Commentary: The Global Reach of U.S. Financial Services Regulation
Traders Magazine Online News, July 20, 2009
The Obama Administration's proposal for financial services regulatory reform leaves global issues to the end-the last nine pages of an 85-page report. This is an interesting choice. Almost everything the Administration proposes in the first 76 pages can be undone by the actions of global regulators abroad.
The cornerstone of the Administration's proposal is the empowerment of the Federal Reserve as a regulator of systemically significant institutions, called Tier 1 Financial Holding Companies (Tier 1 FHCs).
But, let's suppose that one of these Tier 1 FHCs happens to be a foreign corporation operating in a European country. The Administration proposes that the Fed might apply its rules to this foreign Tier 1 FHC.
To imagine what this might look like, let's suppose that the Fed designates Societe Generale, a French banking firm with extensive U.S. operations, as a Tier 1 FHC. The Fed would be entitled to examine the books and records of Societe Generale's operations in France. Going further yet, the proposal suggests the Fed could even apply its rules to the worldwide operations of the foreign firm. This presents the curious spectacle of the Fed attempting to regulate, in a fairly intrusive way, the Chinese operations of Societe Generale.
Installing the Fed as a regulator of more U.S. financial institutions is one thing. Making it the global regulator of systemically relevant institutions is beyond the power of the United States.
Global markets regulation is inextricably linked with affairs of State. To say the least, the United States has from time to time disagreed with the government of France with respect to international issues. Until recently, France enjoyed a much better relationship with Iran than the United States. Even now a decent amount of trade passes between France and Iran, and various banking relationships facilitate this commerce. U.S. businesses are, with limited exceptions, forbidden to trade with Iran. It is not hard to imagine France objecting to a U.S. regulator demanding information that, among other things, details Societe Generale's banking relationships with Iran. My guess is that France would object to the Fed obtaining any non-public information about Societe Generale's operations outside the United States.
To avoid these international conflicts, the Fed could decide to apply its regulations only to Societe Generale's U.S. operations, or those operations that affect the U.S. financial markets. The "mutual recognition" concept developed by the Securities and Exchange Commission during the tenure of Chairman Cox is an example of how this strategy might work. The idea is that we would not impose U.S. securities regulations on operations supervised by non-U.S. securities regulators, but would recognize the right of every country to regulate capital markets in their own way. To avoid duplication of effort by institutions regulated by more than one jurisdiction, we attempted to harmonize some standards. For example, the SEC agreed that IFRS was an acceptable accounting standard, rather than requiring foreign issuers to adopt U.S. GAAP.
The Obama Administration appears to have rejected mutual recognition as an acceptable theory of global financial services regulation. The SEC apparently intends to revisit its IFRS decisions. In any event, mutual recognition would run counter to some other principles the Fed is supposed to consider.
