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B. Providing for Appropriate Oversight of Financial Services Holding Companies
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Oral Statement of Matthew P. Fink
President, Investment Company Institute
Before the Subcommittee on Financial
Institutions and Consumer Credit
Committee on Banking and Financial Services
U.S. House of Representatives
On the "Depository Institution Affiliation and
Thrift Charter Conversion Act" H.R. 268
February 11, 1997
I am Matthew Fink, President of the Investment Company Institute, the national association of the American mutual fund industry. I am pleased to be here today to testify on H.R. 268.
We believe that there are five principles that should underlie legislation to restructure the regulatory framework for the financial services industry. First, grant banks full mutual fund powers; second, modernize the federal securities laws to address bank mutual fund activities; third, permit the affiliation of banks, securities firms, insurance companies and commercial companies; fourth, provide for functional regulation of each entity; and fifth, create an appropriate oversight system for the new financial services holding companies.
H.R. 268 contains provisions implementing each of these principles. As a result, H.R. 268 lays a firm foundation for Congress to build on as it proceeds with financial services reform. My testimony today focuses on the appropriate oversight system for the new holding companies.
Any decision to permit securities, banking and insurance firms to affiliate with each other necessarily raises the question of how government should oversee the new holding companies. Each of the industries -- securities, banking and insurance -- historically has been subject to extensive governmental oversight. But each industry functions under different systems of regulation which rest on different premises and rely on different regulatory tools.
The task facing Congress is to design an oversight system for the new holding companies that will maximize the public interest by protecting consumers, while minimizing the potential for marketplace disruption through inappropriate regulatory requirements.
H.R. 268 constructs an oversight system based on three concepts.
The first concept is strong functional regulation. The bill envisions that each subsidiary of the holding company would be separately regulated by function with, for example, the SEC regulating securities firms, and banking agencies regulating banks.
The second concept is risk assessment, designed to protect banks and the financial system by ensuring that banking agencies receive information identifying the effect that activities of non-banking subsidiaries may have on the safety and soundness of affiliated banks.
The third concept is enhanced regulatory coordination. The bill requires the functional regulators of the various subsidiaries to cooperate with each other in the exercise of their regulatory responsibilities.
We support an oversight system based on these three concepts because it utilizes existing regulatory mechanisms that serve the public interest well. It also is well-designed to enable the banking agencies to monitor risk, both in the context of individual banks and on a system-wide basis.
Importantly, the model does not seek to inappropriately impose safety and soundness regulation on securities firms and other non-bank subsidiaries. This course of action would interfere with the current system of securities regulation which has served to protect investors and make our capital markets the strongest in the world.
Although H.R. 268's oversight provisions provide a solid starting point for financial services reform, the bill should be revised in a number of ways.
Specifically, the role of the National Financial Services Committee should be limited to that of a coordinating and advisory body. Our written testimony identifies provisions of the bill that would grant the Committee broad substantive authority over the Committee's member agencies and over financial services holding companies. These provisions potentially threaten the independence of the agencies and conflict with functional regulation.
Our written testimony also identifies provisions which may be read to grant the banking agencies substantive regulatory authority over holding companies and non-bank subsidiaries. These provisions conflict with the bill's oversight model and conflict with functional regulation.
In sum, H.R. 268 focuses on the key ingredients -- tough functional regulation, effective risk assessment mechanisms, and close interagency coordination -- that are necessary to provide for effective oversight of the new financial services holding companies.
I appreciate the opportunity to appear before you today. I would be happy to answer any questions.
Testimony of Matthew P. Fink
President, Investment Company Institute
Before the Subcommittee on
Financial Institutions and Consumer Credit
Committee on Banking and Financial Services
U.S. House of Representatives
On the "Depository Institution Affiliation and
Thrift Charter Conversion Act" H.R. 268
February 11, 1997
A. Introduction
My name is Matthew P. Fink. I am President of the Investment Company Institute, the national association of the American investment company industry. The Institute's membership includes 6,220 open-end investment companies ("mutual funds"), 443 closed-end investment companies, and 10 sponsors of unit investment trusts. The Institute's mutual fund members have assets of about $3.4 trillion, accounting for approximately 95 percent of total industry assets, and serve over 59 million individual shareholders. The Institute's members include mutual funds advised by investment counseling firms, commercial banks, broker-dealers, insurance companies, and commercial firms. The Institute's bank members advise 1338 mutual funds with over $400 billion in assets, accounting for almost 92 percent of all mutual funds advised by banks.
The Institute has been an active participant in the debate on financial services reform and has testified before Congress on subjects directly relating to financial services reform more than twenty times over the last twenty-two years. I am pleased to be here today on behalf of the Institute to testify with respect to H. R. 268, the "Depository Institution Affiliation and Thrift Charter Conversion Act."
The Institute believes that there are five principles that should underlie legislation to restructure the regulatory framework governing the financial services industry. Simply put, Congress should--
- grant banks full mutual fund powers (e.g. the ability to sponsor and underwrite mutual funds and to have bankers serve on fund boards);
- modernize the federal securities laws to address bank-mutual fund activities;
- permit banks, securities firms, insurance companies and commercial entities to own and affiliate with each other;
- provide for functional regulation of each entity (bank, securities firm, insurance company, etc.) within the resulting diversified organization; and
- create an oversight system governing organizations owning both securities firms and commercial banks that maximizes the public interest in protecting consumers of financial services while minimizing the potential for distortion of the marketplace through unnecessary, duplicative, artificial, or overly rigid regulatory requirements.
H.R. 268 contains important provisions that implement each of these principles. The Institute accordingly believes that H.R. 268 lays a firm foundation upon which Congress safely may build as it proceeds to craft and enact financial services reform legislation. My testimony today primarily will focus on considerations regarding an appropriate oversight model for the new financial services holding company.
B. Providing For Appropriate Oversight of Financial Services Holding Companies
1. H.R. 268's Oversight System—Functional Regulation, Risk Assessment and Enhanced Regulatory Coordination
H.R. 268 constructs an oversight system based on three critical concepts.
Functional Regulation. Functional regulation envisions that each subsidiary of the financial services holding company would be separately regulated by function with, for example, the Securities and Exchange Commission ("SEC") acting as the primary regulator of securities firms and the appropriate federal banking agency acting as the primary regulator of depository institutions. The functional regulator would have authority to set capital standards with respect to, to require reports from, and to perform examinations of, the particular subsidiary it oversees in the holding company complex. The functional regulator would not have authority, however, to set capital standards for, to impose reporting requirements upon, or to conduct examinations of, other entities in the organization.1 The Institute supports the concept of strong functional regulation and these and other provisions of the bill that implement it.
Risk Assessment. H.R. 268 proposes the use of risk assessment mechanisms to protect depository institutions in a holding company from risks to which the activities of any non-banking affiliates might expose them. The risk assessment mechanisms, found primarily in Section 109 of the bill, are based on the premise that the functional regulator for a depository institution can use its supervisory and enforcement powers to protect bank subsidiaries in the complex from risks flowing from the activities of non-bank subsidiaries so long as the banking agency is able to obtain access to information about those activities. To this end, section 109 generally requires a financial services holding company initially, and the holding company's subsidiary depository institutions thereafter, to provide the banking agencies with information and reports designed to identify the impact that the activities of non-banking entities in the complex may have on the safety and soundness of any affiliated depository institutions. The Institute supports the use of these types of risk assessment mechanisms to protect financial service holding company banks.
Enhanced Regulatory Coordination. H.R. 268 also calls for enhanced regulatory coordination among the functional regulators of the various subsidiaries owned by a financial services holding company. Importantly, Section 114 of the bill creates a National Financial Services Committee ("NFSC") made up of the Secretary of the Treasury, the heads of all the federal banking agencies, the Chairman of the SEC and a designated insurance commissioner to perform a variety of functions, including conducting and authorizing studies, consulting with state regulators and making recommendations to Congress and others. In addition, Section 109 generally requires a banking agency to accept information and reports filed with the SEC or a state insurance commissioner when the banking agency is seeking information on the activities of a depository institution affiliate for which the SEC or the state insurance commissioner is the functional regulator. In the same vein, Section 320 requires the SEC and the banking agencies to share with each other upon request the results of examinations, reports, records or other information each may have with respect to the investment advisory activities of financial service holding companies and banks affiliated with financial services holding companies. In addition, Section 122(l) requires the SEC and each banking agency to establish programs for sharing information and enforcing compliance with the securities affiliate safeguards and broker/dealer registration provisions of the bill. The Institute supports each of these measures.
The Institute believes that an oversight model for financial services holding companies based upon functional regulation, risk assessment and enhanced regulatory coordination carries the greatest potential for optimizing both public and private interests. The model leaves in place the regulatory mechanisms that now exist and that serve the public interest well. Securities firms in general and participants in the investment company marketplace in particular already are subject to extensive regulation and supervision by the SEC under the federal securities laws. Indeed, Congress only recently examined the statutory and regulatory scheme governing the investment company industry and concluded that the system was functioning well.2 The success of the existing oversight system is also demonstrated by the renowned strength, depth and liquidity of the U.S. capital markets, including the mutual fund industry.
In addition, the model builds upon the existing regulatory framework in specific and targeted ways, and only as necessary to achieve defined and articulated goals. In this way, the model reduces the potential for subjecting regulated entities to duplicative or potentially inconsistent regulatory requirements, and for distorting the marketplace through unneeded, artificial or overly rigid governmental intervention.
Importantly, the model does not call for the imposition of safety and soundness regulation on the financial services holding company or its non-banking subsidiaries in order to protect holding company bank subsidiaries. As a result of the federal deposit insurance program and other factors, a major objective of banking regulation traditionally has been to attempt to control the risk of financial loss to banking organizations and the U.S. Treasury. The tools used to achieve this objective have ranged from limitations on the kinds of companies with which banks may affiliate, the nature of activities in which banks and their affiliates may engage and the manner in which banks and their affiliates may conduct these activities. Securities regulation, however, rests upon very different foundations.3 The very nature of the securities markets in this country is based on risk taking, and the federal securities laws do not seek to protect investors by limiting risk taking but instead by requiring that its existence be disclosed. Any attempt to impose substantive safety and soundness regulation on securities firms affiliated with banks necessarily would interfere with the vibrancy of the securities markets and would clash with the governing regulatory scheme.
It also is relevant to consider the experience of other agencies under comparable regimes. As the Committee is aware, Section 109 and related provisions are very similar to -- indeed, are based on -- the holding company risk assessment provisions of the Market Reform Act of 1990, pursuant to which the SEC monitors risks to broker-dealers flowing from affiliate activities, and of the Futures Trading Practices Act of 1992, pursuant to which the CFTC assesses dangers to futures commission merchants posed by affiliate activities. After six years of experience with the Market Reform Act, the SEC informed Congress last year that it found the risk assessment provisions to provide a "significant complement" to its existing statutory authority.4 There also has been no indication that the CFTC has expressed any dissatisfaction with the reach or operation of the risk assessment provisions it administers. This experience does not provide any reason to believe that the holding company risk assessment procedures embodied in Section 109 and related provisions would not constitute valuable tools enabling banking regulators to monitor systemic risk or would not otherwise work well in the financial services holding company context.5
In sum, H.R. 268 focuses on the key ingredients -- tough functional regulation, effective risk assessment mechanisms, and close interagency coordination -- that we believe are necessary to provide effective oversight of the new financial services holding company. The proposal lays a promising ground work and we look forward to working with the Committee as it considers ways to enhance and strengthen this approach.
2. Suggested Amendments To H.R. 268's Oversight Model
In order to fully implement the regulatory oversight model described above, the Committee should refine H.R. 268 to ensure that the NFSC's role is that of a coordinating and advisory body. To accomplish this, certain provisions of the bill that grant the NFSC broad substantive authority over its member agencies, in effect placing the NFSC in the role of overseeing existing functional regulators, should be revised. These provisions may threaten the autonomy and independence of the subject agencies and are in conflict with the principles of functional regulation. Other provisions that grant the NFSC substantive authority over the activities of companies in the financial services holding company complex similarly should be revised6 because they also are inconsistent with functional regulation as well as risk assessment.7
In addition, the Committee should revise a number of the bill's provisions which either do or may be misconstrued to grant substantive regulatory authority over the financial services holding company and its non-banking subsidiaries to the federal banking agencies.8 These provisions are at odds with the bill's oversight model and create the potential for many of the dangers associated with the consolidated bank holding company supervision model of oversight.
C. Other Suggested Amendments
The Institute recommends that a number of additional revisions be made to the bill.
- Bank Mutual Fund Powers. H.R. 268's partial repeal of Glass-Steagall Section 32 should be broadened to permit personnel interlocks between a registered investment company or registered investment adviser and any bank. Limiting permitted interlocks to investment companies and advisers affiliated with a bank through the financial services holding company is not necessary to protect mutual fund investors or banks and allowing a broader range of interlocks would further the public interest by broadening the supply of qualified personnel available to serve the banking and mutual fund industries.
- Modernization Of Federal Securities Laws. The provisions of Title III of H.R. 268 modernizing the federal securities laws relating to investment companies should be broadened so as to apply to all depository institutions and not just to depository institutions owned by financial services holding companies. Each of the investor protection and functional regulation policies underlying each of these amendments applies equally in the context of a bank that is not affiliated with a financial services holding company as it does in the context of a bank affiliated with a financial services holding company.
- Measurement Of Predominance In The Investment Advisory Context. H.R. 268 should be amended to make clear that a company is "predominantly a financial company" and therefore eligible to become a financial services holding company if 75% of the company's business is devoted to investment advisory activities. Because investment advisory activities are clearly financial in nature, as H.R. 268 itself recognizes, see §§ 102(n)(5), (19), a company that devotes 75% of its business to investment advisory activities is and should be eligible to become a financial services holding company under the bill. Clarification is necessary to ensure that any formula that is used to measure the percentage of a company's business that is devoted to financial activities does not underestimate the relative importance of a company's investment advisory activities. In particular, if an asset test is used to determine whether or not a company is predominantly a financial company, full credit should be given to assets under management.
D. Conclusion
H.R. 268 contains important provisions that provide a firm foundation for Congress as it proceeds to craft and enact financial services reform legislation. We applaud your efforts to open the debate on financial services reform in a constructive and forward looking manner as we move into the 21st century. We thank you for the opportunity to present our views and look forward to working with the Committee as H.R. 268 moves forward.
Appendix
The Consolidated Bank Holding Company Model of Oversight and Supervision
From time to time, consolidated bank holding company supervision has been recommended as the appropriate model for financial services holding company oversight. This model seeks to protect banks owned in a holding company complex by appointing the Federal Reserve Board (or some other banking agency) to act as superregulator of the holding company and its component firms pursuant to a statutory scheme addressing, and often granting the superregulator broad discretion over, a host of matters ranging from capital standards and activity restrictions to prior notice and approval obligations to direct reporting and examination requirements. Both the existing Bank Holding Company Act as well as the proposed Financial Services Competitiveness Act of 1997 (H.R. 10) are based upon this model. For several reasons, however, the model is inappropriate in the context of a financial services holding company owning both bank and a wide range of non-bank subsidiaries.
Non-Bank Safety and Soundness Regulation. The consolidated bank holding company supervision model should be avoided in the diversified financial services arena because the model almost certainly would lead to efforts to protect banks through imposition of safety and soundness regulation on affiliated securities firms. These efforts necessarily would temper the risk taking upon which the securities markets are based and would interfere with the vibrancy of the securities markets.
Philosophies espoused by potential financial service holding company umbrella regulators leave little doubt that adoption of the model ultimately could lead to imposition of direct safety and soundness regulation on securities firms affiliated with banks. For example, just last year Federal Reserve Board Chairman Greenspan identified the core function of an umbrella supervisor as monitoring and assessing the risks that the nonbank portions of the financial services complex have on the bank subsidiary and generally on the safety net. He also expressed the view that the umbrella supervisor must be able to take actions designed and intended to reduce the perceived risks to acceptable levels.9
History provides confirmation, since it records that when bank regulators have exercised authority over bank securities activities, they have imposed safety and soundness requirements inconsistent with fundamental tenets of securities regulation. For example, the FDIC adopted a rule in 1984 that limited certain insured nonmember bank subsidiaries to underwriting investments quality securities.10 The Release accompanying the rule stated that the FDIC's purpose in adopting the rule was to address the risk associated with bank subsidiaries underwriting securities. The Release also stated the FDIC's view that it had the authority to oversee the direct and indirect securities activities of insured nonmember banks and that it had the authority to address on a case-by-case basis practices, acts or conduct it found to constitute unsafe and unsound practices not specifically addressed by the rule.
Duplicative Regulation. The consolidated bank holding company supervision model places unnecessary burdens on regulated entities. For example, securities firms in general and participants in the investment company marketplace in particular already are subject to extensive regulation and supervision by the Securities and Exchange Commission ("SEC") under the federal securities laws. Indeed, Congress only recently examined the statutory and regulatory scheme governing the investment company industry and concluded that the regulatory system was functioning well in satisfying the underlying Congressional objectives.11 Subjecting securities firms affiliated with banks to the various regulatory and supervisory mechanisms through which consolidated holding company supervision must be implemented, however, needlessly overlays an additional level of often duplicative and potentially inconsistent oversight by the banking regulator administering the model.
Rigidity. The consolidated bank holding company supervision model creates substantial inefficiencies in the financial services holding company context because the activity restrictions and new activity prior notice and approval requirements underlying the model constrain the ability of regulated entities to respond quickly to developments in the marketplace with new products. As SEC Chairman Levitt has pointed out, the consolidated bank holding company supervision model "is not well-suited for companies that seek to compete vigorously in new lines of business and fast-moving markets.12
Innovation. Adoption of the consolidated bank holding company supervision model is unwarranted because of the danger that a single bank-oriented umbrella supervisor would be tempted to stifle innovation and preclude new product developments by a securities affiliate on the grounds that they might compromise the competitive standing of banks. For example, Professor John C. Coffee, Jr. observed in a recent article that a single financial services regulator might have barred or restricted the growth of money market funds in the 1970's because of the competition these funds posed to bank accounts.13 Such an outcome would have been not only anticompetitive but also a notable disservice to consumers and to the capital marketplace, as reflected by the more than $760 billion in assets held by money market funds today.
Safety Net. Adoption of the consolidated bank holding company supervision model is unwarranted because its existence may lead the market to believe that non-bank holding company subsidiaries will be protected by the federal safety net.14
Conclusion. As recent scholarship has noted, "the case for consolidated supervision is far from obvious."15 Experienced regulators have been more direct. In the words of the Treasury Department:
Bank regulation should be concentrated on the bank, which can be effectively regulated, and not on protecting a diversified [financial services holding company] that should be subject to normal market discipline.16
ENDNOTES
1See §§ 105(c), 109, 202(b), 204(c), 209.
2See, e.g., H.R. Conf. Rpt. No. 864, 104th Cong., 2d Sess. 2-3 (September 28, 1996); H.R. Rep. No. 622, 104th Cong., 2d Sess 16-17 (June 17, 1996).
3See, e.g., Board of Governors v. Investment Company Institute, 450 U.S. 46, 61 (1981); Testimony of SEC Chairman William Cary before the Senate Subcommittee of the Committee on Banking and Commerce, SEC Legislation 1963: Hearings before a Subcommittee of the Committee on Banking and Commerce, 88th Cong., 1st. Sess. 20 (1963).
4Hearings before the House Committee on Banking and Financial Services on H.R. 1062, The Financial Services Competitiveness Act of 1995, Glass-Steagall Reform, and Related Issues (Revised H.R. 18), 104th Cong. 1st Sess. 274 n.30 (March 7, 1995) (Statement of SEC Chairman Levitt). See also Hearings Concerning H.R. 1505, H.R. 6 and H.R. 15 Before the Subcommittee on Financial Institutions Supervision, Regulation and Insurance of the House Committee on Banking, Finance and Urban Affairs, 102d Cong., 1st Sess. 241-44 (April 30, 1991) (Statement of SEC Chairman Breeden).
5Other legislation proposes that the Federal Reserve Board ("FRB") act as superregulator of the new financial services holding company and its component firms pursuant to a statutory scheme addressing, and often granting the FRB broad discretion over, a host of matters ranging from capital standards and prior notice and approval obligations to direct reporting requirements. For the reasons explained in the Appendix to this testimony, however, the Institute believes that an oversight system based on a consolidated bank holding company supervision oversight model is inappropriate in the context of a financial services holding company owning both bank and a wide range of non-bank subsidiaries.
6See, e.g., §§ 114(h)(1), 102(m)(2), (4), (5) (authorizing NFSC to establish principles and standards applicable to reporting, examination and supervision of all "financial services institutions" (defined to include broker-dealers, investment companies and investment advisers) that are regulated by NFSC member agencies); 104(c) (NFSC oversight of affiliate transaction rules and exceptions); 121(c)(7) (NFSC oversight of securities coverage exceptions); 122(o) (NFSC oversight of securities affiliate rules and exceptions).
7See, e.g., §§ 104(d) (bank extensions of credit to non-financial affiliates); 123 (unregistered bank retail securities sales).
8See, e.g., §§ 104(b) (affiliate transaction restrictions); 109 (exclusivity of reporting mechanism); 109(e) (enforcement against financial services holding companies); 110 (divestiture); 111(c) (false statement in financial service holding company records); 112(l)(4), (l)(5) (securities affiliate examination); 122(c),(i), (l),(k) (securities affiliate safeguards).
9Remarks by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the 31st Annual Conference on Bank Structure and Competition (May 11, 1995).
10 Rule 337.4 under the Federal Deposit Insurance Corporation Act (12 C.F.R. 337.4).
11 See, e.g., H.R. Conf. Rpt. No. 864, 104th Cong., 2d Sess. 2-3 (September 28, 1996); H.R. Rep. No. 622, 104th Cong., 2d Sess. 16-17 (June 17, 1996).
12 Hearings before the House Committee on Banking and Financial Services on H.R. 1062, The Financial Services Competitiveness Act of 1955, Glass-Steagall Reform, and Related Issues (Revised H.R. 18), Part 2, 104th Cong., 1st Sess. 273 (Mar. 7, 1995) ("march 1995 Hearings") (Statement of SEC Chairman Levitt).
13 See, e.g., Coffee, Competition Versus Consolidation: The Significance of Organizational Structure in Financial and Securities Regulation, 50 The Business Lawyer 447, 456 (1995).
14 See Hearings on H.R. 1062 before the House Comm. on Banking and Financial Services, 104th Cong. 1st Sess. 138-39 (February 28, 1995) (Statement of Alan Greenspan, Chairman of Board of Governors of the Federal Reserve System); Remarks by Alan Greenspan, supra, at note 1.
15 Franklin R. Edwards, The New Finance 162 (AEI Press 1996).
16 U.S. Department of the Treasury, Modernizing the Financial System: Recommendations for Safer, More Competitive Banks (Feb. 1991) at 61 (emphasis in original).
