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- ICI Comment Letters
Statement of Matthew P. Fink
President, Investment Company Institute
Before the Committee on Banking
and Financial Services,
U.S. House of Representatives
On the "Financial Services
Competitiveness Act of 1997"
May 14, 1997
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Table of Contents
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I. Oral Statement of Matthew P. Fink
I am Matthew P. Fink, President of the Investment Company Institute, the national association of the American mutual fund industry. I am pleased to be here today to testify on H.R. 10.
The mutual fund industry believes that there are five principles that should underlie financial services reform legislation. First, grant banks full mutual fund powers; second, modernize the federal securities laws to address bank mutual fund activities; third, permit the affiliation of banks, securities firms, insurance companies and commercial companies; fourth, provide for functional regulation of each entity; and fifth, create an appropriate oversight system for the new diversified financial services organizations. My testimony today focuses on the appropriate oversight system.
Each of the securities, banking and insurance industries historically has been subjected to extensive governmental oversight. But each of the oversight systems rests upon very different philosophical premises and relies upon very different regulatory tools.
For example, the securities markets are founded on risk-taking. In keeping with the nature of the marketplace, the federal securities laws do not seek to limit risk. Thus, the securities laws do not limit the kinds of companies with which securities firms may affiliate, and the securities laws do not regulate the activities of affiliates of securities firms. Instead, the securities laws require disclosure of risk.
Banking regulation rests upon very different foundations. Unlike the securities laws, banking regulation seeks to control risk. Thus, banking regulators traditionally have limited the types of firms with which banks can affiliate, and have regulated the operations of both banks and their non-bank affiliates.
H.R. 10 and other bills before the Banking Committee propose to permit banking, securities, and insurance firms to affiliate in new diversified financial services organizations. It does not follow that Congress should impose the old traditional bank regulatory system upon these new organizations.
Unfortunately, H.R. 10 imposes this old system in the form of consolidated bank holding company supervision. Consolidated supervision will create inefficiencies for the new financial services organizations and their non-bank subsidiaries, and potentially will interfere with their ability to compete in the marketplace. It could subject financial firms to duplicative and potentially conflicting regulatory requirements. It almost certainly will lead to the imposition of safety and soundness regulation upon non-banking companies. It may lead the market to believe that these non-banking entities will be protected by the federal safety net.
Proponents of consolidated supervision have not shown that it is necessary to protect the banking or financial systems. Making sure that the Federal Reserve System has adequate authority over banks would appear to address most concerns. Enactment of mechanisms that would provide the Fed with information about the holding company and its non-bank subsidiaries would appear to address the remainder.
The Institute believes that a new oversight system should be created to oversee new diversified financial services organizations. Specifically, the Institute believes that this new oversight system should be shaped around three concepts: functional regulation, bank-centered supervision and enforcement, and enhanced regulatory coordination.
Functional regulation envisions that each subsidiary of the diversified financial services holding company would be separately regulated by function with, for example, the Securities and Exchange Commission acting as the primary regulator of securities firms and the appropriate federal banking agency acting as the primary regulator of banks.
Bank-centered supervision and enforcement refers to a system in which obligations, transaction restrictions, and prohibitions considered necessary in order to protect the safety and soundness of banks within the holding company are imposed directly on banks, rather than on other entities affiliated with the banks.
Enhanced regulatory coordination means providing mechanisms for cooperation among the functional regulators in carrying out their functions.
We believe that an oversight system grounded in functional regulation, bank-centered supervision and enforcement, and enhanced regulatory coordination would maximize the public interest by protecting consumers of financial services while minimizing the potential for marketplace distortions.
Congress should not impose traditional banking type regulation on the new diversified financial services organizations.
I appreciate the opportunity to appear before you today. I would be happy to answer any questions.
My name is Matthew P. Fink. I am President of the Investment Company Institute, the national association of the American investment company industry. The Institute's membership includes 6,220 open-end investment companies ("mutual funds"), 443 closed-end investment companies, and 10 sponsors of unit investment trusts. The Institute's mutual fund members have assets of about $3.4 trillion, accounting for approximately 95 percent of total industry assets, and serve over 59 million individual shareholders. The Institute's members include mutual funds advised by investment counseling firms, commercial banks, broker-dealers, insurance companies, and commercial firms. The Institute's bank members advise 1434 mutual funds with over $400 billion in assets, accounting for almost 92 percent of all mutual funds advised by banks.
The Institute has been an active participant in the debate on financial services reform and has testified before Congress on subjects directly relating to financial services reform more than twenty times over the last twenty-two years. I am pleased to be here today on behalf of the Institute to testify with respect to H.R. 10, the "Financial Services Competitiveness Act of 1997."
The Institute believes that there are five principles that should underlie financial services reform legislation. Simply put, Congress should:
grant banks full mutual fund powers (e.g. the ability to sponsor and underwrite mutual funds and to have bankers serve on fund boards);
modernize the federal securities laws to address bank-mutual fund activities;
permit banks, securities firms, insurance companies and commercial entities to own and affiliate with each other;
provide for functional regulation of each entity (bank, securities firm, insurance company, etc.) within the resulting diversified organization; and
create an oversight system governing organizations owning both securities firms and commercial banks that maximizes the public interest in protecting consumers of financial services while minimizing the potential for distortion of the marketplace through unnecessary, duplicative, artificial, or overly rigid regulatory requirements.
Some elements of these principles are reflected in various provisions of H.R. 10. Importantly, the bill makes progress towards creating a two-way street by defining insurance activities as "financial in nature" so as to be permissible within the new organization. More progress, however, is needed. For example, many mutual fund companies are affiliated with entities involved to some degree in real estate or other commercial activities. In order for these companies fully to participate in the financial services industry, any reform legislation ultimately enacted needs to contain a statutory provision permitting financial firms to have some part of their business involved in nonfinancial activities. Congress should decide for itself the scope and amount of permissible nonfinancial activities and should embody its determinations clearly in the statute. The judgments involved are legislative, not administrative, in character, and also are too important to leave to the discretion of future banking or other regulators.
My testimony today will focus primarily on considerations regarding the appropriate oversight model for the new diversified financial services organization. The Institute believes that appropriate oversight of a diversified financial services organization must be shaped around three critical concepts: functional regulation, bank-centered supervision and enforcement and enhanced regulatory coordination. The Institute has a deep and fundamental concern with the system of consolidated holding company supervision which pervades H.R. 10's regulatory regime. While H.R. 10 recognizes the adverse consequences flowing from blind application of consolidated bank holding company supervision to diversified financial services organizations and tries to mitigate their impact, H.R. 10's proposed solutions are inadequate because they treat the symptoms rather than the disease. They do not negate the overarching influence of the consolidated supervision that is at the core of H.R. 10.
III. Providing For Appropriate Oversight of Diversified Financial Services Organizations
A. Elements of the Optimal Oversight Model—Functional Regulation, Bank Centered Supervision and Enforcement and Enhanced Regulatory Coordination
The Institute believes that appropriate oversight for a diversified financial services organization should be shaped around the following three basic concepts.
Functional Regulation. Functional regulation envisions that each subsidiary of the depository institution holding company would be separately regulated by function with, for example, the Securities and Exchange Commission ("SEC") acting as the primary regulator of securities firms and the appropriate federal banking agency acting as the primary regulator of depository institutions. The functional regulator would have authority to set capital standards with respect to, to require reports from, and to perform examinations of, the particular subsidiary it oversees in the holding company complex. Functional regulation in general leaves undisturbed the existing regulatory framework as it applies to non-bank subsidiaries owned by a diversified financial services organization.
Bank-Centered Supervision and Enforcement. Bank centered supervision and enforcement refers to a system in which obligations, transaction restrictions or prohibitions considered necessary in order to protect the safety and soundness of banks within the holding company are imposed directly on the banks, rather than on other entities affiliated with the banks. Likewise, administrative efforts to monitor and enforce compliance with these obligations, restrictions and prohibitions would be channeled into examinations and enforcement proceedings directed against the banks, rather than into examinations and enforcement proceedings directed against other affiliated entities.
Enhanced Regulatory Coordination. Enhanced regulatory coordination means providing mechanisms for cooperation among the functional regulators in carrying out their functions. This process would involve creating mechanisms for sharing information and coordinating enforcement actions. It also could include the authority to conduct relevant studies, consult with state regulators and make recommendations to Congress and others.
B. The Benefits of This Oversight Model
An oversight model based on these concepts most appropriately protects the public interest while minimizing the potential for distortion of the marketplace. The system would provide the necessary framework for addressing potential risks that may flow from the creation of the new diversified organization while imposing the fewest restrictions on the organization's ability to satisfy consumer demand for new and innovative services.
Preserves the Existing Regulatory Framework. The model builds from a solid foundation because it leaves in place the regulatory mechanisms that now exist and that serve the public interest well. Securities firms in general and participants in the investment company marketplace in particular already are subject to extensive regulation and supervision by the SEC under the federal securities laws. Indeed, Congress only recently examined the statutory and regulatory scheme governing the investment company industry and concluded that the system was functioning well.1 The success of the existing oversight system is also demonstrated by the renowned strength, depth and liquidity of the U.S. capital markets, including the mutual fund industry.
Avoids Duplicative Regulation. In addition, the model adds to the existing regulatory framework in specific and targeted ways, and only as necessary to achieve defined and articulated goals. In this way, the model reduces the potential for subjecting regulated entities to duplicative or potentially inconsistent regulatory requirements, and for distorting the marketplace through unneeded, artificial or overly rigid governmental intervention.
Focuses on the Entity Requiring Protection. The model also is optimal because it focuses legislative and administrative attention upon the bank in the holding company complex -- the institution that both the existing separation of banking and commerce and the new oversight model are designed primarily to protect. It is indirect and inefficient to seek to protect one institution by regulating others. Further, attempts to protect banks by imposing new obligations upon their affiliates seem to imply concern with the content or administration of the existing regulatory system governing banks. Any such concerns should be dealt with directly, rather than by imposing new layers of bureaucracy and regulatory burden upon the holding company or its non-bank subsidiaries.
Imposes No Safety and Soundness Regulation Upon Non-Banks. In keeping with this focus on the entity requiring protection, the model avoids the imposition of safety and soundness regulation on the financial services holding company or its non-bank subsidiaries in order to protect holding company bank subsidiaries. As a result of the federal deposit insurance program and other factors, a major objective of banking regulation traditionally has been to attempt to control the risk of financial loss to banking organizations and the U.S. Treasury. The tools used to achieve this objective have ranged from limitations on the kinds of companies with which banks may affiliate, the nature of activities in which banks and their affiliates may engage and the manner in which banks and their affiliates may conduct these activities. Securities regulation, however, rests upon very different foundations.2 The very nature of the securities markets in this country is based on risk taking, and the federal securities laws do not seek to protect investors by limiting risk taking but instead by requiring that its existence be disclosed. Any attempt to impose substantive safety and soundness regulation on securities firms affiliated with banks necessarily would interfere with the vibrancy of the securities markets and would clash with the governing regulatory scheme.
Imposes Additional or Different Supervisory Requirements Only As Necessary to Address Identified Problems. An important corollary of an oversight model based upon the principles of functional regulation, enhanced regulatory coordination and bank-centered supervision and enforcement is that substantial deviations from the principles should be individually explained and justified. For example, as a precondition to the imposition of new or expanded obligations upon holding companies or their non-bank subsidiaries, there must exist a specific and identifiable problem that cannot be solved within the framework of existing or expanded powers over the bank, or within the framework of existing powers over the holding company and non-bank subsidiaries. In the event such a problem is shown to exist, any solution to the problem involving expanded regulation of the holding company or its non-bank subsidiaries must be demonstrated to be narrowly crafted and effectively tailored to solving the problem without creating new and unnecessary inefficiencies or burdens that may distort the marketplace or adversely affect competition. Vague unease or residual apprehensions about the dangers of affiliations between banks and non-banking institutions should not be allowed to diminish landmark legislation by embedding in the statute a regulatory oversight apparatus that undermines the very benefits that led Congress to embark upon financial services reform in the first place.
C. Consolidated Supervision Has Adverse Consequences In the Context of a Diversified Financial Services Organization
Like the existing Bank Holding Company Act, H.R. 10 is based on the consolidated bank holding company model of supervision, which in general seeks to protect banks owned in a holding company complex by appointing the Federal Reserve Board (or some other agency) to act as superregulator of the holding company and its component firms. Thus, under H.R. 10, a company must apply to the Federal Reserve Board to become a financial services holding company ("FSHC") or investment bank holding company ("IBHC") in the first instance.3 Thereafter, the Board would have the authority to determine the scope of activities permissible within the FSHC or IBHC;4 to approve initial acquisitions of securities affiliates by FSHCs or IBHCs;5 to permit particular FSHC activities to be conducted through a securities affiliate;6 to set capital standards for FSHCs, IBHCs and their non-bank subsidiaries;7 to require reports of and to examine any FSHC or IBHC or any subsidiary under certain circumstances;8 to order a FSHC or IBHC or any non-bank subsidiary thereof to cease any activity or require divestiture of the holding company's bank or non-bank subsidiary;9 to enforce the safeguards applicable to securities affiliate operations and transactions;10 to promulgate additional securities affiliate safeguards as well;11 and to issue other rules designed to protect "depository institutions and the separation of banking and commerce."12
In short, H.R. 10 would grant the Federal Reserve Board authority to regulate the new FSHC or IBHC from top to bottom. This type of comprehensive holding company supervision is simply inappropriate for a FSHC or IBHC owning both bank and a wide range of non-bank subsidiaries.
Rigidity. Consolidated supervision creates substantial inefficiencies for diversified financial services organizations. For example, its activity restrictions and new activity prior notice and approval requirements constrain the ability of regulated entities to respond quickly to developments in the marketplace with new products. As SEC Chairman Levitt has pointed out, the consolidated bank holding company supervision model "is not well-suited for companies that seek to compete vigorously in new lines of business and fast-moving markets."13
Duplicative Regulation. The consolidated bank holding company supervision model places unnecessary burdens on regulated entities. Thus, for example, a securities firm affiliated with a depository institution could be subjected to reporting requirements or examination by the Board in addition to the existing statutory and regulatory obligations imposed through self-regulatory organizations or the SEC. Financial firms unaffiliated with banks would be free to compete without carrying this extra weight.
Non-Bank Safety and Soundness Regulation. Philosophies espoused by potential financial service holding company umbrella regulators leave little doubt that adoption of the model ultimately could lead to imposition of direct safety and soundness regulation on securities firms affiliated with banks. For example, just last year Federal Reserve Board Chairman Greenspan identified the core function of an umbrella supervisor as monitoring and assessing the risks that the non-bank portions of the financial services complex have on the bank subsidiary and generally on the safety net. He also expressed the view that the umbrella supervisor must be able to take actions designed and intended to reduce the perceived risks to acceptable levels.14
History provides confirmation, since it records that when bank regulators have exercised authority over bank securities activities, they have imposed safety and soundness requirements inconsistent with fundamental tenets of securities regulation. For example, the FDIC adopted a rule in 1984 that limited certain insured nonmember bank subsidiaries to underwriting investment quality securities.15 The Release accompanying the rule stated that the FDIC's purpose in adopting the rule was to address the risk associated with bank subsidiaries underwriting securities. The Release also stated the FDIC's view that it had the authority to oversee the direct and indirect securities activities of insured nonmember banks and that it had the authority to address on a case-by-case basis practices, acts or conduct it found to constitute unsafe and unsound practices not specifically addressed by the rule.
Innovation. Adoption of the consolidated bank holding company supervision model is unwarranted because of the danger that a single bank-oriented umbrella supervisor would be tempted to stifle innovation and preclude new product developments by a securities affiliate on the grounds that they might compromise the competitive standing of banks. For example, Professor John C. Coffee, Jr. observed in a recent article that a single financial services regulator might have barred or restricted the growth of money market funds in the 1970's because of the competition these funds posed to bank accounts.16 Such an outcome would have been not only anticompetitive but also a notable disservice to consumers and to the capital marketplace, as reflected by the more than $962.5 billion in assets held by money market funds today.
Safety Net. Adoption of the consolidated bank holding company supervision model is unwarranted because its existence may lead the market to believe that non-bank holding company subsidiaries will be protected by the federal safety net.17
D. Consolidated Supervision Has Not Been Shown To Be Necessary To Serve the Public Interest
Observers and participants, while not contesting the foregoing, nonetheless have urged that Congress should impose consolidated bank holding company supervision in order to further banking objectives. However, it appears that the considerations that have been identified apply primarily to the banks that would be owned by a diversified financial services organization, and could be addressed largely by ensuring that the Federal Reserve Board or other banking agencies have adequate regulatory authority over such banks. In those instances where somewhat broader measures might be called for, provisions enabling the Board to obtain access to information about the holding company and its non-bank subsidiaries from the appropriate banking regulator for such banks would appear to satisfy the articulated concerns. Certainly, it has not been shown how or why these considerations call for full blown Federal Reserve Board regulatory authority over the holding company and its non-bank subsidiaries along Bank Holding Company Act lines.
Payment and Settlement Systems. It has been argued that full consolidated bank holding supervision is necessary to enable the Federal Reserve Board to ensure the safe operation of the nation's payment and settlement systems. But, the various payment and settlement systems in the nation operate primarily through banks, and not through bank holding companies or their non-bank subsidiaries.18 Indeed, the Board has acknowledged that, "[i]n all these payment and settlement systems," it is commercial banks that "play a central role, both as participants and as providers of credit to nonbank participants,"19 and that, together with the Federal Reserve, provide the "infrastructure" for the systems.20 As a result, adequate authority over participating banks would appear to be the critical element needed for the Board to facilitate the smooth operation of, and to protect itself and the participating banks from the risks involved in, the operation of these systems. Indeed, Chairman Greenspan has acknowledged that, in order for the Federal Reserve to discharge its role, the Board needs "supervisory authority over the major bank participants" in the systems.21 To the extent that the Board needs information about or supervisory authority over other components of the FSHC or IBHC affiliated with such bank participants, or over non-bank participants such as clearinghouses, depositories or others, the Board should articulate with some precision the authority it needs and the reasons it needs the authority.
Information for Purposes of Carrying Out Central Bank Responsibilities. It has been suggested that full consolidated bank holding company supervision is required in order for the Federal Reserve Board to carry out its economic stabilization and monetary policy responsibilities. The Board effectuates these responsibilities largely through banks, however, and not through bank holding companies or their non-bank subsidiaries.22 As a result, it again is far from clear why these responsibilities require the extension of Board regulatory authority over the holding company or non-bank companies affiliated with such banks, or why a more tailored and targeted solution than full-blown consolidated supervision would not be sufficient.
Subsidy. Consolidated holding company supervision has been offered up as a cost that must be paid for the subsidy that comes with owning a federally insured bank. Many respected banking regulators have expressed doubt as to whether this subsidy exists, however, on either a gross basis or on a net basis that takes into account the costs of complying with existing bank centered supervision and enforcement.23 But, even if the subsidy does exist, there has been no showing that any resulting risks to individual depository institution holding company complexes or to the banking system more broadly may not be fully addressed within the context of an oversight system that is based on the principles of functional regulation, enhanced regulatory coordination and bank centered supervision. In this regard, it is important that recent testimony of respected banking regulators, as well as of the Chairman of the Securities and Exchange Commission, supports the view that such an oversight system is fully capable of dealing with any such concerns.24 It is also of note that Chairman Greenspan has reported that the Federal Reserve Board already is in the process of "sharply reduc[ing]" consolidated supervision of all existing bank holding companies, and believes that the "case is weak" for any consolidated supervision of any depository institution holding company in which the bank is not the dominant unit and is not large enough to induce systemic problems should it fail.25
Information for Purposes of Risk Assessment and Avoiding Contagion Effects. It also has been asserted that consolidated supervision is necessary in order to provide the Federal Reserve Board with "information," "intelligence," "knowledge" and "expertise" about the activities and financial condition of banks that are not otherwise subject to the primary jurisdiction of the Board and of non-banking members of the holding company complex. The Board needs this data, it is said, in order for the Board, its examiners and economists to stay abreast of developments in the industry; to understand the impact of the Board's macroeconomic policies and activities; to learn about the consolidated risk management techniques used by some members of the financial services industry; and to monitor the possibility of contagion effects in a holding company structure, where difficulties in a non-banking subsidiary might spread to a well-capitalized bank affiliate.
It again is far from apparent why these considerations justify the imposition of consolidated supervision. If the Board needs additional information from or about banks that are subject to the primary jurisdiction of other bank regulators, it is difficult to understand why the direct solution is not for the Board to obtain copies of the needed information from these other bank regulators. Similarly, to the extent the Board has a legitimate need for information about the risks posed by the activities of a holding company or its non-bank subsidiaries to an affiliated bank, holding company risk assessment mechanisms appear to present a much more cost-effective solution than consolidated supervision.
Holding company risk assessment would permit the functional regulator for a bank owned by a diversified organization to obtain information about the holding company or its non-bank subsidiaries from the bank itself or from the functional regulator of the holding company or the non-bank subsidiaries. Section 109 of H.R. 268, for example, contains precisely these types of mechanisms. The mechanisms in H.R. 268 are very similar to, and indeed are based on, the risk assessment provisions of the Market Reform Act of 1990, pursuant to which the SEC monitors risks to broker-dealers flowing from affiliate activities, and the Futures Trading Practices Act of 1992, pursuant to which the CFTC assesses dangers to futures commission merchants posed by affiliate activities.
After six years of experience with the Market Reform Act, the SEC informed Congress last year that it found the risk assessment provisions to provide a "significant complement" to its existing statutory authority.26 There also has been no indication that the CFTC has expressed any dissatisfaction with the reach or operation of the risk assessment provisions it administers.
This experience suggests that holding company risk assessment procedures would provide valuable tools enabling banking regulators to monitor individual and systemic risk in the financial services holding company context. Certainly, banking regulators or other observers have not explained why these holding company risk assessment mechanisms, with or without appropriate modifications, are not up to the job.
Adequate Information Is Available Without Bank Holding Company-Type Supervision: The Foreign Bank Supervision Enhancement Act. It also has been urged that reform legislation should require consolidated bank holding company supervision because Congress not long ago made the existence of consolidated supervision overseas a prerequisite for foreign banks to establish operations in the United States under the Foreign Bank Supervision Enhancement Act ("FBSEA").27 However, the FBSEA is actually concrete proof that consolidated supervision along Bank Holding Company Act lines is not necessary to achieve the goals of an effective, efficient and tough regulatory system for diversified financial services organizations.
The FBSEA provides that a foreign bank may not establish a U.S. branch or agency unless the Federal Reserve Board first determines that the "foreign bank is subject to comprehensive supervision or regulation on a consolidated basis by the appropriate authorities in its home country".28 This statutory standard, however, does not limit the establishment of U.S. offices to only those foreign banks whose home countries provide for ownership of banks in a holding company format or whose home countries regulate the holding company and its subsidiaries under a statutory regime similar to the Bank Holding Company Act.
To the contrary, the standard merely requires the Board to ensure that the foreign bank's "home country supervisor receives sufficient information on the worldwide operations of the foreign bank (including the relationships of the bank to any affiliate) to assess the foreign bank's overall financial condition and compliance with law and regulation."29 The administrative history of the Board's Regulation K is crystal clear on this point:
Certain commenters asked the Board to recognize that some countries do not regulate holding companies, other owners of banks or nonbanking subsidiaries of banks. The Board notes that the general standard is established in the context of consolidated supervision of the bank itself. With regard to sister or parent companies of the bank, the comprehensive supervision standard focuses on how the supervisor reviews transactions between a foreign bank and its affiliates rather than on direct supervision of these companies.30
In determining whether the home country supervisor has access to adequate information about the foreign bank and its operations, the Board considers a wide range of factors. These factors include, among other things, the extent to which the home country supervisor:
ensures that the foreign bank has adequate procedures for monitoring and controlling its activities worldwide;
obtains information on the condition of the foreign bank and its subsidiaries and offices outside the home country through regular reports of examination, audit reports or otherwise;
obtains information on the dealings and relationships between the foreign bank and its affiliates, both foreign and domestic;
receives from the foreign bank financial reports that are consolidated on a worldwide basis, or comparable information that permits analysis of the foreign bank's financial condition on a worldwide, consolidated basis;
evaluates prudential standards, such as capital adequacy and risk asset exposure, on a worldwide basis.31
These factors are not prerequisites, but simply signposts that guide the Board's analysis of the comprehensive supervision inquiry.32 Indeed, the Board can and does find the existence of comprehensive supervision on a consolidated basis even though the regulatory framework in the home country may not even be characterized by one or more of the factors listed above.33 That is because FBSEA "do[es] not mandate that the information [needed to effectuate comprehensive supervision] be obtained in a particular form or through particular methods."
Simply put, FBSEA itself acknowledges that "legal systems for supervision and regulation vary from country to country" and that effective supervision can be achieved "without imposing the U.S. regulatory system [governing bank holding companies] on foreign banks outside the United States."34 As a result, it is hard to see why FBSEA would support the imposition of this same system on diversified financial organizations inside the United States.
Burden of Proof. As scholars have noted, at best "the case for consolidated supervision is far from obvious."35 Experienced banking regulators have pointed out that, even if the imposition of the system might somehow possibly be justified, the arguments needed to do so remain to be made. In the words of former FDIC Chairman William Isaac:
Perhaps a case can be made for umbrella supervision, but it hasn't been done yet. We will need a great deal more information about precisely what problems the umbrella supervisor will be expected to address. We will also need a much clearer delineation of what authority the umbrella supervisor will have.36"
Others have been more direct. In the words of SEC Chairman Levitt:
The Fed's regulation of the holding company, we feel[,] is not warranted. This type of supervision, we are concerned, would impose costs and could discourage investments by securities firms in banks. It also might combine disparate balance sheets to which different forms of prudential capital requirements apply. If I were to characterize the greatest concern I have with this, it is the danger that consolidated oversight would stifle the kind of entrepreneurship which is part of the securities industry and which, I think, is a terribly important part of what it does and should continue to do.37
E. H.R. 10 Attempts But Fails to Ameliorate the Adverse Consequences of Consolidated Supervision
H.R. 10 recognizes that applying full-blown consolidated bank holding company supervision to diversified financial services organizations will result in a variety of adverse consequences and contains a number of provisions designed to mitigate the harmful effects. These provisions provide only partial and inadequate solutions, however, because they merely treat the symptoms instead of the disease. A few examples suffice to illustrate the point.
For example, the bill generally requires a FSHC or IBHC to obtain prior Board approval to engage in activities that are financial in nature or to acquire a securities affiliate.38 In an effort to soften this requirement to some small degree, the bill would permit a FSHC that is engaged predominantly in non-banking activities and that meets certain other criteria to engage in activities previously determined by the Board to be financial in nature (or, in the case of IBHCs, to acquire a securities affiliate) so long as the FSHC provides the Board with notice after the FSHC has commenced the activities.39 While this provision obviously is preferable to a full prior approval requirement in all cases, the fundamental flaw in the provision is that it perpetuates the assumptions and procedures of the Bank Holding Company Act. And, it does so at the competitive expense of the securities and other financial firms who will have to bear the brunt of these procedures. Thus, a securities firm affiliated with a depository institution would have the added supervisory obligations of filing a prior notice, determining that prior notice is not required or filing a subsequent notice in order to engage in a financial activity in circumstances where the activity may already be regulated by the firm's functional regulator and where the firm's competitors are free to commence the activity without regulatory permission at all.
Similarly, the bill gives the Board broad authority to promulgate capital standards for FSHCs, IBHCs and their non-bank subsidiaries.40 The bill then attempts to temper the authority by directing the Board to give "due consideration" to the activities conducted by the holding company and its subsidiaries, and any comparable capital requirements already imposed on the holding company by any other state or federal regulatory authority.41 This check on the Board's power lacks demonstrable substantive content, however, and does not prevent the Board from imposing operational inefficiencies and competitive harm upon the diversified organization through potentially inconsistent, duplicative or unnecessary capital requirements. Indeed, these and other similar considerations recently led the Board to propose that the Board refrain from imposing separate capital requirements upon Section 20 securities affiliates in the bank holding company context alone.42
The bill also gives the Board authority to modify and supplement the safeguards contained in the bill on relationships or transactions among depository institutions, their affiliates and their customers.43 The bill attempts to limit the exercise of the Board's discretion by authorizing the Board to exercise this authority only where "such action is consistent with the purposes of this Act," and providing a non-exclusive list of purposes of the Act that may justify such action.44 This standard is so broad, however, as to leave the Board with essentially unfettered discretion in this regard.
The standard also would permit the imposition of such safeguards directly upon the securities affiliate in the holding company complex, and with no input from the securities affiliate's functional regulator. Thus, for example, under the purpose of "the enhancement of the financial stability of financial services holding companies,"45 the regulator legitimately could impose a broad range of safety and soundness-type safeguards upon non-bank entities within the FSHC or IBHC complex. Other provisions of the bill also appear to empower the Board to regulate the safety and soundness of the holding company and its non-bank subsidiaries.46
Further, the bill authorizes the Board to require reports from FSHCs and IBHCs and any of their subsidiaries.47 The bill tries to ameliorate the impact by stating that the Board should exercise its power "in a manner that is the least burdensome" to FSHCs and their subsidiaries,48 and by directing the Board "to the fullest extent possible" to accept reports that a FSHC has been required to provide to other federal or state supervisors or self-regulatory organizations.49 The relief provided by these standards is illusory, however, in that the standard again contains no objective substantive content and again would vest the Board with essentially unchecked discretion. This is especially true with respect to FSHCs engaged predominantly in non-banking activities, where the bill states only that the reporting scheme adopted by the Board for banking FSHCs shall apply in the manner and "to the extent provided by the Board."50
The same kinds of deficiencies plague the examination provisions of the bill. H.R. 10 expressly authorizes the Board to conduct examinations of FSHCs, IBHCs and each of their subsidiaries.51 The bill tries to undo some of the damage by directing the Board to limit "to the fullest extent possible" the focus and scope of its examinations52 and to use "to the fullest extent possible" the reports of examination made by other regulators.53 Similarly, the bill provides with respect to FSHCs engaged predominantly in non-banking activities that the Board should not examine the holding company unless certain conditions are present.54 These provisions, however, again contain no objectively verifiable standard and impose no tangible limit upon the Board's discretion. Indeed, in the case of FSHCs engaged predominantly in non-banking activities, the provisions would expressly authorize the Board to consider examinations if the Board determines that examinations are necessary in order to accomplish the purposes of the bill.55
A further defect in the reduced supervision offered to firms engaged predominantly in non-banking activities is the nature of the qualifying criteria contained in the statute. A FSHC would have to have no more than 10%, and an IBHC no more than 25%, of its assets in banking, in order to be entitled to operate under this reduced supervision.56 These numerical tests obviously would disqualify a large number of holding company complexes, even though they are engaged predominantly in non-banking activities.
Finally, the bill extends administrative civil and federal criminal jurisdiction authority over a diversified financial services organization and its non-bank subsidiaries without making any effort to ease the effect of these provisions. Indeed, two subsections of the bill would amend every provision of the federal banking laws and of the United States Criminal Code to extend to FSHCs and IBHCs all of the provisions of federal banking and criminal law previously applicable only to banks and bank holding companies.57 The Committee and Congress should give more consideration and attention to the implications of these provisions before enacting such a dramatic and expansive extension of civil and criminal authority and power.
Chairman Greenspan has aptly noted in discussing other aspects of financial services reform that "[o]ur ability to foresee accurately the future implications of technologies and market developments in banking, as in other industries, has not been particularly impressive."58 By adopting an oversight system based upon consolidated holding company supervision, "we run the risk of locking in a set of inappropriate regulations that could adversely alter the development of market structures" in circumstances where "we are likely to find it impossible to correct our errors."59 Through adherence to the principles of functional regulation, bank-centered supervision and enforcement and enhanced regulatory coordination, Congress has the best chance of avoiding both overbroad cures that try to fix what is not broken and potentially costly misjudgments that needlessly impede the modernization of the financial services industry.
H.R. 10 contains important provisions that pave the way for a two-street in the financial services industry, and provides a starting place for Congress as it proceeds to craft and enact financial services reform legislation. We applaud your efforts to open the debate on financial services reform in a constructive and forward looking manner as we move into the 21st century. We thank you for the opportunity to present our views and look forward to working with the Committee as H.R. 10 moves forward.
2 See, e.g., Board of Governors v. Investment Company Institute, 450 U.S. 46, 61 (1981); Testimony of SEC Chairman William Cary before the Senate Subcommittee of the Committee on Banking and Commerce, SEC Legislation 1963: Hearings before a Subcommittee of the Committee on Banking and Commerce, 88th Cong., 1st. Sess. 20 (1963).
13 Hearings before the House Committee on Banking and Financial Services on H.R. 1062, The Financial Services Competitiveness Act of 1995, Glass-Steagall Reform, and Related Issues (Revised H.R. 18), Part 2, 104th Cong., 1st Sess. 273 (Mar. 7, 1995) ("March 1995 Hearings") (Statement of SEC Chairman Levitt).
17 See Hearings on H.R. 1062 before the House Comm. on Banking and Financial Services, 104th Cong. 1st Sess. 138-39 (February 28, 1995) ("February 1995 Hearings")(Statement of Alan Greenspan, Chairman of Board of Governors of the Federal Reserve System); Remarks by Alan Greenspan, supra, at note 14.
18 See, e.g., Federal Reserve System Staff Study, Clearance and Settlement in U.S. Securities Markets at 4, 17-18 (Mar. 1992); Junker, Summers and Young, A Primer on the Settlement of Payments in the United States, 77 Fed. Res. Bull. 847, 847-850, 854-857 (Nov. 1991); Bank for International Settlements, Payment Systems in Eleven Developed Countries, Ch. 11 at 216-17, 223-30 (3rd ed. 1989); Clair, The Clearing House Interbank Payments System: A Description of Its Operation and Risk Management, Federal Reserve Bank of Dallas, at 2, 21 and Appendix C (June 1989); see also Eisenbeis, Systemic Risk: Bank Deposits and Credit at 75-76, reprinted in, Kaufman, ed., 7 Research In Financial Services, Private and Public Policy: Banking, Financial Markets and Systemic Risk (1995).
20 Junker, Summers and Young, A Primer on the Settlement of Payments in the United States, 77 Fed. Res. Bull. at 848; accord Summers, Clearing and Payment Systems: The Role of the Central Bank, 77 Fed. Res. Bull. 81, 84, 86 (Feb. 1991).
21 Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Subcommittee on Capital Markets, Securities and Government Sponsored Enterprises of the Committee on Banking and Financial Services, U.S. House of Representatives at 7 (Mar. 19, 1997) (March 1997 "Greenspan Statement"); February 1995 Hearings at 128-29 (Statement of Chairman Greenspan) (emphasis supplied).
22 See, e.g., Board of Governors of the Federal Reserve System, The Federal Reserve System, Purposes & Functions, at 33-59 (1994) (explaining the three mechanisms through which the Federal Reserve implements monetary policy (open market purchases and sales of U.S. government securities, discount window lending to depository institutions and adjustments in depository institution reserve requirements), the manner in which these mechanisms directly impact the amount of reserves in the banking system, and the resulting effects upon various components of the financial system and the economy); Stigum, The Money Market 16-34, 36-423 (3rd ed. 1990).
23 See Written Statement of Comptroller of the Currency Eugene A, Ludwig before the Subcommittee on Financial Institutions and Consumer Credit of the House Committee on Banking and Financial Services on H.R. 268 at 10-11 (February 13, 1997) ("Ludwig Statement"); Written Statement of FDIC Chairman Ricki Helfer on Financial Modernization before the Subcommittee on Capital Markets, Securities and Government Sponsored Enterprises of the House Committee on Banking and Financial Services at 33-61 (March 5, 1997)("Helfer Statement"); American Banker, Subsidy? Greenspan Argument Is Really About Turf, March 27, 1997 at p. 6 (former FDIC Chairman William Isaac).
24 Ludwig Statement at 11 ("even if a subsidy exists, appropriate regulatory safeguards can be established to restrict the transfer of any subsidy between a bank and its affiliates, regardless of whether those affiliates are subsidiaries of the bank or the bank holding company"); Written Statement of SEC Chairman Arthur Levitt before the Subcommittee on Financial Institutions and Consumer Credit of the House Committee on Banking and Financial Services on H.R. 268 at 13-14 (February 13, 1997) ("February 1997 Levitt Statement")("Increased risks admittedly would accompany a more concentrated financial system resulting from the affiliation of securities firms and banks. The Commission believes that such risks can be managed, however, with separate and segregated entities having strong capital and with firewalls that are implemented within a simple, clear regulatory structure").
26 March 1995 Hearings at 274 n.30 (March 7, 1995) (Statement of SEC Chairman Levitt). See also Hearings Concerning H.R. 1505, H.R. 6 and H.R. 15 Before the Subcommittee on Financial Institutions Supervision, Regulation and Insurance of the House Committee on Banking, Finance and Urban Affairs, 102d Cong., 1st Sess. 241-44 (April 30, 1991) (Statement of SEC Chairman Breeden). Under the Market Reform Act, the SEC "receives essentially the same information that an affiliated bank holding company of a registered broker-dealer is required to file with the Federal Reserve Board." February 1997 Levitt Statement at 5 n.6.
27 Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Subcommittee on Financial Institutions and Consumer Credit of the House Committee on Banking and Financial Services at 11 (Feb. 13, 1997) (February 1997 "Greenspan Statement").
33 See, e.g., Coutts & Co., AG, 79 Fed. Res. Bull. 636 (1993)(no mention of affiliations)(England and Switzerland); Bank of Taiwan, 79 Fed. Res. Bull. 541 (1993)(no mention of consolidated financial reports).