The following letter was sent in response to the US Treasury’s request for public input on a solution to the financial crisis and was the first of numerous subsequent communictions. The original Treasury request follows our comment below.
November 27, 2007
Mr. Jeffrey Stoltzfoos
Department of the Treasury
Office of the Assistant Secretary for Financial Institutions
By Facsimile: 202 622-0256
Dear Ms. Cummings,
Jeffrey Stolzfoos suggested this fax to you, saying that it would be read and forwarded to him.
I am responding to your request for comments on regulation at the suggestion of Eric Nordman, Director of Research of the National Association of Insurance Commissioners, who is familiar with my work and referred your material, “Review by the Treasury Department of the Regulatory Structure Associated with Financial Institutions” (Billing Code 4811-42) to me.
1.1 The key problems left unaddressed by current regulatory structures are that financial markets regulators:
a. must have access to appropriate and reasonably granular market information, including comparative analytics, performance reviews (by individual investments), operating metrics, etc. At a minimum, there must be contractual clarity (to properly assess issues of moral hazard and risk), as well as real markets, preferably price and terms in real time.
Because regulators do not currently have access to sufficient data they appear frequently too overwhelmed to think: regulation suffers;
b. often leave their jobs to go to work for the institutions they regulate…meaning that their results can (however unwittingly) be biased in their analysis in favor of the institutions they regulate. (A personal example: Recently, an insurer declared that my $2 million life insurance policy had lapsed, while electronically generated bank records proved the contrary. Absent any appropriate statistics on these lapse rates, the regulators found for the insurer, refusing to cross-reference the records we provided that we claim reveal a fraud against this consumer. The CT Attorney General has since written in our behalf to the CT Insurance Commissioner and the matter will be reviewed. But statistical analysis of comparative lapse rates would presumably reveal the reason behind the insurer’s bias.);
c. often permit regulated entities to determine the rules by which they are regulated – meaning that even those who might abuse the system for financial advantage get to opine freely on how the measures are to be interpreted (!);
d. consider measures of a 99.9 or 99.99 percent statistical certainty of risk avoidance to be appropriate. However, this level of uncertainty still allow for errors in between 1 in a 1000 and 1 in 10,000 circumstances. That result is unacceptably when implicating multi-trillion dollar risks or markets;
e. the frequency of occurrence for a peril or hazard is different than a measure of frequency occurrence for a particular risk of a particular severity;
f. experts claim it will take 50 years to move from current statistical measures (Gaussian math) to ones that properly predict the frequency of a particular risk severity;
g. data density increases dynamically the perception of frequency of a risk (i.e., today’s more sensitive measures make risk seem to occur more often).
1.2. Market convergence has not caused “Straight-through processing” in financial services, or any unifying force that connects the transactional food chain and would reduces wholesale and retail sector costs in insurance and reinsurance, loans and lines of credit.
1.2.1 The way that regulation functions means that the framework is constantly fragmented.
We call this the retail/wholesale market disconnect. (Example: in capital markets, there is currently no price/term recovery across market sectors, meaning the critical linkage is lost between: time; initial inquiry; primary market execution with price and description of risk;
subsequent performances of risk; secondary market pricing of risk; etc. If these separate market aspects were connected by a clear economic benefit, costs would come down, volumes would increase.)
1.2.2 Current risk measures are proven inadequate by the nature of the current global crisis; holding companies must all use comparable measures with clear explanations for any divergences from a standard.
1.2.3 A methodology must be used that connects all links in the marketplace chain in a seamless process that encourages market efficiency through pure economic benefit. We have created a related, market solution for the insurance industry that is soon to be deployed as The National Insurance Exchange. We are told that this business model has received the first ever joint endorsement of the two trade groups representing insurance industry intermediaries.
1.3 Key objectives of financial regulation
a. Price/term discovery;
b. Standardization of work and process flows, operating metrics, underwriting standards, risk and performance measures, documents, etc.
c. Clarity of risk description;
d. Operating efficiency;
e. Ease and cost of audit
1.3.1 Government guaranteed institutions must have at least the same – preferably stronger – standards than those that exist for un-guaranteed institutions
1.3.2 The cost of money is the stabilizing element for all unregulated institutions because it is presumed to be correct, risk variable and market priced (except for fraud)
1.3.3 Granular data, analysis and operating metrics are a requirement for proper market oversight
1.2.4 The absence of data and analytics and uniform work and process flow measures consistently blinds regulation – just as it impedes the marketplace where best information is a proven determinant of performance. We propose use of a transaction credit that buys access to both lower next transaction costs and lower costs of access to information.
1.3.5 This approach should result in a “viral” adoption of a uniform set of basic principals of regulation.
1.4 The consumer has his interest consistently ill-served by financial market regulators (at least when it comes to insurance and banking/lending markets) because the market are opaque. Injections of transparency, strategic market intelligence that reveal critical information and advantage needs to be structurally induced with an economic incentive.
1.5 State regulators are the “critical canary in the (financial) birdcage” on a local level, as no federal response is presently available; however any form of regulation is impossible without access to proper data and analytics.
1.6 The United States is the acknowledged leader in both market creation and technology. It should use these strengths to define and re-define the regulatory (and transactional) space to meet its needs. The recent sales of transaction platforms to foreign interests indicate the value of these assets. Keeping them under domestic control can best occur by linking transactions (The Market) to information (Technology).
2.1.1 Various structural approaches to the existence of depository institutions can co-exist if there are common visible marketplaces, with data and analytics that reflect the precise financial circumstance, along with standardized documents, clearance functions, etc.
2.1.3 The optimal approach to all markets is that they are wild and free, volatile, visible and subject to legitimate market forces (including fear and greed)
2.1.4 If the above answer is true, central bank regulation is able to better focus on policy issues, leaving transactional detailed analysis to local authorities
2.1.5 No solution is appropriate if it does not have conventions that actually induce usage through economic and strategic benefit in the on-going creation of an efficient, transparent marketplace.
2.1.6 The consumer must always receive a proper regulatory response and, should that response not occur, the consumer needs recourse through multiple branches of government.
2.2.1 See above answers
2.2.2 Federal interests must focus on limiting all possibility for subsidized markets; insurance and banking – like all financial services – are best left wild and free, where competitive forces prevail over time.
2.23 All markets need more operating and pricing efficiency – and this comes from lower costs, which clearly and inevitably results from our approach
2.2.4 See answer to 2.2.2
Securities and Futures
2.3.1 All financial markets are united in the sense that they provide different solutions to risk transfer: standardize the marketplace and you standardize products and operations
2.3.2 Some risks are local and require state regulation
2.3.3 Henry Kaufman recently suggested some kind of “uber regulator” but all solutions require standardization of work and process flows and the resulting descriptions, data/analytics and operating metrics
2.3.4 Regulation is always best when it is limited by any particular need, other than a search for what is actually occurring in the marketplace. This can only happen in an efficient market – one that is governed by the rational search for the incremental profit dollar.
2.3.5 All regulation must be balanced, weighing the needs of the consumer at least equally with that of the institutional investor. All market sectors need to be united and subject to a common measure, one that finds them “the best deal” at the lowest cost.
2.3.6 Liquid cash markets lead to liquid futures markets which in turn lead to liquid options markets. This can only occur when the arbitrage between sectors is exposed to competitive threat, which occurs only when the sector are made transparent – as can happen immediately by using our solution in a visible setting that evidences clear economic benefit.
Moore’s law initially postulated doubling chip densities every 18 months. Decades later, this law has placed massive data density in the hands of the potential analyst. Still, there remains no consistent approach to unite, collect and deploy the data and use it to clarify financial markets. This must change if the marketplace is to properly clear the necessary risks in a cost-efficient manner.
A précis of our proposed solutions follows:
The Marketcore solution is applicable to all financial markets and includes immediate market acceptance due to lower transaction costs. It is:
- An electronic display of specific economic credits that, at the option of the participant, can be used to either buy low cost variable term, discounted access to future transactions and/or market information
- The capture of all data related to a transaction rests in an “Infomediary” section of the marketplace
- A credit display of linkages that create a seamless chain of work flows” “straight through processing”
- Low cost entry and exit of new products/services, resulting in a more vibrant marketplace
Benefits of the Marketcore solution to Insurance/Reinsurance and Loans and Lines of Credit
- Market intelligence: access to all necessary information about the counterpart and the proposed, or executed, transaction
- Standardized data structures for documents, clearance, communications, risk performance, etc.
- Cross sector arbitrage
- A listing of unique, fungible, and ubiquitous credits, available to participants and based off of paid transaction fees. It is useable for a defined term and functions as a clear economic benefit in the form of a cost reduction of either the next transaction fee or access to strategically critical market information
- A branding mechanism that offers a distinguishing feature that defines a fully complying marketplace, with counterparts that perform as expected
- Transactions that drive credits as credits drive transactions = viral growth
The result is lower costs, improved liquidity, greater revenues, growing market shares for participants – a vibrant marketplace that is always stimulative to the economy without being inflationary
Validation of MC’s work has been received from:
2000-1 KPMG “This solution rivals FNMA and FHLMC – it covers all products (not just mortgages), it has potentially full market reach (with potential retail, not just wholesale, market focus), and global, not just domestic markets.”
2003 Grant of insurance patent
2004 National Association of Insurance Commissioners, Head of Research “… timely and well thought out…the best solution I have yet seen”
2005 Council of Insurance Agents and Brokers (CIAB), public endorsement of MC proposal for an exchange for insurance and reinsurance
2006 Superior Access Insurance Services (A Pequot Ventures-owned company) licensed the insurance patent for the purpose of forming an exchange for insurance and reinsurance, The National Insurance Exchange, with the first-ever, joint public endorsement by the two leading trade groups: The CIAB and The Big I”. A commercial license occurs for only .5 to 2% of all patents and is considered an important validation.
2007 Congressional Research Service (CRS) consults with MC on the writing of legislation to address issues of catastrophic risk exposure facing the nation, as well as broader issues of risk transfer and distribution.
The original “Review by the Treasury Department of the Regulatory Structure Associated with Financial Institutions, November 2007” follows here:
BILLING CODE 4811-42
DEPARTMENT OF THE TREASURY
Review by the Treasury Department of the Regulatory Structure Associated with Financial Institutions.
AGENCY: Department of the Treasury, Departmental Offices.
ACTION: Notice; request for comments.
SUMMARY: The Treasury Department is undertaking a broad review of the regulatory structure associated with financial institutions. To assist in this review and obtain a broad view of all perspectives, the Treasury Department is issuing this notice seeking public comment.
DATES: Comments should be submitted electronically and received by Wednesday, November 21, 2007.
ADDRESSES: Please submit comments electronically through the Federal eRulemaking Portal – “Regulations.gov.” Go to http://www.regulations.gov, select “Department of the Treasury – All” from the agency drop-down menu, then click “Submit.” In the “Docket ID” column, select “TREAS-DO-2007-0018” to submit or view public comments and to view supporting and related materials for this notice. The “User Tips” link at the top of the Regulations.gov home page provides information on using Regulations.gov, including instructions for submitting or viewing public comments, viewing other supporting and related materials, and viewing the docket after the close of the comment period. Please include your name, affiliation, address, e-mail address and telephone number(s) in your comment. Where appropriate, comments should include a short Executive Summary (no more than five single-spaced pages). All statements, including attachments and other supporting materials, received are part of the public record and subject to public disclosure. You should submit only information that you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: Jeffrey Stoltzfoos, Senior Advisor, Office of the Assistant Secretary for Financial Institutions, (202) 622-2610 or Mario Ugoletti, Director, Office of Financial Institutions Policy, (202) 622-2730 (not toll free numbers).
SUPPLEMENTARY INFORMATION: The Treasury Department is currently engaged in a number of initiatives associated with maintaining the competitiveness of United States capital markets. One of those initiatives is evaluating the regulatory structure associated with financial institutions. The regulatory structure for financial institutions in the United States has served us well over the course of our history. Much of the basic regulatory structure associated with financial institutions was established decades ago. While there have been important changes over time in the way financial institutions have been regulated, the Treasury Department believes that it is important to continue to evaluate our regulatory structure and consider ways to improve efficiency, reduce overlap, strengthen consumer and investor protection, and ensure that financial institutions have the ability to adapt to evolving market dynamics, including the increasingly global nature of financial markets. The Treasury Department’s review of regulatory structure will focus on all types of financial institutions: commercial banks and other insured depository institutions; insurance companies; securities firms; futures firms; and other types of financial intermediaries.
The Treasury Department is soliciting comments to assist in this review. The Treasury Department would be particularly interested in comments on the specific questions set forth below, or on other issues related to the regulatory structure associated with financial institutions. We are also interested in specific ideas or recommendations as to how we can improve our current regulatory structure.
I. General Issues
1.1 What are the key problems or issues that need to be addressed by our review of the current regulatory structure for financial institutions?
1.2 Over time, there has been an increasing convergence of products across the traditional “functional” regulatory lines of banking, insurance, securities, and futures. What do you view as the significant market developments over the past two decades (e.g. securitization, institutionalization, financial product innovation and globalization) and please describe what opportunities and/or pressures, if any, these developments have created in the regulation of financial institutions?
1.2.1 Does the “functional” regulatory framework under which banking, securities, insurance, and futures are primarily regulated by respective functional regulators lead to inefficiencies in the provision of financial services?
1.2.2 Does the “functional” regulatory framework pose difficulties for considering overall risk to the financial system? If so, to what extent have these difficulties been resolved through regulatory oversight at the holding company level?
1.2.3 Many countries have moved towards creating a single financial market regulator (e.g., United Kingdom’s Financial Services Authority; Japan’s Financial Services Agency; and Germany’s Federal Financial Supervisory Authority (BaFin)). Some countries (e.g., Australia and the Netherlands) have adopted a twin peaks model of regulation, separating prudential safety and soundness regulation and conduct-of-business regulation. What are the strengths and weaknesses of these structural approaches and their applicability in the United States? What ideas can be gleaned from these structures that would improve U.S. capital market competitiveness?
1.3 What should be the key objectives of financial institution regulation? How could the framework for the regulation of financial institutions be more closely aligned with the objectives of regulation? Can our current regulatory framework be improved, especially in terms of imparting greater market discipline and providing a more cohesive look at overall financial system risk? If so, how can it be improved to achieve these goals? In regards to this set of questions, more specifically:
1.3.1 How should the regulation of financial institutions with explicit government guarantees differ from financial institutions without explicit guarantees? Is the current system adequate in this regard?
1.3.2 Is there a need for some type of market stability regulation for financial institutions without explicit Federal Government guarantees? If so, what would such regulation entail?
1.3.3 Does the current system of regulating certain financial institutions at the holding company level allow for sufficient amounts of market discipline? Are there ways to improve holding company regulation to allow for enhanced market discipline?
1.3.4 In recent years, debate has emerged about “more efficient” regulation and the possibility of adopting a “principles-based” approach to regulation, rather than a “rules-based” approach. Others suggest that a proper balance between the two is essential. What are the strengths, weaknesses and feasibility of such approaches, and could a more “principles-based” approach improve U.S. competitiveness?
1.3.5 Would the U.S. financial regulatory structure benefit if there was a uniform set of basic principles of regulation that were agreed upon and adopted by each financial services regulator?
1.4 Does the current regulatory structure adequately address consumer or investor protection issues? If not, how could we improve our current regulatory structure to address these issues?
1.5 What role should the States have in the regulation of financial institutions? Is there a difference in the appropriate role of the States depending on financial system protection or consumer and investor protection aspects of regulation?
1.6 Europe is putting in place a more integrated single financial market under its Financial Services Action Plan. Many Asian countries as well are developing their financial markets. Often, these countries or regions are doing so on the basis of widely adopted international regulatory standards. Global businesses often cite concerns about the costs associated with meeting diverse regulatory standards in the numerous countries in which they operate. To address these issues, some call for greater global regulatory convergence and others call for mutual recognition. To what extent should the design of regulatory initiatives in the United States be informed by the competitiveness of U.S. institutions and markets in the global marketplace? Would the U.S. economy and capital market competitiveness be better served by pursuing greater global regulatory convergence?
II. Specific Issues
2.1 Depository Institutions
2.1.1 Are multiple charters for insured depository institutions the optimal way to achieve regulatory objectives? What are the strengths and weaknesses of having charters tied to specific activities or organizational structures? Are these distinctions as valid and important today as when these charters were granted?
2.1.2 What are the strengths and weaknesses of the dual banking system?
2.1.3 What is the optimal role for a deposit insurer in depository institution regulation and supervision? For example, should the insurer be the primary regulator for all insured depository institutions, should it have back-up regulatory authority, or should its functions be limited to the pricing of deposit insurance, or other functions?
2.1.4 What role should the central bank have in bank regulation and supervision? Is central bank regulatory authority necessary for the development of monetary policy?
2.1.5 Is the current framework for regulating bank or financial holding companies with depository institution subsidiaries appropriate? Are there other regulatory frameworks that could or should be considered to limit the transfer of the safety net associated with insured depository institutions?
2.1.6 What are the key consumer protection elements associated with products offered by depository institutions? What is the best regulatory enforcement mechanism for these elements?
2.2.1 What are the costs and benefits of State-based regulation of the insurance industry?
2.2.2 What are the key Federal interests for establishing a presence or greater involvement in insurance regulation? What regulatory structure would best achieve these goals/interests?
2.2.3 Should the States continue to have a role (or the sole role) in insurance regulation? Insurance regulation is already somewhat bifurcated between retail and wholesale companies (e.g., surplus lines carriers). Does the current structure work? How could that structure be improved?
2.2.4 States have taken an active role in some aspects of the insurance marketplace (e.g., workers’ compensation and residual markets for hard to place risks) for various policy reasons. Are these policy reasons still valid? Are these necessarily met through State (as opposed to federal) regulation?
2.3 Securities and Futures
2.3.1 Is there a continued rationale for distinguishing between securities and futures products and their respective intermediaries?
2.3.2 Is there a continued rationale for having separate regulators for these types of financial products and institutions?
2.3.3 What type of regulation would be optimal for firms that provide financial services related to securities and futures products? Should this regulation be driven by the need to protect customers or by the broader issues of market integrity and financial system stability?
2.3.4 What is the optimal role for the states in securities and futures regulation?
2.3.5 What are the key consumer/investor protection elements associated with products offered by securities and futures firms? Should there be a regulatory distinction among retail, institutional, wholesale, commercial, and hedging customers?
2.3.6 Would it be useful to apply some of the principles of the Commodity Futures Modernization Act of 2000 to the securities regulatory regime? Is a tiered system of regulation appropriate? Is it appropriate to make distinctions based on the relative sophistication of the market participants and/or the integrity of the market?
Executive Secretary of the Treasury