The Changing Global Regulatory Environment

The global financial crisis has sparked unprecedented efforts to reform and modernize regulatory and supervisory structures.

The discussions are being held in both international fora, such as the G-20, as well as at the national level, particularly in the United States, European Union and United Kingdom. And, while there is agreement among governments on the need for changes to regulatory structures, the details of these changes are proving more complicated.

While the implications for regulatory reform are global, the decisions are being made at the local level. Politicians in the U.S. Congress, the parliaments of EU member states and elsewhere will ultimately decide the fate of many of the ideas currently being advanced to reshape the regulatory and supervisory structures that govern the financial system.

Because of the uncertainty inherent in these political processes, JPMorgan Chase & Co., our customers, business partners and investors around the world have to carefully monitor unfolding events and prepare for different possible outcomes. JPMorgan Chase & Co.'s International Government Relations team, working out of Washington, New York and London, with partners across the firm's key markets, is actively engaged in the reform efforts. This summary offers a brief analysis of the major issues under consideration, and points out some of the key areas for stakeholders in the global markets to follow in the weeks and months to come.

Systemic Risk
While systemic risk mitigation is one of the key regulatory issues on the agenda, achieving satisfactory systemic risk oversight and regulation remains a challenge.

• In the United States, the Obama administration has proposed to have the Federal Reserve supervise systemically important institutions, while a Financial Services Oversight Council (FSOC) made up of the key financial regulators is created to fill supervisory gaps, facilitate cooperation of policy, resolve regulatory disputes and identify emerging risks. Under this proposal, all large, interconnected financial services firms (including hedge funds, private equity, insurance, broker-dealers and banks) that are systemically important will be labeled Tier 1 Financial Holding Companies (FHCs) and will be subject to consolidated supervision by the Federal Reserve. Tier 1 FHCs will have higher capital requirements and more robust supervision of liquidity and risk management structures. The administration has also proposed wider resolution authority, with the FDIC generally still appointed as conservator/receiver and some authority being extended to the SEC.
• These proposals have garnered significant pushback from legislators in both U.S. political parties and even from other regulators. Their primary criticism is that these reforms place too much power in the Fed, which some see as having been ineffective in the current financial crisis, and which could potentially be a distraction from its main role of monetary policy.
• In Europe, a proposed new Systemic Risk Board (ESRB) would be tasked with analyzing information relevant to financial stability and issuing early risk warnings. The EU has also proposed a new System of Financial Supervisors (ESFS) that will serve as a coordinator of the national day-to-day supervisors. The key issue in the EU appears to be whether this gives Brussels enough authority to handle cross-border supervision.
• Globally, the Financial Stability Board (FSB) has released principles for cross-border cooperation on crisis management. These include developing common support tools, encouraging the development of wind-down procedures and sharing information on systemic implications.

Consumer Protection
Another key issue in the debate is ensuring adequate protections for consumers. On this issue, the Obama administration has proposed the creation of a Consumer Financial Protection Agency (CFPA) that would have broad authority, including enforcement powers, to ensure that consumer protection regulations over financial products are written fairly and enforced vigorously. The proposed CFPA is designed as an independent agency with stable and robust funding to serve as the sole rule-maker for consumer financial protection statutes. Supporters believe it will reduce gaps in supervision and enforcement, improve coordination with states and promote consistent regulation of similar products. The CFPA would also approve so-called "plain vanilla" products, which financial institutions would be required to offer consumers.

This controversial proposal has led to significant debate. Members of the U.S. Congress, as well as outside stakeholders, are questioning the need for a new agency, as well as the breadth and scope of the consumer protection powers vested in the federal government under the administration's proposal. While the White House and several key leaders in Congress seem intent on establishing a CFPA, there is significant ongoing discussion about the agency's powers, particularly concerning preemption, enforcement and the ability of the government to define products that lenders must offer.

Regulating the Unregulated
Global proposals also address areas of the markets that have historically been either lightly regulated, such as the over-the-counter derivatives markets, or unregulated, such as hedge funds.

Entities: In the United States and in Europe, there are proposals to require hedge funds, private equity and other private pools of capital, and venture capital firms to register with regulators. In Europe, this has raised significant debate. The EU has also gone further, requiring capital standards for larger firms and mandating that funds outside the EU's jurisdiction meet standards set by the EU (with a three-year grace period) if they want to market their products in the EU.

Products: Under the Obama plan, all standardized OTC derivatives would be cleared through a central counterparty (CCP), while customized derivatives would be subject to higher capital and margin requirements. In Europe, the key focus has been on credit default swaps (CDS), with a mandate that EU entities be cleared through EU-based central counterparties. This push to standardize and clear derivatives transactions has been supported by the industry and is largely in line with the thinking of the G-20, which has asked the industry to develop a standardization plan.

However, these proposals have raised a number of concerns for the end users of derivatives as well as the institutions that facilitate the transactions. In the United States, proposals that sought to require end users to face a CCP faced intense criticism. As a result, the House Financial Services Committee announced a moderated agreement that does not impose a CCP requirement. An outstanding concern among end users is the extent to which capital requirements for customized products are significantly higher and consequently increase the costs of hedging activity. At the international level, some countries are contending that portions of the European plan are nationalistic and could pave the way to protectionism.