GAO Issues New Guidelines for Regulatory Reform

Report Makes Nine Recommendations to Modernize Outdated System
GAO Issues New Guidelines for Regulatory Reform
The Government Accountability Office (GAO) on Thursday issued a new report that sums up what many in the financial services industry have known for years - the regulatory system is in dire need of a makeover.

The GAO report, "A Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory System," lists nine characteristics that should be reflected in any new regulatory system to be crafted by Congress and the new Administration.

And without coming right out and calling for specific agencies to be consolidated or eliminated (as the Treasury Department did last spring), the GAO does suggest that the regulatory system needs to be more "efficient and effective" to provide necessary oversight and avoid future economic crises.

'We're in a Financial Mess...'

While many in financial services may see the GAO report as a knee-jerk reaction to the worst financial crisis in 75 years, the agency actually has been calling for systemic changes to the financial services sector's regulatory structure since 1994. The GAO began work on this report back in April 2008, long before the collapses, bankruptcies and market implosions that gained momentum last summer.

The GAO's report is a telling sign, observers say, that the era of deregulation is over.

"What remains to be seen is whether the pendulum will swing back with vengeance in mind, and whether the regulatory system can be restructured to be both more effective and more efficient," says Mark Schwanhausser, a research analyst in multichannel financial services at Javelin Strategy &Research, a firm focusing on the financial services industry. "That will be a daunting challenge that will shape banking for decades to come."

The GAO initiative is long overdue, says Javelin's Tom Wills, Security, Fraud & Compliance senior analyst. "It took a crisis to spur positive action, but the upshot here is simplification, and that can only be a good thing."

The need for regulatory reform and consistent regulations applied to all companies - especially those non-banking institutions that have been loosely regulated -- has been a topic of many conversations over the years, says Steve Katz, former CISO at Citigroup and Merrill Lynch. "I know it's going to sound like heresy to all of the little companies and hedge funds out there, but all those little companies and hedge funds need to be regulated the same as every other company in the industry. If you want to play with the big boys, there has to be one set of regulations, or don't play in the game."

Katz succinctly states the case for regulatory reform: "We're in a financial mess, and the regulations no longer make any sense. We need a consolidated regulator that has a consistent set of regulations applied to everyone across the industry."

Even with a new President about to take office - and with economic issues firmly on his mind -- real movement to restructure the regulatory system may be months or even years away. But the handwriting is on the wall, says Javelin's Schwanhausser. "In the meantime, the banking industry would be wise to embrace change rather than fight it," he says. "This is a time to identify regulatory changes that will be a catalyst for beneficial changes, embrace them and even overhaul their policies and practices preemptively to get ahead of the regulatory backlash."

GAO Recommendations

The GAO report outlines the history of the current financial regulatory system, the developments in markets and the changes that have created challenges for it - including the subprime mortgage crisis and other elements responsible for the global recession --and then presents an evaluation framework that could be used by lawmakers and other policymakers to shape regulatory reform.

To develop this report, the GAO pulled from existing GAO reports and met with representatives of financial regulatory agencies, industry associations and consumer advocacy groups.

Among the GAO's recommendations:

Clearly Defined Regulatory Goals - Goals should be clearly articulated and relevant so that regulators can effectively carry out their work and be held accountable.

Appropriately Comprehensive - Financial regulations should cover all activities that pose risks or are otherwise important to meeting regulatory goals and should ensure that appropriate determinations are made about how extensive such regulations should be, considering that some activities may require fewer regulations than others.

Systemwide Focus - Mechanisms should be included for identifying, monitoring and managing risks to the financial system regardless of the source of the risk.

Flexible and Adaptable - A regulatory system that is flexible and forward-looking allows regulators to readily adapt to market innovations and changes.

Efficient and Effective - Effective and efficient oversight should be developed, including eliminating overlapping federal regulatory missions where appropriate, and minimizing regulatory burden without sacrificing effective oversight. Any changes to the system should be continually focused on improving the effectiveness of the financial regulatory system.

Consistent Consumer and Investor Protection - Consumer and investor protection should be included as part of the regulatory missions to ensure that market participants receive consistent, useful information and legal protections for similar financial products and services, including disclosures, sales practice standards and suitability requirements.

Regulators Independence - Regulators should have independence from inappropriate influence, and be given the prominence and authority to carry out and enforce statutory missions and be clearly accountable for meeting regulatory goals.

Consistent Financial Oversight - Similar institutions, products, risk and services should be subject to consistent regulation, oversight and transparency. This should help minimize negative competitive outcomes while harmonizing oversight, both within the U.S. and internationally.

Minimal Taxpayer Exposure - A regulatory system should foster financial markets that are resilient enough to absorb failures and limit the need for federal intervention and limit taxpayers' exposure to financial risk.

To read the full GAO report: Download The Full Report (PDF)

About the Author

Linda McGlasson

Linda McGlasson

Managing Editor

Linda McGlasson is a seasoned writer and editor with 20 years of experience in writing for corporations, business publications and newspapers. She has worked in the Financial Services industry for more than 12 years. Most recently Linda headed information security awareness and training and the Computer Incident Response Team for Securities Industry Automation Corporation (SIAC), a subsidiary of the NYSE Group (NYX). As part of her role she developed infosec policy, developed new awareness testing and led the company's incident response team. In the last two years she's been involved with the Financial Services Information Sharing Analysis Center (FS-ISAC), editing its quarterly member newsletter and identifying speakers for member meetings.

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