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The G-20 Summit in Toronto: U.S. Financial Reform and the G-20 Leaders' Agenda

This week, the U.S. House of Representatives and the U.S. Senate reported out of conference committee an historic financial reform bill, one consistent with the key priorities that President Obama laid out a year ago.  The bill puts the U.S. at the forefront of global financial reform, and advances the agenda to strengthen the international financial system laid out at London and Pittsburgh.  These reforms will reduce moral hazard, limit the buildup of systemic risk, bring new transparency to the derivative market and create a more resilient financial system better able to support strong economic growth.   The U.S. is working closely with the European Union and others to ensure that the G-20’s ambitious agenda for regulatory reform is implemented.

  1. End Too Big To Fail:  In Pittsburgh, G-20 Leaders agreed that we “should develop resolution tools and frameworks for the effective resolution of financial groups to help mitigate the disruption of financial institution failures.”  In the United States, if a big financial firm is failing, it will have only one fate:  liquidation. There will be no taxpayer funded bailout. Instead, regulators will have the ability to shut down and break apart failing financial firms in a safe, orderly way – without putting the rest of the financial system at risk, and without asking the taxpayers to pay a dime.  We are working at the international level to put in place a regime in which banks hold more and higher quality capital and face a mandatory leverage ratio so banks can sustain a significant level of unanticipated losses, comparable to those experienced in the crisis. 
  2. Safer, More Transparent Derivatives Market to Help Main Street Businesses: In Pittsburgh,  G-20 Leaders agreed that “standardized OTC derivative contracts should be traded on exchanges...and cleared through central counterparties” and that all OTC derivative contracts should be reported to trade repositories. By bringing the derivatives markets out of the shadows, U.S. financial reform will benefit those businesses that use derivatives to manage their commercial risks. That’s good for every farmer and every manufacturer that uses derivatives the way they were meant to be used.  Derivatives reform will also require capital and margin requirements for every dealer and major market participant, helping prevent a future AIG.
  3. Closes Loophole in Regulation of Major Financial Firms: In London, G-20 Leaders agreed that “large and complex financial institutions require particularly careful oversight given their systemic importance” and laid out additional recommendations to address moral hazard caused by these firms.  Loopholes that allowed firms like Lehman Brothers, Bear Stearns and AIG to operate without tough standards or oversight were major contributors to the financial crisis.  U.S. financial reform will close these loopholes and create accountable regulation for all firms that pose the most risk to the financial system. It will end the ability of financial firms to avoid tough standards by manipulating their legal structure.  
  4. Bring Transparency to Hedge Funds: In London, G-20 Leaders agreed that “hedge funds or their managers will be registered and will be required to disclose appropriate information on an ongoing basis to supervisors or regulators.”  U.S. financial reform will require advisers to hedge funds to register with the SEC for the first time, bringing transparency and oversight to these unregulated financial firms.
  5. Constrain the Size and Risks of the Largest Firms: In Pittsburgh, G-20 Leaders noted the unique risk posed by Systemically Important Financial Institutions highlighting that in addition to proposals that seek the orderly resolution of firms, the FSB should “propose … possible measures including more intensive supervision and specific additional capital, liquidity, and other prudential requirements." In the U.S, financial reform will prevent any financial firm from growing by acquisition to more than 10 percent of the liabilities in the financial system. This will reduce the adverse effects of the failure of any single firm and prevent the further concentration of our financial system.  The reform will require higher capital and liquidity requirements and more intensive supervision for firms that pose the most risk. 
  6. Reform Pay Practices at Financial Firms: In Pittsburgh, G-20 Leaders agreed that “excessive compensation in the financial sector has both reflected and encouraged excessive risk taking”, they endorsed the FSB’s  implementation standards aimed at aligning compensation with long-term value creation, and not excessive risk taking .  U.S. financial reform will give shareholders a vote on the compensation of senior executives at the companies they own and require that the compensation committees of corporate boards uphold high standards for independence.  The Federal Reserve, FDIC, OCC, and OTS recently released guidance on compensation practices for banks and the SEC issued enhanced rules for disclosure on compensation packages for listed firms.
  7. Separate Banking and Speculative Trading: The G-20 Leaders in Pittsburgh, as part of its core commitment to financial regulatory reform, highlighted that “reform is multi-faceted but at its core must be stronger capital standards, complemented by clear incentives to mitigate excessive risk-taking practices.”  In addition to higher capital and tougher standards for the largest, most interconnected firms, U.S. financial reform will protect taxpayers and depositors by separating risky, speculative “proprietary trading” from the business of banking.  These reforms will make clear that banking entities must focus on their customers, and not on proprietary trading or hedge fund or private equity investments.  It will also limit the derivatives activities of banks to derivatives regarding traditional banking products. 
  8. Strong Consumer Protection: In Pittsburgh, G-20 Leaders agreed to “promote successful regulatory and policy approaches and elaborate standards on financial access, financial literacy, and consumer protection.”  Instead of seven federal agencies with only partial responsibilities for consumer financial protection, there will be one agency dedicated solely to establishing and enforcing clear rules of the road for banks, mortgage companies, payday lenders, and credit card lenders.
  9. Crack Down on the Abuses in Mortgage Markets:  In Pittsburgh, G-20 Leaders agreed that “far more needs to be done to protect consumers, depositors, and investors against abusive market practices.”  They agreed that securitization originators should retain a part of the risk of the underlying assets to encourage them to act prudently.  In London, Leaders agreed on “more effective oversight of the activities of credit rating agencies”, including registration, managing conflicts of interest, and assuring the transparency and quality of the rating process.  U.S. financial reform will ban abusive practices in the mortgage markets, for example requiring mortgage brokers and banks to consider a family’s ability to repay when making a loan. The reforms will also require lenders and Wall Street loan packagers to keep skin in the game when selling off loans to investors and make full disclosure so investors know what’s in those packages. Reforms of credit rating agencies will help make sure investors do not rely unwisely on their ratings on these packages.
  10. Support Long-Term Job Growth by Helping Prevent Future Crises: The G-20 Leaders in Pittsburgh recognized that “we must take care not to spur a return of the practices that led to the crisis. The steps we are taking here, when fully implemented, will result in a fundamentally stronger financial system than existed prior to the crisis.” Further, the G-20 noted“…we want growth without cycles of boom and bust and markets that foster responsibility not recklessness.” Financial reform will ensure businesses a more stable and predictable source of credit through the business cycle and reduce the risk of a sharp and sudden cut‐off because of financial panic. By making the financial system safer and stronger, reform will reduce the chances that a financial crisis deprives businesses of the credit they need to grow and to create jobs.

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