Preliminary Observations on the U.S. Treasury "Blueprint for a Modernized Financial Regulatory Structure"

The U.S. Department of the Treasury today issued its “Blueprint for a Modernized Financial Regulatory Structure.” The Treasury Blueprint has been widely reported and presents a complex raft of proposals that will be digested and debated over time. This is not a summary the Blueprint, which is available at: http://www.treas.gov/press/releases/reports/Blueprint.pdf and summarized in a Treasury “Fact Sheet,” available at: http://www.treas.gov/press/releases/reports/Fact_Sheet_03.31.08.pdf. Rather, we review briefly the context in which the Blueprint has been issued and note here certain items that we and our clients will monitor during discussions of the Blueprint.

Several commentators, including Sheila Bair, Chairman of the Federal Deposit Insurance Corporation, have noted that if regulators were to start from scratch, they would not design the current system of U.S. regulation of financial institutions. The system of multiple regulators and charters for financial institutions in the United States has been developed over many years of incremental changes made largely in response to moments of crisis.

Most recently, the Federal Reserve, Treasury and other regulators have taken decisive action under difficult market conditions to increase liquidity by extending discount window facilities to non-depository institutions and have provided special financing to facilitate the sale of Bear Stearns. More significant reforms will require legislative action, which most observers agree is unlikely before the general election in November 2008.

Treasury developed the Blueprint following its March 2007 Capital Markets Conference and an October 2007 request for public comment. In presenting the Blueprint, Secretary Paulson emphasized that its recommendations are not intended as a response to current conditions and, with few exceptions, would not be implemented “until after the present market difficulties are past.”

The Blueprint proposal reflects an objectives- or principles-based approach to regulation, includes recommendations for short-term and intermediate-term action and describes an “optimal” regulatory structure for long-term consideration. This optimal structure is objectives-based and would establish a single federal charter for insured depository institutions, a single (optional) federal insurance charter and a third charter for all other types of financial services providers. The Federal Reserve would be responsible for market stability of all three types of financial institutions; a new regulator would be responsible for business conduct of all three types of institutions, including consumer protection issues; and a third prudential regulator would be responsible for the financial regulation of federally-insured depository institutions and federal insurance institutions.

An initial review of the proposed “optimal” regulatory structure suggests that certain institutions that are currently focused on a single area of activity (such as broker-dealers, futures commission merchants or national banks) and subject to a single regulator under the current regime would report to at least two and up to three regulators. The stated goal of increasing efficiency would require the new regulators to coordinate closely, particularly in areas where an institution’s controls and policies may be adopted to address issues raised under all three regulators’ mandates. The Blueprint indicates that Treasury would perform this coordinating role.

Other key terms of the Blueprint include:

- phasing out the federal thrift charter, transitioning existing thrifts to a national bank charter over a two-year period, and closing the Office of Thrift Supervision;

- merging the Securities and Exchange Commission and the Commodity Futures Trading Commission into a single regulator of securities and futures markets in the intermediate-term, including recommendations for SEC action to implement a principles-based regulatory approach and adopt certain rules in advance of such a merger;

- a proposal that all non-bank, non-insurance financial services providers, including securities firms, futures firms, exchanges, investment advisors, private pools of capital, and surplus lines insurers, become subject to a new “financial services firms” charter administered by the new business conduct regulator, in addition to being supervised by the Federal Reserve as market stability regulator;

- the suggestion that under the optimal regulatory structure, and subject to certain conditions, depository institutions should be able to affiliate with a broader variety of other entities within a holding company structure, including commercial firms;

- a recommendation that the Federal Reserve charter, regulate, and supervise any payment or settlement systems it determines to be systemically important, including licensing the U.S. operations of any systemically important payment or settlement system based abroad; and

- an optional federal insurance charter that, if adopted, would be expected to increase opportunities for international insurers to enter the U.S. market, where the prospect of becoming subject to state regulation has been a significant barrier in the past.

Please feel free to contact any of your regular contacts at the firm or any of our partners and counsel listed under Banking and Financial Institutions in the “Our Practice” section of this website if you have any questions.