Corporate & Securities Law

By Jim Hamilton

The G20 has proposed a massive overhaul of the entire system of financial regulation based on transparency, risk management, the convergence of accounting standards, and the global sharing of information among regulators. The group also endorsed a college of regulators concept for global financial institutions, which has found some favor in the EU. In a communiqué, the G20 set out a number of immediate benchmarks to be accomplished in the first quarter of 2009; and longer range goals with no set timetable. The proposals, which are surprisingly granular, establish an ambitious reform blueprint for regulators like the SEC and standard setters like the IASB and FASB.

Immediately, the FASB and IASB must enhance guidance for the valuation of complex illiquid securities and mandate more disclosure for off-balance sheet vehicles. Even more, regulators and standard setters must enhance the disclosure investors receive about complex financial products. On another front, the governance of the IASB must be enhanced to ensure transparency and a relationship between the Board and securities regulators such as the SEC. As a longer range goal, the G20 fully endorsed a single set of global accounting standards of high quality.

Another immediate goal is the registration of credit rating agencies under regimes that avoid conflicts of interest, provide greater disclosure to investors and issuers, and differentiate ratings for complex products. The European Commission recently proposed the regulation of credit rating agencies under a regime based on differentiation.

Also immediately, regulators should build on the imminent launch of central counterparty services for credit default swaps, in the US the NY Fed is vetting such a system, and speed efforts to reduce the systemic risks of credit default swaps and OTC derivatives transactions. Market participants must be required to support exchange-traded or electronic platforms for credit default swaps contracts. Overall, regulators must ensure that the infrastructure for OTC derivatives can support growing volumes.

Risk management is a central principle of the reform of financial regulation. Enhanced guidance must be developed immediately to bolster the risk management practices of financial institutions. Banks and other firms must examine their internal controls and implement sound risk management practices. In particular, banks should have effective risk management and due diligence over structured products and securitization.

For their part, regulators must require that firms have risk management practices that can measure risk concentrations and large counterparty risk positions across products and borders. The Basel Committee should develop new stress testing models. Importantly, executive compensation schemes must not reward excessive short-term returns or risk taking. Rather, incentives should promote stability.

Finally, it is crucial that regulators cooperate on regional and international levels. They must share information about cross-border threats to market stability. Specifically, the G20 said that colleges of regulators should be immediately established for all global financial institutions as part of the oversight of cross-border firms. Major global banks should meet regularly with their oversight college for a comprehensive review of their risk management regimes.

Full post as published by Jim Hamilton's World of Securities Regulation on November 15, 2008 (boomark / email).