The Obama administration is pre-announcing the regulatory reforms announcements (see their outline below), so much so one might miss what is coming out of Congressional hearings on the topic.
I believe that only ostriches can now deny the need for establishing a federal insurance resource center and a basic federal insurance regulatory structure.
Geither's response? Let's ignore the entire insurance industry. What's in a name? (AIG)
Insurance is a complex and important part of the U.S. financial industry with more than $6.3 trillion in assets under management and $1.23 trillion in annual premiums.
Here is a CNBC interview from last month with Subcommittee Chair Kanjorski overviewing the need for insurance regulation:
Last week, House Financial Services Committee Subcommittee, Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, held a hearing, The Effective Regulation of the Over-the-Counter Derivatives Markets.
Chair Kanjorski's statement on the Wild, Wild West of the Financial World.
Today, we meet to consider another area of our capital markets woefully lacking in effective regulatory oversight: over-the-counter derivatives. Within less than three decades over-the-counter derivatives have become a staggering $500 trillion market, in notional value.
This market also has the potential to cause considerable harm. Last year, AIG infamously came crashing down because its lightly regulated Financial Products unit engaged in credit default swaps in the over-the-counter markets without holding sufficient capital to hedge the risks.
Clearly, some of these customized contracts cannot easily fit within a mandatory clearing or exchange trading regime. We therefore must find a delicate balance. Subjecting all contracts to mandatory exchange trading may cast too wide a net. Yet the clearing of most products – not all – through a central clearing entity seems appropriate and should not impose an undue burden on the affected parties. However, carving out too many exemptions as we tackle regulatory reform could create widespread economic harm in the long term.
Even where clearing of contracts proves unfeasible, transparency can still exist. By mandating the collection of relevant data in a repository, we can help to ensure that regulators maintain access to useful trading information and perhaps detect warning signs of systemically risky transactions. Electronic trading also increases transparency. Further, electronic execution streamlines trading, minimizes mistakes, and enhances monitoring of the over-the-counter derivatives markets.
Contrast that with the below Obama administration derivatives framework.
Utah Law School Professor Johnson believes a system needs to designed carefully (what a concept for our government!):
Congress should proceed in efforts to reduce counterparty credit risk. However, I believe that the effort to clear all OTC derivatives through regulated central counterparties (CCPs) should be done slowly and methodically and with substantial input from OTC derivatives market participants. Congress should be aware that requiring OTC derivatives to be cleared through CCPs represents a seismic and unproven shift as to how OTC derivatives are traded, processed, assessed and function.
Most of this hearing is various corporate interests blasting the regulatory proposals on derivatives, especially an open exchange. Hedge funds scrabble to hire more lobbyists to prevent legislation and companies issue that infamous threat to simply move offshore.
Congressman Lynch notes the soft shoe on derivatives:
Taking a "soft approach" to regulating over-the-counter (OTC) derivatives would be a mistake, but that appears to be the direction lawmakers are leaning, said U.S. Representative Stephen Lynch on Tuesday.
"I get the sense who's winning this fight and I don't think it's the American taxpayer," said Lynch at a House of Representatives capital markets subcommittee hearing on proposals to crack down on OTC derivatives.
At the hearing, faced with a panel of industry executives testifying as witnesses, many lawmakers from both parties called for a balance between too much and not enough centralized clearing and exchange trading of OTC derivatives.
Lynch said: "By allowing a significant part of the derivatives market to just go off unregulated ... We're setting ourselves up to fail."
He said, "We're not going to regulate this, I get the sense of it right now.
Here is the Obama administration pre-announcement announcement of their regulatory reform structure as Summers & Geither layout the proposed framework:
- Increased Capital and Liquidity Requirements
- Federal Reserve as Systemic Risk Regulator
- Coordinate Existing Regulatory Agencies
- Improve Reporting on ABS
- Reduce Reliance of Credit Rating Agencies
- Financial Consequences throughout securitization chain
- All derivatives regulated
- more security safeguards in futures, securities trading
- consumer regulatory protection agency
- resolution "mechanism" for institutions who impose systemic risk
- Coordination with other national systems
Ah, so you're going to coordinate with other nations. Here is the EU on insurance industry regulation, just announced to be ignored by the administration.
EU Parliament member Skinner's proposal is an independent council body to oversee European Systemic Risk. The proposed framework is:
- collect and analyse all information relevant for monitoring and assessing potential threats to financial stability that arise from the macro-economic developments and developments within the financial system as a whole
- identify and prioritise such risks
- issue warnings where risks appear to be significant;
- where necessary give recommendations on the measures to be taken in reaction to the risks identified
- monitor the required follow-up to warnings and recommendations
- liaise effectively with the IMF, the Financial Stability Board and other third country counterparts
In contrast, the United States currently regulates 6,000 insurance entities through a patchwork of state regulators and Geithner mentions none of the insurance sector will be addressed (to date).
The EU should release their reports and proposals on OTC derivatives regulation tomorrow.
So, to sum, what does all of this mean? Frankly we must see the actual legislation in some detailed final form. But I would read the hearing and pre-annoucement announcement tea leaves as:
Regulation on derivatives is a major war, we have much more power being handed to the Federal Reserve and we have the Obama administration wanting to ignore the entire insurance industry.
Here is an older piece which gives an excellent background on derivatives.