Systemic Risk and Adviser Oversight Dominate Talks with Capitol Hill Policymakers

The Dodd—Frank Wall Street Reform and Consumer Protection Act is one of the most sweeping pieces of financial services legislation ever enacted. And despite having more than eight months to analyze and assess the complex law, we are only starting to understand its broad impact.

In reality, the implementation decisions made by financial regulators are likely to be as important as the law itself in determining whether the reforms actually bring much-needed stability to the U.S. financial system and beyond. Meanwhile, the political landscape has changed dramatically since the law's passage. Indeed, last year saw a mad dash by Democratic leaders to galvanize anger over the financial meltdown by pushing regulatory reform over the goal line. The current legislative outlook is markedly different; Republication lawmakers, who by and large opposed the Dodd—Frank Act, have gained more clout in setting the regulatory agenda since winning control of the House and picking up seats in the Senate in the November 2010 midterm elections.

With the stakes so high, it is as important as ever for CFA Institute to leverage its unique position as a policy authority on ethics in the capital markets to educate decision makers on key issues hanging in the balance. To that end, CFA Institute recently held a Congressional briefing for legislative staff representing key members of the House Financial Services Committee and the Senate Committee on Banking, Housing, and Urban Affairs. The CFA Institute delegation — which included President and CEO John Rogers, CFA; Board of Governors Vice Chair Daniel S. Meader, CFA; and Board of Governors member Alan M. Meder, CFA — also had an opportunity to meet with Financial Industry Regulatory Authority (FINRA) Chairman and CEO Richard Ketchum and SEC Commissioners Troy Paredes and Luis Aguilar.

Does Dodd—Frank Put an End to "Too Big to Fail"?

The Capitol Hill meetings offered an opportunity to inform a range of critical issues, including the importance of identifying, monitoring, and mitigating systemic risks in the financial system. The timing of our discussion coincided with the recent debate in Washington over whether Dodd—Frank actually puts an end to the "too big to fail." During a recent House Oversight and Government Reform Subcommittee on TARP (Troubled Asset Relief Program) and Financial Services hearing, outgoing Special Inspector General for the Troubled Asset Relief Program Neil Barofsky warned that TARP exacerbated the "too big to fail" problems by creating a perception that large financial institutions will have unconditional federal support.

This comes at a time when U.S. financial regulators in charge of making decisions about "systemically important" firms are divided on how many financial institutions should be identified as such.

In terms of preventing a repeat of the 2008 financial crisis, the creation of the Office of Financial Research (OFR) was one of the most important features of Dodd—Frank when it was enacted. Unfortunately, more than eight months later, there is still no OFR director.

Budget Woes Could Force SEC Outsourcing

Strengthening and reinvigorating existing federal agencies responsible for policing financial institutions and markets and protecting investors and consumers are as essential as the provision of systemic risk oversight. And while Dodd—Frank has imposed a vigorous rule–making and enforcement agenda on the SEC — including responsibility for derivatives, hedge fund advisers, and credit rating agencies — so far Congress hasn't provided the SEC any extra funding to take on these new regulatory duties. Ultimately, depriving the agency of necessary funding could force the SEC to outsource adviser oversight to a self-regulatory organization (SRO) like FINRA.

We recently asked U.S. members in asset management what they thought of the SEC's oversight of registered investment advisers (RIAs) and whether they thought a change was needed to that arrangement. Of the more than 1,300 members who responded to the survey (PDF), 65 percent said they did not believe the SEC was doing "an adequate job" regulating but 57 percent said the SEC was the preferred agency to regulate RIAs in the future. CFA Institute members as well as nonmember RIAs have consistently expressed a similar preference over the years.

In a recent study, the SEC, facing the likely possibility of severe funding constraints, left the possibility open that one or more SROs, under SEC oversight, could examine advisers.

The situation remains fluid. If the SEC is not granted the additional resources — the cash-strapped regulator already has imposed travel restrictions and other cost–cutting measures on staff — it will have no choice but to look outside for oversight support. In that case, CFA Institute will work closely with that entity, whether it's FINRA or another SRO, to gain a better understanding of its vision for the investment adviser examination and fee process.

Until then, CFA Institute will continue to monitor the impact of the Dodd—Frank Act as it unfolds.