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Thank you for the opportunity to be here today and to speak about the critical topic of financial regulatory reform.
Two years ago, the global economy was deep in crisis.
In the United States, our financial system stood on the verge of collapse, not because of one gap or breakdown in our system, but because of many.
Firms took on risks they did not fully understand.
In Washington, regulators did not make full use of the authority they had to protect consumers and limit excessive risk.
Loopholes allowed large parts of the financial industry to operate without oversight, transparency, or restraint.
Policymakers were too slow to fix a broken system.
Around the world, other countries faced similar predicaments. And given the inter-connectedness of the global financial system, soon the entire global economy was at risk in ways we had never before experienced.
Over the past two years the global community has worked together to restore stability and growth. But from the start we also knew – in the United States and around the world – that we had an obligation to fix the flaws in our financial systems that had helped trigger this crisis.
In July, when President Obama signed into law the Dodd-Frank Act -- the most significant financial reforms since the 1930s – the United States took a tremendous step forward.
The Act builds a stronger financial system by addressing major gaps and weaknesses in regulation. It puts in place buffers and safeguards to reduce the chance that another generation will go through a crisis of similar magnitude. It protects taxpayers from bailouts. It brings fairness and transparency to consumers of financial services. And it lays the foundation for a financial system that is pro-investment and pro-growth.
Today, I would like to highlight some of the most important elements of our new framework, share our progress so far in implementing that framework, and set our work in the context of the broader global effort at financial regulatory reform.
We are hard at work on the construction of a system that is more robust, more transparent and more resilient.
First the Dodd-Frank Act creates a framework and provides new tools to identify and manage systemic risk in a way that we could not do before.
Before the Dodd-Frank Act, there was no single government entity charged with monitoring and responding to risk across the financial system. Gaps and inconsistencies led to regulatory arbitrage, and some of the largest, most interconnected firms were able to escape meaningful supervision.
The new law creates the Financial Stability Oversight Council, chaired by the Secretary of the Treasury, and composed of the heads of the financial regulatory agencies. The Council is charged with identifying risks to financial stability, responding to any emerging threats in the system and promoting market discipline. The Act also provides the Council with the responsibility to decide which nonbank financial institutions and financial market utilities will be designated as systemically important and to recommend what heightened prudential standards should be applied to those firms – with a view not only to the safety of specific institutions, but, critically, to the stability of the entire system.
In order to constrain systemic risk effectively, the Council and its members must be able to monitor systemic risk effectively. Doing that requires improvements in financial reporting and analytical capacity in the regulatory community.
That is why, alongside establishing the Council, the Dodd-Frank Act also established the Office of Financial Research.
The OFR was created to address the critical need of regulators, policymakers, and industry for data that are more standardized, more useful, and more reliable. The OFR's capacity to organize and analyze data will help the Council make more informed decisions about potential threats to the financial system.
Given the global nature of this crisis, it is no surprise that this ability to look beyond the safety of individual firms or markets to the health of the broader financial system is one of the key areas of reform called for by the international regulatory community. At the London Summit in April 2009, the G-20 Leaders agreed that their authorities should be able to identify and take account of macro-prudential risks across the financial system to limit the build-up of systemic risk. Last week, the G-20 Leaders called on the Financial Stability Board, the IMF and the Bank for International Settlements to further develop frameworks for a new set of policy tools in this area.
Second, the Act requires that regulators impose substantially stronger prudential standards.
Risk-based capital, leverage, and liquidity standards will be tougher for all firms, providing a more reliable buffer against both firm-specific failures and systemic shocks. And firms that are bigger and more complex will have to hold more capital than smaller and less complex firms, requiring them to internalize risks they impose on the system by virtue of their size and complexity.
The Dodd-Frank Act imposes a new mandatory stress-testing regime on the largest bank holding companies and designated non-bank firms. It requires them to establish living wills, laying out a credible plan for breakup and wind-down in the event of severe financial distress. Regulators are now able to require all financial firms, including holding companies, to take swift action to remedy declines in capital levels and other critical measures of financial health. And, as the Volcker Rule requires, there will be restrictions on certain risky activities by banks, such as investing in hedge funds and proprietary trading, as well as on the excessive growth by acquisition of the very largest financial firms.
We are also seeing movement on stronger prudential standards in the international community. Inadequate capital was at the core of the crisis, and we strongly support the work done by the Basel Committee to improve the quality and quantity of capital, impose a leverage ratio, and develop tougher liquidity standards. We are committed to continue our implementation of Basel II, apply the tougher capital requirements on banks' trading books known as Basel 2.5, and implement the new, tougher Basel III standards on time.
We also welcome the work done by the Financial Stability Board to strengthen the intensity of supervision of the systemically important financial institutions – something the Dodd-Frank Act also requires us to do.
Third, the Act establishes a comprehensive regulatory framework for the derivatives markets – the source of so much risk and uncertainty in the recent crisis.
Standardized derivatives will be centrally cleared and all derivatives will be reported to trade repositories. Standardized over-the-counter derivatives will also be traded on exchanges or electronic trading platforms to increase transparency and efficiency of these markets.
Regulators will impose strong prudential standards, including capital and margin requirements, and strong business conduct standards on over-the-counter derivative dealers and all other major OTC market participants. And the SEC and CFTC now have full enforcement authority – to monitor markets, set position limits and take action against manipulation and abuse. Through a narrowly tailored end-user exemption, the Act ensures that commercial firms will be able to hedge their risks effectively and efficiently.
Derivatives should reduce risk, not magnify it. They should be a force for stability, not contagion. By bringing the derivatives markets out of the shadows, the new law benefits every business that uses derivatives to manage real risks.
These are global markets that should have open, transparent, and prudentially sound infrastructure supporting them. That is why the G-20 committed to this and our regulators are working through CPSS and IOSCO to make sure we all agree to robust prudential and information sharing requirements. We commend the European Commission's proposals on central clearing. We look forward to continued collaboration on their future work on derivatives trading and market abuse--ensuring that we have open, transparent and non-discriminatory regimes, without geographic mandates, on both sides of the Atlantic.
The fourth key element of the Dodd-Frank Act is putting an end to the problem of Too Big to Fail in the United States. The Act gives the U.S. government the authority to shut down and break apart large non-bank financial firms whose imminent failure might threaten the broader system. Modelled on pre-existing authority to wind down failed banks, this resolution authority closes a gap with respect to non-bank financial firms that severely limited the federal government's options during the crisis, for example with AIG or Lehman.
It allows the U.S. government to wind down a failing financial firm wiping out shareholders, firing culpable management, and allowing creditors to take losses while stabilizing the financial system.
Any losses that cannot be covered through sales of the firm's assets will be recouped from the largest financial institutions through an ex-post assessment.
As a result, no firm will be insulated from the consequences of its actions. No firm will be protected from failure. No firm will benefit from the perception that taxpayers will be there to break their fall. The Act makes absolutely clear that taxpayers will never be asked to bear the costs of a financial firm's failure.
We strongly believe that other countries need to develop the types of tools we have long had for orderly resolution for banks– and now non-banks. Last week, G-20 Leaders reaffirmed their committed to implement national resolution systems with the powers and tools to ensure that all financial institutions can be resolved safely, quickly and without destabilizing the financial system or exposing the taxpayers to the risk of loss. These national systems are essential if regulators are to develop effective cross-border resolution plans.
Fifth, the Act enhances the federal government's ability to monitor the insurance sector and coordinate and develop federal policy on major domestic and international insurance issues. The crisis highlighted the lack of expertise within our federal government regarding the insurance industry. In response, the Act establishes the Federal Insurance Office which will provide the U.S. Government – for the first time -- dedicated expertise regarding the insurance industry.
The Office will monitor for problems or gaps in insurance regulation that can contribute to a systemic crisis in the insurance industry or the financial system; gather data and information on the industry and insurers; and coordinate policy in the insurance sector.
The Act does not provide the Federal Insurance Office with general supervisory or regulatory authority over the business of insurance. The States remain the functional regulators. Through the Office, however, the federal government will work toward modernizing and improving our system of insurance regulation.
With the Office, Treasury is now better able to work with other nations to increase international cooperation on insurance regulation, enhancing our collective efforts in addressing risks posed to the financial system. The Federal Insurance Office is in the process of becoming a member of the International Association of Insurance Supervisors where it will represent the United States. The Secretary of the Treasury, together with the United States Trade Representative, is now empowered to negotiate certain international agreements regarding prudential insurance measures and the Office will assist the Secretary. We anticipate that the Federal Insurance Office will be actively involved, for example, in working with the representatives of other countries on reinsurance collateral and U.S. equivalence under Solvency II.
Sixth, the Act establishes a single agency dedicated to consumer financial protection.
The Bureau of Consumer Financial Protection, is an independent entity within the Federal Reserve, with a clear mission: to promote transparency and consumer choice, and to prevent abusive and deceptive practices.
The CFPB will consolidate seven agencies' existing functions for supervising the largest banking institutions for compliance with consumer financial protection laws.
And it will supervise the consumer financial services activities of many non-bank financial firms that sell consumer financial services – an entirely new federal function.
This is an area that hasn't received a lot of international attention to date. However, just this past weekend, the G-20 leaders agreed to ask the FSB, the OECD, and others to explore options for advancing consumer financial protection through informed choice that includes disclosure, transparency, and education and protection from fraud and abuse. We look forward to working with them.
Now, the Act does much more. But each of these is a critical element: a focus on systemic risk; heightened prudential standards; comprehensive regulation of derivatives; an end to too big to fail; the creation of a Federal Insurance Office; and robust consumer protection.
Enactment of the legislation was, of course, not the end of the financial reform effort. We have now begun the difficult and complex process of implementation.
We have made significant progress in the months since enactment. Wherever possible, we are providing clarity to the public and to the markets. We are moving as quickly and as carefully as we can. But the task we face cannot be achieved overnight. We have to write new rules in some of the most complex areas of finance; consolidate authority spread across multiple agencies; set up new institutions for addressing systemic risks and for consumer protection; and negotiate with countries around the world.
We have made important progress creating the new regulatory bodies established under the Act. These institutions are at the heart of the Dodd-Frank Act – the Financial Stability Oversight Council, the Office of Financial Research, and the Consumer Financial Protection Bureau. And I would like to take a few moments to update you on our progress standing them up.
First, the Financial Stability Oversight Council. As Chair, Treasury has moved quickly to convene the Council earlier this month, ahead of the date required by the Act. At this first meeting, Council members engaged on important substantive issues. They requested public input on the criteria the Council should use to designate systemically important nonbank financial companies for Federal Reserve supervision. And they requested public comment on the Council's study on the Volcker Rule's limitations on proprietary trading at certain financial institutions.
More broadly members released an integrated roadmap for implementing the Dodd-Frank Act that reflects the priorities of the various regulatory agencies. And they adopted bylaws and a transparency policy.
On November 23, the Council is scheduled to have its second meeting. I expect that the Council will continue its work on systemic risk and discuss the criteria for designating systemic non-bank financial institutions and financial market utilities. The Council is also making progress standing up its operations, including budget, staffing, and organizational structure.
The Council's success in carrying out these critical functions will depend on its ability to act in a collaborative manner. While each member agency is responsible for a specific part of the financial sector or for certain aspects of its functioning, the Act holds the Council and its members collectively accountable for maintaining stability across the financial system. Accordingly, the Council's approach preserves the independence of regulators to fulfil their individual responsibilities while maximizing the coordination required for the Council to achieve its broader mission of financial stability.
Here in Europe, national governments and the European Union are setting up institutions with similar mandates for monitoring systemic risks. We look forward to cooperating with them in the future, particularly through the Financial Stability Board and the Basel Committee, to share best practices as we develop approaches to macro-prudential supervision.
The second institution Treasury is creating is the Office of Financial Research. The OFR is working with regulators and industry, laying the groundwork to standardize financial reporting and develop reference data that will identify and describe financial contracts and institutions. Data standardization will provide for more consistent and complete reporting, making the data available to decision makers easier to obtain, digest, and utilize.
Over the coming weeks and months, the OFR will begin to define a set of standards for reporting of financial transaction and position data. The OFR will collaborate with the financial industry, data experts, and regulators to develop an approach to standardization that works for everyone.
We are mindful that the OFR must not duplicate existing government data collection efforts or impose unnecessary burdens. That is why we are working with the regulators to catalogue carefully the data they already collect to ensure the OFR relies on their data whenever possible. The OFR is also exploring ways in which it could act as a central warehouse of data for the regulatory community, which could generate efficiencies and interagency cooperation.
For example, new reporting requirements in the Dodd-Frank Act, which are consistent with reforms supported by the G-20, will make possible a comprehensive cataloging of derivatives in order to track their redistribution of risk through the system. Data standards will make it easier for individual firms to assess their own risks and will improve discipline by giving market participants better information on what individual firms are doing.
Beyond establishing standards, the OFR is also required to develop and publish key reference data that will describe financial institutions and contracts. Regulators and supervisors, as well as private firms and investors, rely on such reference data to analyze risk. The OFR is beginning the effort to put all of this in place.
Now the true measure of success will be in how it facilitates more robust and sophisticated analysis of the financial system, both for the government and the private sector. This is critical for our Council as well as its international counterparts. We look forward to identifying and addressing key data gaps.
The third institution is the Consumer Financial Protection Bureau. Treasury has set up an implementation team focused on establishing key functions of the bureau such as research and supervision of bank and non-bank financial institutions, and building the CFPB's supporting infrastructure.
The Secretary has designated July 21, 2011, as the date on which the CFPB will assume existing authorities of seven federal agencies, and we have made substantial progress preparing the CFPB to incorporate staff and assume authorities from those agencies.
Let me conclude by expressing the U.S. government's deep appreciation for the meaningful effort our international friends here and around the world have been making to implement fundamental financial reform.
There is no doubt that the regulatory frameworks that many countries had in place ahead of this crisis simply did not work. They failed to prevent a historic global recession that has cost us all dearly. They must be fixed. And in Washington we have tried to lead by example.
But this is a challenge for all of us to meet. In the wake of the severe, globally synchronized financial crisis, we must develop the most globally convergent financial protections the world has ever attempted. So as we protect against future crisis; and as we promote lasting global growth; we need to act in a coordinated fashion.
That doesn't mean that our strategies will be identical. They shouldn't be. While global convergence is essential in areas such as capital and derivatives regulation, in other areas the reforms we seek may be best served by different nations pursuing different means. A specific implementation approach that works for the United States may not work for the United Kingdom.
But we should never forget that we all have the same goal. We need a level playing field. And by implementing new standards; by ending too big to fail; by enhancing global regulation; and by establishing stronger international coordination to prevent future crises, we will improve the soundness and resilience of the global economy. This is about stability. This is about growth. But most importantly this is about better serving our people, our workers, our entrepreneurs, our businesses and the generations to come.
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