Financial reform heats up

This is going to be a big week for financial reform. A division of the Treasury Department is looking to regulate the asset management industry. The Obama administration is also in the midst of negotiating the details of the Volcker rule, which bans firms from trading for their own accounts.

Here’s the Wall Street Journal story on the new asset management regulations:

The asset-management industry is pushing back against a powerful, yet little-known Treasury Department office that is laying the groundwork for tougher federal regulation of mutual funds and other asset managers.

Large firms such as BlackRock Inc., Pacific Investment Management Co. and Fidelity Investments are blasting a report by the Office of Financial Research that found asset managers could pose risks to the broader financial system. The finding is significant because it is among the criteria a group of senior U.S. regulators will use to determine whether large asset managers are “systemically important” and should be drawn in for stricter oversight.

The Financial Stability Oversight Council, which is chaired by Treasury Secretary Jacob Lew and includes top officials from the Federal Reserve, Securities and Exchange Commission and other agencies, is in the early stages of considering the risks associated with the asset-management industry, with a focus on BlackRock and Fidelity, according to people familiar with the council’s discussions. The council can designate firms as systemically important under the 2010 Dodd-Frank law, which created the FSOC and Office of Financial Research to help prevent a repeat of the financial crisis.

The council this year has designated American International Group Inc., Prudential Financial Inc. and General Electric Co.’s GE Capital unit with the systemic label, and MetLife Inc. is under review. The Fed hasn’t outlined rules for these firms yet but has said it would be flexible in applying rules to different industries. Insurers and asset managers fear they will face requirements to rein in risk taking similar to those applied to banks.

By singling out some of the largest asset managers for greater oversight, the government is extending its reform mandate and could make it more challenging for them to generate returns. Other Wall Street firms are concerned about their ability to make money as well. The New York Times had this story on the Volcker Rule:

The Obama administration, currently stumbling through the health care overhaul, has reached a critical stage in its other signature effort: reining in Wall Street.

The push to reshape financial oversight hinges on negotiations in the coming weeks over the so-called Volcker Rule, a regulation that strikes at the heart of Wall Street risk-taking. The rule, which bans banks from trading for their own gain, has become synonymous with the Dodd-Frank overhaul law that Congress adopted after the financial crisis.

Treasury Secretary Jacob J. Lew has strongly urged federal agencies to finish writing the Volcker Rule by the end of the year — more than a year after they had been expected to do so — and President Obama recently stressed the importance of the deadline.

While regulators are optimistic they will complete the rule soon, even after facing a lobbying onslaught from Wall Street, they have little time to overcome the internal wrangling that has stymied them for years.

The tension among regulators — five agencies are writing the rule — has centered on just how stringent to make it.

The National Journal outlined some of the issues the five agencies are struggling to resolve as they make the new rules:

The biggest problem hasn’t been the difficulty of defining which trades are permissible under the Dodd-Frank statute. (Hedging and market-making—in which a firm says it will buy and sell stocks at a given price—are OK; making risky bets for profit, known as “proprietary trading,” is not. The line between them, Wall Street and regulators argue, is fuzzy.) The problem hasn’t even been the stupefying amount of work Dodd-Frank handed to regulators, who must devise 398 rules, according to law firm Davis Polk & Wardwell, without giving all the relevant agencies enough of a funding boost for the job. Three years in, and they’re still only 40 percent there.

No, say Wall Street and former Washington officials: The biggest problem may be the cultural gaps between the five agencies charged with writing the Volcker Rule. It’s not the first time regulators have had to work together, but such collaboration—particularly between banking cops and market cops—was less frequent before Dodd-Frank. It is expected to become more common, and the Volcker Rule experience suggests that it won’t be easy.

The Dodd-Frank statute convenes the Federal Reserve Board, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, the Securities and Exchange Commission, and the Commodity Futures Trading Commission. Together, they are meant to write the rule, named for Paul Volcker, the former Fed chairman and a reform advocate. That means they’ve got to get everyone on board, and any agency can hold up the process over any point. This has produced frustrating delays, Volcker said at a conference in March. “How many times people told me six months ago, ‘It’ll be two weeks, Paul! We’re going to get the regulation out. It looks like it’s right there.’ Doesn’t happen,” he said. “Two months later, ‘Well, before the end of December.’ ‘Well, before the end of January.’ You cannot operate an effective regulatory system this way.”

The greatest cultural divide is between the three banking regulators (the Fed, the FDIC, and the OCC) on one side and the two market regulators (the SEC and the CFTC) on the other. The banking types have historically worked confidentially to examine institutions’ practices and correct them when they’re out of line; these officials cooperate and even embed staff at the banks themselves, so it stands to reason they prefer flexibility on this rule and other parts of financial-regulatory reform, say former officials and financial-regulation experts who asked to speak anonymously in order to generalize. The market regulators, on the other hand, are focused on investor protection and disclosure; they like to draw bright, easily enforceable lines, the officials say.

The difference between the market and banking regulators just may make this task a difficult one to finish. Either way, a year after the deadline, it’s time for them to take some of the uncertainty out of the markets and make a decision on final rules for firms to implement.