regulation. This will reportedly be followed by the June 18th testimony of Timothy Geithner before the House Financial Services Committee.Reuters reports that it is likely that the administration plan will effectively carve up the existing regulatory framework into four agencies. These will be:
1)the FED
2)the FDIC
3) a new entity which will be the merger of: Office of Thrift Supervision and the Office of the Comptroller of the Currency
4) another new entity which will be the merger of the: SEC and CFTC
Here's an outline of how it is supposedly all supposed to break down:
THE FED
The new plan will support putting the Federal Reserve in charge of broadly overseeing systemic market risk.
While the Fed may lose some of its oversight powers over consumer protection (such as credit cards and insurance issues) it will likely gain several new regulatory powers including supervisory powers over: broker dealers, private equity, derivatives and hedge funds.
The FED's Advisory Committee
The FED would be backed up by a so-called, "advisory committee" (similar to the President Working Group on Financial markets) to assist in monitoring system risk.
THE FDIC
The proposal will give new power to the Federal Deposit Insurance Corp. (FDIC) to oversee the unwinding of troubled financial institutions.
OFFICE OF THRIFT SUPERVISION AND THE OFFICE OF THE COMPTROLLER OF THE CURRENCY
It has also been speculated that the Obama administration will propose merging the Office of Thrift Supervision and the Office of the Comptroller of the Currency. So effectively instead of the current four bank regulatory agencies, we would be left with three larger ones.
THE SEC + CFTC
It has also been reported that a likely merger of the SEC and CFTC is likely - this new entity would oversee: investor protection and market integrity. Although other reports have come out, including this one by Bloomberg, suggesting that Geithner may not support such a merger. Such public dissent by Geithner is nothing new as continued turmoil seems to persist between Geithner and President Obama's chief economic advisor, Larry Summers.
Where is the Unsystemic Risk (Aka: Operational Risk) Regulatory Oversight?
While it has also been reported by CNBC that republicans are preparing their own version of financial system regulatory overhaul, on the surface it seems that these plans have essentially completely ignored, or severely minimized, the risks association with the operational risks in hedge funds.
Operational risks (i.e. - legal and compliance risks, valuation and accounting risks, reputational risks, asset verification, third part independence etc.) are exactly the types of risks that led to the Madoff scandal and the recent deluge of hedge fund frauds and Ponzi schemes. Ignoring such risk fosters a lax regulatory environment that could foster the next Madoff.
It seems as if the voices of the hedge fund industry lobby groups such as AIMA and the MFA, at least in the US, were loud enough to steer the discussion away from operational risk.
Where are the investor advocate groups touting the importance of enhanced operational risk disclosures for hedge funds and private equity?
With regards to alternative investments these proposed plans are essentially the polar opposite of the gist of the European Union's directive which - while still not focusing on operational risk - places a great deal more emphasis on overall transparency, risk reporting and monitoring.
How many more Madoff's will it take before the US, and the rest of the world, begins to dedicate the appropriate focus towards truly monitoring operational risk?
Many compliance and legal professionals in the US feel that a good first step would be with the SEC enhancing form ADV disclosures, but it seems as if this is a low priority on Mary Schapiro's to do list.
A Mini Regulator Not A Super Regulator
The planned merging of the SEC and CFTC, with the combined oversight of the Fed, effectively creates a super regulatory agency for the hedge fund industry.
With respect to operational risk in the alternatives space, this is the wrong approach.
Operational risk data collection and on-going monitoring from hedge funds and private equity will best be served by an experienced regulator focused on the nuances and specifics of the hedge fund industry. Lumping hedge funds together with all other financial institutions (such as banks, mutual funds, thrifts, insurance companies etc.) is simply the wrong approach. Too many small operational issues will slip through this broad regulatory net. These smaller issues may not be deadly in isolation but in aggregation they can snowball into a Madoff like blizzard for the financial markets.
A better approach would be a smaller regulatory agency (or dedicated division of a larger regulator) with the nimbleness and detailed knowledge and experience necessary to properly oversee and monitor operational risk in
[caption id="" align="alignleft" width="192" caption="Harry Markopolos"]
[/caption]hedge funds. To quote Harry Markopolos (the man who knew Madoff was a fraud) - they should have enough experience to "have gray hair or no hair."
Unfortunately for US investors, and perhaps fortunately for the hedge fund industry lobbies, who generally it seems oppose such increased transparency and disclosure requirements are not in the plan for the short term regulatory framework.
A Continued Hedge Fund Exodus from Europe?
This proposed lax operational risk disclosure environment, the failing of increased hedge fund regulation on the state level (i.e. - recent news of Connecticut's recent decision to let proposed hedge fund legislation, which would in part
[caption id="" align="alignright" width="92" caption="Crispin Odey"]
[/caption]enhance disclosure requirements, die for the time being) combined with the hedge fund industry's disdain over the EU directive, may add more fuel to the talks of a European hedge fund exodus, from hedge fund manager's such as Crispin Odey, from UK to the US. Hopefully, the US is appropriately planning for the impending deluge.
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