Peeking at the Future of Financial Regulation

From: Compliance Week

Matt Kelly

ometimes the wisdom of our financial regulators truly impresses me—and that’s not sarcasm, either. The folks overseeing our financial system can make profound insights about how the banking system can run more smoothly.

Of course, I doubt financial regulators will actually do much with the profound insights they sometimes spout. But hey, baby steps.

The latest evidence to this point is the first annual report of the Office of Financial Research, published last Friday. The OFR is one of the multiple new agencies created by the Dodd-Frank Act; it’s intended to be the research department that supports the Financial Stability Oversight Council, that mishmash of existing financial regulators that Dodd-Frank also created when lawmakers were too chicken to consolidate oversight into a single agency like they should have.

As think tanks go, however, the OFR actually proves to be pretty thoughtful. Its report—all of 33 pages long, and an easy read in one sitting—first gives a straightforward review of the dumb policies and beliefs in the 2000s that led to the financial crisis in 2008. It then gives an overview of what new threats might unravel financial markets again, and how the OFR plans to study those threats so it can detect them early and let the Financial Stability Oversight Council take action. For compliance officers in the financial sector, the report is well worth a read.

The crux of the report, which also foreshadows how regulators will handle financial firms in the future, is right on the opening page:

The crisis revealed significant deficiencies in the data available to monitor the financial system. Financial data collected were too aggregated, too limited in scope, too out of date, or otherwise incomplete. The crisis demonstrated the need to reform the data collection and validation process and to strengthen data standards, to improve the utility of data both for regulators and for market participants.

In other words: Yet again, it’s all about the data. I’ve written about this before as recently as last week, and we’re going to see this theme of data transparency time and again.

The OFR then proceeds to explain its early goals of determining exactly what types of data financial regulators already collect, and whether any gaps exist in those piles of data. Compliance and risk officers should find that chore familiar; what you do on a firm-wide level—scouring business units for silos of information, to better understand all the risks the company has—the OFR is attempting to do with regulatory agencies. The buzzword for what the OFR wants to achieve is “macro-prudential regulation,” but really, it’s enterprise risk management for the financial system as a whole.

How the OFR views this task is what compliance and risk officers should find interesting. The report goes on at some length about the challenges of comparing one regulator’s pile of data against another, so you can get a holistic picture of all the information you have and put that information to good use. The funny thing is, the IT executives down the all from you already have a term for labels that describe what’s in a silo of data: meta-data, which literally means “data about data.” Even more telling, the Securities and Exchange Commission and your accounting executives have a term for data about data as well: XBRL.

That’s what XBRL is, after all—a series of labels you apply to your company’s financial information, so outsiders can quickly find all the information about revenues, or R&D spending, or product returns, or whatever. Classify financial information by type, and investors can then easily compare the same type of financial information across multiple companies.

Clearly the OFR wants to use the same logic, one order of magnitude up the scale. It will apply some sort of tagging language (XBRL or something similar) to data about financial risks, so it can get that system-wide view of what financial firms are doing and what risks are percolating. And if the OFR imposes that sort of system on financial regulators, it’s a short leap to the prospect of all financial regulators imposing even more XBRL directives on you, the financial firm.

This should not surprise most firms, since the Federal Deposit Insurance Corp. and other financial regulators have dabbled in XBRL for years anyway. I would just expect more of it. And once the OFR does find gaps in macro-prudential regulation, the Financial Stability Oversight Council will (presumably) want to seal those gaps. That will mean more reporting of more data, and more tags on those reports along the way.

Now, that bit earlier about me doubting that regulators will actually put any of this insight to good use. This is where my inner cynic bursts free.

Remember that for all the useful suggestions the OFR might produce, regulatory agencies will still need to convert those suggestions into actual rules and policy; the OFR itself has no power to adopt anything. Now, if Congress had created a systemic risk regulator back as Dodd-Frank was crafted in 2010, that super-agency would (one hopes) have the clout to promulgate rules to ensure financial stability and ward off emerging risks. But Congress didn’t do that. It created the Financial Stability Oversight Council, merely a roundtable of regulators-in-chief trying to herd each other toward some allegedly common goal.

That is, Congress diffused responsibility for oversight of the financial system among many agencies. And if you want a way to evade hard choices and then pass blame around when something goes wrong, that’s an excellent way to do it. Could we some day see the OFR identify emerging risks and propose solid solutions, only to watch regulators stalemate over the details and point fingers when disaster strikes?

What, in Washington? Nah, that never happens.

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