking, securities, and insurance sectors. SEC staff, for example, participates in the Joint Forum's Working Group on Risk Assessment and Capital, which has undertaken a number of cross-sectoral initiatives that have arisen out of the financial crisis — including a recent report that examined the range of various Special Purpose Entities found across the financial sectors, the motivations of market participants who rely on them, how effectively certain structures achieve the transfer and management of risks, and suggested policy implications and issues for consideration by the supervisory community and market participants.
Various Bodies Charged With Accounting and Auditing Standard-Setters
Further, the Commission participates in oversight bodies charged with maintaining the public accountability of independent accounting and auditing standard-setters. SEC Chairman Schapiro, for example, is a member of the Monitoring Board of the International Accounting Standards Committee Foundation (IASCF), which was formed early this year to strengthen the institutional governance and accountability of the Foundation. Through this Board — comprised of authorities responsible for establishing accounting standards in their jurisdictions (currently, the SEC, Financial Services Agency of Japan (JFSA), and IOSCO Emerging Markets and Technical Committees), capital market authorities that permit, or like the SEC, are considering permitting, or require the use of International Financial Reporting Standards in their jurisdictions have a means to more effectively carry out their mandates regarding investor protection, market integrity, and capital formation. Among other things, the Monitoring Board approves appointments and re-appointments to the board of trustees of the Foundation.
In addition, the Commission is represented through IOSCO in the Monitoring Group for the Public Interest Oversight Board, which serves as a mechanism for promoting the public interest in the development of international standards for auditing by the International Federation of Accountants.
The Commission also participates in regional and bilateral mechanisms for discussion and promotion of common approaches to regulation. SEC Commissioner Aguilar is the Commission's liaison to the Council of Securities Regulators of the Americas, or COSRA, which aims to develop high quality and compatible regulatory structures among authorities in the Western hemisphere.
Bilateral Dialogues and Agreements
Commission staff, along with staff of the Federal Reserve Board, the Commodity Futures Trading Commission, and other US government agencies, also participates in a number of Treasury-led financial regulatory dialogues with several jurisdictions, including the European Commission, Japan, China, and India, as well as Australia and our North American partners, Canada and Mexico.
To complement these bilateral dialogues which focus mainly on securities regulation, the SEC also engages in broader financial sector dialogues with our counterparts, including, among others, the UK Financial Services Authority, the Japan Financial Services Agency, the Committee of European Securities Regulators (CESR), the China Securities Regulatory Commission, the Securities and Exchange Board of India, and the Korea Financial Supervisory Commission.
In addition, the Commission and a number of other securities regulators have recently entered into — and this is important — bilateral "supervisory" memoranda of understanding that go well beyond sharing information on enforcement investigations. These supervisory MOUs, such as those the SEC has signed with the UK's Financial Services Authority and the German consolidated financial services regulator (known as the "BaFin"), represent groundbreaking efforts by national securities regulators to work together to coordinate their oversight of financial firms that increasingly operate across borders.
Finally, the Commission has been actively working to raise the standards of cross-border enforcement cooperation. Over two decades ago, the Commission entered into its first bilateral memorandum of understanding for the sharing of information in securities enforcement matters with the United Kingdom. Today, the Commission has bilateral agreements with 20 jurisdictions. These bilateral agreements triggered the creation of the IOSCO Multilateral Memorandum of Understanding (MMoU) in 2002. Since then, 55 jurisdictions, including the SEC, have implemented the principles for cross-border enforcement cooperation contained in that MMoU, and another 27 jurisdictions have committed to do so. As additional jurisdictions sign on, the SEC's capacity and ability to pursue wrongdoers across borders significantly improves. This becomes increasingly important as more and more SEC investigations involve some international component.
The Commission also is continually working to increase the level of enforcement cooperation that it provides foreign counterparts. Today, for example, the SEC has broad authority to share supervisory information as well as to assist foreign securities authorities in their investigations through a variety of tools, including exercising the SEC's compulsory powers to obtain documents and testimony.
These are just some of the organizations and mechanisms through which the Commission seeks to foster cooperation and coordination with the international community.
Specific International Initiatives
Let me now highlight some specific international initiatives that the Commission has been actively involved in conjunction with various international organizations.
In the wake of the financial crisis, there have been a number of international regulatory developments to strengthen the global financial system. These initiatives, developed through IOSCO's joint working group with the Committee on Payment and Settlement Systems (CPSS) and the Joint Forum, have been undertaken in conjunction with calls from the G20 and the FSB to ensure that all systemically important financial institutions, markets, and instruments are subject to an appropriate degree of regulation and oversight. These areas include, for example, credit rating agencies, accounting and auditing standards, hedge fund regulation, unregulated financial markets and products, and supervisory cooperation.
Recent IOSCO Projects
In 2008, IOSCO's Subprime Task Force issued a report that examined the underlying causes of the financial crisis and the implications for international capital markets. The report provided recommendations in key areas of concern to securities regulators, such as issuer transparency and investor due diligence, firm risk management and prudential supervision, and valuation and accounting issues.
In addition, due to concerns highlighted by the G20 Leaders, last fall, IOSCO established task forces on unregulated entities, unregulated financial markets and products, and supervisory cooperation. The Commission has contributed significantly to each of these projects.
IOSCO Task Force on Unregulated Entities
With regard to unregulated entities, following extensive consultation, IOSCO published a final report in June of this year regarding hedge fund regulation. In the report, IOSCO agreed to a set of high-level principles to provide appropriate guidance for addressing the risks posed by hedge funds in their own jurisdictions while supporting a globally consistent approach. The six principles include requirements on mandatory registration for funds or their advisers, ongoing regulation, and provision of information for systemic risk assessment purposes. The report also states that regulators should cooperate and share information to facilitate efficient and effective oversight of globally active hedge fund managers and hedge funds.
IOSCO is continuing work on defining the fundamental information that hedge funds, their advisers, or counterparties should provide to regulators to allow them to assess the systemic importance of individual actors and identify possible financial stability risks.
Also, a hedge fund industry group has recently developed a set of industry global standards. The Task Force is reviewing these industry standards to determine their adequacy and how regulators could verify the industry's compliance with those standards. Finally, the Task Force plans to consider possible financial resource requirements for hedge funds determined by the activities and the level of risk engaged in by those funds.
Personally, I view hedge funds as a powerful illustration of problematic regulatory gaps. I think the focus on hedge funds in recent years is due to the fact that they play an increasingly significant role in our financial markets. They can contribute to liquidity and price discovery and provide investors with opportunities for portfolio diversification and capital protection in down markets. However, hedge funds also pose potential risks to investors and to the stability of the financial system.
Yet, as the saying goes, you cannot regulate what you cannot see. The Commission currently lacks basic data about hedge funds and hedge fund advisers, such as information about how many hedge funds operate in the United States, the size of their assets, their performance returns, and who controls them. Thus, it lacks significant knowledge concerning an important segment of the market. In addition, because neither hedge funds nor their advisers are required to register with the Commission, they are not subject to our periodic examination program. This makes it much more difficult for the Commission to identify misconduct prior to significant losses occurring.
I believe that the Commission should have clear authority to require hedge fund managers to register as investment advisers. The costs and benefits of imposing obligations on hedge funds themselves, such as requiring them to use an unaffiliated custodian and subjecting them to leverage limitations and net capital ratios, also should be considered. At a minimum, I believe, hedge funds acting as active market liquidity providers should be regulated as dealers under the federal securities laws.
IOSCO Task Force on Unregulated Financial Markets and Products
In early September, IOSCO's Task Force on Unregulated Financial Markets and Products published a final report that explored regulatory issues focused on two systemically important markets that featured prominently in the recent financial crisis — securitization and the credit default swap (CDS) markets. The report contained a number of recommendations regarding possible regulatory approaches to promote fair, efficient, and orderly financial markets. For example, with respect to securitization, the report included recommendations designed to realign the incentives of originators and sponsors of securitized products and to improve disclosures relating to risks. With respect to the CDS markets, the report recommended, among other things, that regulators: provide a sufficient regulatory structure for the establishment of central counterparties (CCPs) for clearing standardized CDSs; encourage financial institutions and market participants to work on standardization; and facilitate timely disclosure of price, volume, and open-interest data. The Task Force continues to consider whether additional work should be undertaken regarding implementation of these recommendations.
In addition, the Commission has worked closely over the past year with international regulators and central banks in gaining first-hand experience in applying the 2004 Recommendations for Central Counterparties (RCCPs) issued by CPSS and IOSCO to proposed arrangements for OTC credit derivatives transactions. These 15 recommendations set out comprehensive standards for risk management of a central counterparty (CCP), such as participation requirements, measurement and management of credit exposures, margin requirements, and default procedures, to name a few. This work has revealed some challenges to successfully applying the recommendations to CDSs, particularly with respect to valuation models. The CPSS and IOSCO have since created a joint working group (co-chaired by the European Central Bank) to propose further guidance. This working group is expected to complete its report by the middle of 2010.
CDSs are another good example of a gap in our regulatory system. These instruments played an important role in the recent market crisis. Current estimates are that the credit default swap market alone may have exceeded $55 trillion in notional value. And yet, despite its enormous size and systemic importance, the Commission is explicitly prohibited from regulating this market. Among other things, this prohibition constrains our ability to require appropriate disclosures, such as position and trade reporting, as well as information regarding counterparties. I believe that the Commission should be authorized to exercise jurisdiction over all OTC financial derivatives that have a significant impact on the debt and cash equity securities markets.
I therefore support the repeal of statutory prohibitions in the Commodity Futures Modernization Act of 2000 on the federal regulation of swap agreements. I also believe that establishing central counterparties for credit default swaps would be an important step in reducing the counterparty risks inherent in that market, and thereby help to mitigate potential systemic impacts. The Commission has taken important steps in this direction, and I look forward to continuing our work in this area.
New IOSCO Task Force on Supervisory Cooperation
As operations globalize, there has also been a growing need and reliance on supervisory cooperation to effectively regulate and oversee global operations of our markets and market participants. To this end, this past spring, IOSCO established a Task Force on Supervisory Cooperation, which is co-chaired by SEC Commissioner Casey along with the Chair of the French AMF, to develop principles on regulatory cooperation in the supervision and oversight of market participants whose operations cross international borders. Final principles are expected to be published in February 2010.
IOSCO Standing Committee on Credit Rating Agencies (CRAs)
With regard to credit rating agencies, in light of the interest the G20 has expressed, at its February meeting this year, IOSCO agreed to turn the CRA Task Force into a permanent standing committee, Standing Committee 6 on Credit Rating Agencies (SC6). SC6 will continually evaluate regulatory and policy initiatives with regard to CRA activities and oversight, and seek cross-border regulatory consensus through such means as the IOSCO Code of Conduct Fundamentals for CRAs. The Code of Conduct, amended in 2008 as a consequence of "lessons learned" during the early "subprime crisis," has already been substantially adopted by at least seven rating agencies, including the largest ones.
Dan Gallagher, SEC's Co-Acting Director of the Division of Trading and Markets, has been appointed as the first chair of this standing committee. SC6 has begun hosting meetings with top leaders of the CRA industry and the heads of various IOSCO Technical Committee delegations. A major issue that SC6 is considering is how IOSCO members who regulate CRAs can better coordinate their oversight efforts, given that the largest CRAs operate in multiple jurisdictions and frequently use analysts and resources based in different offices when making a rating, and how IOSCO can facilitate this coordination and information sharing.
Additional Developments in Oversight of Credit Rating Agencies
In addition to the work of SC6, several large jurisdictions are in the process of implementing regulations for the oversight of CRAs, in light of the problems with ratings of structured finance products over the past several years. The EU and Japan, for example, have recently implemented new CRA regulatory oversight regimes.
EU CRA Regulation
A major feature of the EU CRA Regulation is the requirement that generally only ratings published by CRAs registered in the EU can be used by EU financial institutions for various regulatory purposes. This is a more stringent standard than in the U.S. In order to allow ratings produced by non-EU CRAs to be used in the EU, the Regulation establishes an endorsement mechanism under which an EU-registered CRA may "endorse" ratings by an unregistered affiliate located outside the EU. This endorsement is only allowed if the unregistered affiliate is subject to a legal and supervisory framework equivalent to the EU standards.
CRA Regulation in Japan
Japan too has introduced regulations. They seek to ensure that CRAs (which it refers to as "credit rating service providers") comply with the IOSCO CRA Code of Conduct and are consistent with international efforts in this area. The regulatory framework includes a new registration system for credit rating service providers and supervisory measures (including the ability of the Japan FSA to order a credit rating service provider to produce any documents or reports related to its business, to inspect its offices and documents, and to order it to change its business policy or to take other necessary measures to improve the business operation). Thus, their authority is much more pervasive than in the U.S.
Recent Commission Rulemaking
I would also note that, last month, the Commission embarked on another round of new rulemaking that, among other things, includes requirements for the NRSROs to provide more disclosure of their ratings histories and proposals for them to disclose certain information about its revenues, which currently is not public. I believe the additional disclosures should provide investors with more information to make informed decisions, and I look forward to reviewing the comment letters on the proposals.
Proposed Roadmap for the Potential Use of IFRS in the United States
Finally, with respect to something that is near and dear to my heart — accounting standards — in August 2008, the Commission proposed for public comment a Roadmap for the potential mandatory use of IFRS financial statements by U.S. issuers. The Roadmap sets out milestones that, if achieved, could lead to the required adoption of IFRS by U.S. issuers in their filings with the SEC. The comment period for the Roadmap ended on April 20, 2009, with over 200 letters received.
The issues raised by the proposed IFRS roadmap continue to be a priority for me. I believe we should move forward to IFRS if and only if it is the right thing to do for U.S. investors. Although I remain committed to striving towards one global set of high-quality accounting standards, I continue to believe that there are critical issues that still need to be addressed as the Commission moves forward on a decision to adopt IFRS for U.S. registrants. Importantly, before I am willing to support such a move to IFRS, I must be satisfied that the standards will continue to be set through an independent process to provide transparent information for the benefit of investors.
Another critical issue to me is the Roadmap's milestone of having the two accounting standard setters, the FASB and the IASB, improve accounting standards so that U.S. issuers will report their financial information using the highest quality accounting standards possible.
Today, the FASB and the IASB are continuing to work on projects to comprehensively readdress the accounting for financial instruments, which has been the subject of much controversy throughout the credit crisis. The projects would address classification and measurement of financial instruments (that is, whether and where fair value should be used in accounting for investments), as well as impairment, and hedging.
In terms of timing, I expect that you will be hearing more from us on IFRS in the next few months.
Thank you for letting me share with you the diverse and exciting work being done around the world with respect to financial regulation. These are just a few examples of the collaborative work being accomplished through various international organizations and forums in which the SEC takes part, as well as initiatives taken up by individual jurisdictions, to address the regulatory challenges that come with our increasingly global capital markets. Our recent collaborative work — both at home and internationally — has shown significant progress in strengthening the global financial regulatory system.
I believe it is imperative that the SEC continue to foster these important relationships and actively engage both bilaterally and multilaterally with regulatory counterparts, in order to fully achieve its mission of protecting investors, ensuring fair and orderly markets, and promoting capital formation in a global marketplace. Improved coordination of regulation, surveillance, and enforcement will result in more efficient and less costly regulation for regulated entities, and hopefully will better serve the protection of investors.