Regulatory revolution needed to keep pace with change

Financial markets have undergone tremendous change over the past two decades. New York was once the capital market of choice. Now, domestic and international firms can access capital in an increasing number of liquid, sophisticated, and well-run market centers throughout the world. Investment and commercial banks are no longer the only sources of financing as hedge funds, venture capital and private equity firms have become important sources of capital.

Change is also evident in our own domestic markets. Many of our stock exchanges are now for-profit entities. They are, like their listed members, publicly traded corporations. And the traditional ways of conducting transactions are in decline. Most of the world’s floor-based stock exchanges, such as the New York Stock Exchange, are moving to platforms where buyers and sellers meet electronically.

There has also been considerable innovation in the kinds of instruments being traded in our markets. Options, swaps, exchange-traded funds, derivatives, even good old-fashioned debt and equity products are increasingly complex.
Lending has also changed significantly. In the past, unique banking charters were created to meet specific lending needs: thrifts for mortgages and commercial banks for business and general consumer lending. These institutions provided credit through local branches with highly personalized underwriting guidelines. Over time, however, the differences between commercial bank and thrift charters have narrowed. In addition, deregulation and the development of a national consumer credit system have allowed banks to provide credit cards, mortgages and commercial loans on a national basis.

In short, almost every aspect of our financial markets has changed dramatically. Despite these changes, however, our financial regulatory structure has remained relatively static.

The Securities and Exchange Commission (SEC) is the primary regulator of U.S. capital markets. Congress established the SEC in the 1930s and its basic structure has been in place for decades. The Commodity Futures Trading Commission (CFTC)  was created to oversee trading in futures contracts of physical and agricultural commodities such as crops and livestock. Today, the CFTC oversees a sophisticated financial-derivatives and futures market with a nominal value in the trillions of dollars.

U.S. banks are regulated by a dual system comprised of five agencies at the federal level and numerous agencies at the state level. Over the years, different regulators were created to supervise the diverse bank charters, each of which was originally designed to serve a different end with powers narrowly tailored to that end.

Unlike other financial institutions, the insurance industry is regulated by the states. Although the state-based system dates back to the 1800s, Congress formally delegated insurance regulation to the states in 1945. Consequently, each state, U.S. territory, and the District of Columbia has its own insurance department that licenses and regulates the insurance companies, the products they sell and the agents and brokers operating within their borders. The state-based system has many strengths, but it does not always accommodate the complexities of a national insurance market.

Strong financial markets are crucial to overall economic performance. Indeed, the preeminence of our markets has been essential to our sustained economic growth. Three recent studies, including one conducted by the U.S. Chamber of Commerce Commission on the Regulation of the U.S. Capital Markets in the 21st Century, have identified, however, that our capital markets are facing increasing global competition. Further, each study indicated that regulatory complexity and inefficiency are key factors with respect to market competitiveness. In light of these findings, policymakers must understand that the markets themselves are now in competition and that the best-regulated markets are going to attract the most business.

Economic competition generates innovation and change because that is the nature of a free-market system. Unfortunately, our public sector is not nearly as responsive to market forces. Sometimes that is a good thing. When it is not, it is incumbent upon us to reexamine the regulatory institutions and structures that have begun to lag behind the industries they regulate. In my opinion, that time has come for the regulators of the financial-services industry.

Shelby is the ranking member of the Senate Banking, Housing and Urban Affairs Committee.


SPECIAL REPORT: CAPITAL MARKETS
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