House Hearings Explore Mandate of Systemic Risk Regulator

As the House Financial Services Committee readies legislation on system risk, the Capital Markets subcommittee held hearings on the securities, capital markets, and credit default swaps issues surrounding systemic risk. According to subcommittee Chair Paul Kanjorski, Congress may impose a systemic risk test as part of governmental review of mergers. In addition, he noted that credit default swaps have generally fallen through the cracks of our fragmented regulatory system. Similarly, hedge funds have gone largely unregulated.

Insofar as hedge funds impact the systemic financial markets, they will come within the ambit of a systemic risk regulator. Former subcommittee Chair Richard Baker testified that the factors used to decide if a hedge fund poses a systemic risk are the amount of the fund’s assets. the concentration of its activities, and the fund’s interconnectivity to other market participants.

Mr. Baker, who is now CEO of the Managed Funds Association, said that the four components of systemic risk regulation are a central systemic risk regulator; confidential reporting of information to such regulator; establishing a clear regulatory and the scope of its authority, and a mandate to protect the financial system.

A single systemic risk regulator is needed, he said, because multiple regulators with responsibility for overseeing systemic risk likely would not work because no one regulator would oversee the entire system and assess potential systemic risk from a holistic perspective.

It is critical that the information gathered by the systemic risk regulator be kept confidential and fully protected from public disclosure. The hedge fund industry believes that a systemic risk regulator can fulfill its mandate to protect the financial system
without publicly disclosing all the proprietary information of financial institutions.

Positing that a systemic risk regulator must have access to information in order to adequately assess potential risks to the financial system, Mr. Baker supports a systemic risk regulator having the authority to request and receive, on a confidential basis, from hedge funds that it determines to be of systemic relevance, any information that the regulator determines is necessary or advisable to enable it to adequately assess potential risks to the financial
system.

Moreover, the systemic risk regulator needs broad authority with respect to information gathering, along with resources and capabilities to effectively analyze that information.

Mr. Baker emphasized that the systemic risk regulator’s mandate should be the protection of the financial system. Investor protection and market integrity should not be part of its mandate.

Also, the systemic risk regulator must have the ability to be both forward-looking to address potential systemic problems as well as deal with systemic problems after they have arisen. Further, when a failing market participant does pose such a risk, said Mr. Baker, the systemic risk regulator should be authorized to directly intervene to ensure an orderly dissolution or liquidation of the market participant.

T. Timothy Ryan, SIFMA CEO, testified that the mission of a systemic risk regulator should be to mitigate systemic risk, maintain financial stability, and address any financial crisis. The regulator should have authority over all financial institutions and markets regardless of charter, functional regulation or unregulated status.

While there is no single commonly-accepted definition of systemic risk, SIFMA defined systemic risk as the risk of a systemic financial crisis characterized by a significant risk of the contemporaneous failure of a substantial number of financial institutions or of financial institutions or markets controlling a significant amount of financial resources that could result in a severe contraction of credit or have other serious adverse effects on economic conditions or financial stability.