Firms Fund Resolution of Failed Institutions in House Bill
The House Financial Services Committee on Tuesday took several major steps toward financial regulatory reform legislation. The Committee, along with the US Treasury Department, released a draft version of legislation designed to address systemic risk and the issue of "too big to fail" institutions. The "Financial Stability Improvement Act of 2009" sets up the Financial Services Oversight Council to monitor systemic risks and gives significant authority to the Federal Reserve to step in where regulators fail to quickly address developing problems among firms that pose systemic risk. The legislation also provides for orderly winding-down of failed firms and puts an end to "too big to fail," according to a Committee statement. A new system for unwinding failing firms would replace traditional bankruptcy situations where complex interrelationships between large firms are unsettled, endangering broader financial stability. Under the legislation, the costs involved in resolving a failing firm would be repaid first from the assets of the failed firm at shareholders' and creditors' expense. If any costs remain after that, they would be repaid from assessments on all large financial firms. Large institutions with assets of $10bn or more would essentially pay for winding down of failing firms through a resolution fund, which would provide for a flexible repayment period to avoid potential pro-cyclical effect of assessments on large firms. "In this instance we follow the 'polluter pays' model where the financial industry has to pay for their mistakes -- not taxpayers," the Committee said. The legislation also directs federal banking regulators and the Securities and Exchange Commission (SEC) to establish rules to require creditors to retain 10% or more of credit risk associated with loans transferred or sold for securitization. Regulators could adjust the level of risk retention either above or below the 10% mark, but no lower than 5%. When assets not originated by creditors are securitized, the securitizer must retain the credit risk. Similar capital requirements the European Union (EU) is beginning to enforce are dragging down stocks in the sector, according to industry reports, although they don't specify the mechanisms behind the action. The Financial Stability Improvement draft legislation is not the only bill the Committee considered on Tuesday. The Committee also approved HR 3818, the Private Fund Investment Advisers Registration Act, by a 67-1 vote. The bill would force many financial providers to register with the SEC. The bill aims to give regulators greater understanding of the operations and potential threats posed by private advisers. By enforcing new record-keeping and disclosure requirements on private advisers, the bill gives regulators authority to oversee a segment of the market previously exempt from "any meaningful regulation," according to a Committee statement. The bill also allows regulators to examine records of investment advisers whose actions were previously secretive. “The past year has shown that the deregulation or in many cases, lack of regulation, of financial firms is an idea of the past," said Rep. E. Kanjorski (D-Pa.) in a statement. "Advisors to financial firms must receive government oversight and we must understand the assets of financial firms, including for hedge funds, private equity firms, and other private pools of capital. Under this legislation, private investment funds would become subject to more scrutiny by the SEC and take more responsibility for their actions." Now that the bill passed the important hurdle of a Committee vote, it moves to the House floor for a vote. Write to Diana Golobay.