Volcker Report on Financial Regulation Favors Twin Peaks Approach of Tresury Blueprint for Reform
With former Federal Reserve Board Chair Paul Volcker reported to be President-Elect Obama’s principal adviser on the financial and securities markets, a recently released report by Mr. Volcker on the structure of financial regulation takes on heightened importance. The report, under the auspices of the Group of Thirty, seems to favor the twin peaks model of financial regulation over other models, such as the integrated regulator approach of a single universal regulator, which is used in the UK.
The twin peaks approach was recommended for US financial regulation by the Treasury blueprint for reform issued earlier this year. The two other regulatory models examined in the report are the functional approach under which regulation is determined by the business being transacted by the entity; and the institutional approach. under which the firm’s legal status determines which regulator oversees it.
According to the report, the twin peaks approach is designed to garner many of the benefits and efficiencies of the integrated approach, while at the same time addressing the inherent conflicts that may arise from time to time between the objectives of safety and soundness regulation and consumer protection and transparency. The twin peaks approach is currently used in the Netherlands and Australia.
The twin peaks approach embodies the principle of regulation by objective under which one agency’s objective is prudential supervision, while the other agency focuses on business conduct and consumer protection. The Treasury blueprint, which promotes regulation by objective approach, differs from existing twin peaks models on that it advocates a business conduct regulator separate from the transparency and markets regulator. The Treasury blueprint proposes that the transparency and market regulator be the SEC.
Current twin peaks jurisdictions link investor protection with market fairness and transparency mandates and have a single regulator in charge of all three mandates. Since most securities regulators have deep experience with business conduct regulation, this role has usually been given to the securities regulators in jurisdiction using twin peaks regimes. The report points out that the business conduct regulator is not limited to rulemaking, but can also develop arbitration and mediation systems.
It is quite clear that the Volcker report views the current US regulatory structure as an exception to the four standard regimes. The anomalous US regulatory structure is a creature of historical precedent, politics, and culture. The US system is functional with institutional aspects, said the report, with the added complexity of state-level agencies and actors. While the current structure is quite complex, it soldiered on until the current crisis exposed its weakness and the need for structural reform.
The report says that the institutional approach is largely based on a business model that no longer exists. Many large financial firms are involved in a cross-section of products and services rather than in the monoline activities of the past. This approach also suffers from potential inconsistencies in applying regulations by disparate regulators.
A major drawback of functional regulation, said the report, is that it can be extremely difficult to distinguish which activity comes within the jurisdiction of which regulator. A problem with the integrated approach is that if the universal regulator fails to spot an issue there is no other regulator to fill the void.