Saturday, December 27, 2008

Alabama Administrator Advocates Steps to Close "Gap" in Regulatory Information Sharing

In remarks delivered at NASAA's Regulatory Reform Roundtable, Alabama Securities Director and former NASAA President Joseph Borg stated that we must close the vacuum, or "gap," in financial regulation that led to the current financial crisis. According to Borg, the crisis has revealed that an enormous amount of unregulated capital is traded through esoteric instruments on opaque markets. Borg believes that these products, which were created through consolidation and creative expansion in the financial services industry, must be subjected to effective information analysis and regulation in order to detect and manage risk in the financial markets.

Borg acknowledged that the current form of ad hoc information sharing among regulatory agencies suffers from inefficiencies and a lack of coordination. Regulators, who historically have been siloed and compartmentalized, have had difficulty in coordinating and cooperating on forward-looking analyses of certain instruments, such as structured products. The inability or unwillingness of agencies to break down barriers has allowed for gaps in the monitoring and detection of systemic market risk by preventing regulators from seeing what was "around the curve," Borg said.

Borg argued, however, that the solution does not lie in the centralization of interagency coordination at the highest levels of government. Rather, he believes, the goal must be truly horizontal interagency planning performed virtually simultaneously. In Borg's view, we must mandate robust information exchange by establishing and enforcing minimum standards of information sharing at the appropriate agency level, while still protecting the sources of that information.

In order to facilitate an increase in communication and cooperation, Borg suggests the establishment of a council of experts that would monitor financial activity in all sectors and recommend any necessary corrective action. As envisioned by Borg, the council would be comprised of both state and federal regulators, academics, and others with expertise in securities, banking, and insurance. This new "financial products commission" would have no regulatory authority other than carefully defined powers to collect data from market participants and regulators. The council would examine the totality of the data in order to identify systemic risks or the emergence of new products not subject to adequate regulation. The council would then pass on its recommendations for corrective action to the various regulatory agencies with the ultimate policy making decisions, Borg said.

Borg believes that the proposed council could also be used to improve risk understanding and accounting. Borg noted that accounting measures are the primary data used for corporate decisions and regulatory requirements, even though current GAAP accounting methods are backward-looking by definition and not well suited for providing risk transparency. Borg stated that the use of cross sector financial expertise may result in a new branch of accounting, risk accounting, which captures the linkages and vulnerabilities of the entire financial system, and not just those of the banking system.