Many Bullets Dodged In Financial Services Reform 

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WASHINGTON

As 2009 ended, the outlook was for financial services reform to be potentially far less disruptive to the industry than projected even as late as mid-year.

That was when the Obama administration—with the support of the House Financial Services Committee--proposed legislation that for one would include new oversight by a Consumer Financial Protection Agency.

And that was less than a year after one of the greatest downturns in U.S. economic history, including the need for the U.S. government to provide more than $180 billion at one point to keep American International Group from failing, prompted calls for a wholesale remaking of the financial services regulatory landscape.

Through intense lobbying, the industry won a carve-out that exempted all state-regulated insurance companies from its oversight. The language exempting the industry from this proposed agency’s authority is quite broad.

Other new overlays that were envisioned included oversight by federal regulators on top of existing state regulation; a clearinghouse for all derivatives trading that would have radically impacted the current system of customized derivatives that reflected the need of insurance companies to hedge financial instruments with a long shelf life.

Another concern was legislation that would have given federal regulators the authority to use the assets of operating insurance companies as well as their troubled holding companies to pay for liquidating it. This legislation would also have affected the current guaranty system used to resolve troubled insurance companies.

House legislation that was scheduled to be on the floor in December either removed or significantly diluted these provisions.

And, legislation that would create a Federal Insurance Office with strong powers, especially on trade issues, particularly on prudential agreements, and state laws that conflicted with international agreements have also been watered down to provide the proposed agency with far less authority than originally envisioned by the Obama administration.

The industry is still fighting a provision in authority that seeks to bar federal regulators from propping up large, financially-troubled financial institutions by requiring other large institutions to contribute to a fund that would be used to resolve the troubled firms.

The pre-funding power was included in the House bill on the floor, although the threshold for institutions tapped to contribute to the fund has been raised from $10 billion to $50 billion.

At the same time, the industry is fighting any bill that provides pre-payment authority to a federal agency. Insurance trade groups have joined a coalition that includes trade groups representing mutual funds, securities firms and an umbrella organization that represents large financial services firms of all stripes to lobby against a pre-funding mechanism.

And, all of these provisions are included in H.R. 4173, the Wall Street Reform and Consumer Protection Act of 2009, that the House passed on Dec. 11. Senate staffers and industry lobbyists say members of the Senate Banking Committee are making strong progress in drafting bipartisan legislation more amenable to the industry that the committee hopes to unveil before the Senate leaves for its Christmas recess.

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It is clear, however, that both the House and Senate will include in their reform plans provisions that will create a Federal Insurance Office within the Treasury Department and give the government broad authority to deal with troubled financial institutions, including insurers.

The House version is Title VI of H.R. 5173.

As passed by the committee, the FIO will have no authority to regulate insurers, and its ability to negotiate international agreements, as originally proposed, will be watered down significantly in the final bill.

A manager’s amendment requires the proposed FIO to share the authority to negotiate international agreements with the Office of the U.S. Trade Representative.

Moreover, any agreements reached would only be effective after a “layover” period in which time Congress would have the authority to take action.

The manager’s amendment also provides for review in federal court for challenges brought against federal preemption of state insurance regulations.

Another amendment adopted by the committee would require the new agency to study and report to Congress in one year on how to modernize and improve the system of insurance regulation in the U.S.

The bill also provides for review in federal court for challenges brought against federal preemption of state insurance regulations.

Another amendment adopted by the committee would require the new agency to study and report to Congress in one year on how to modernize and improve the system of insurance regulation in the U.S.

The study would measure progress against the Obama administration’s six principles for insurance regulatory reform. 

At the same time, Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, said during debate on the measure that creating an optional federal charter for insurance remains on the table, and the committee will hold hearings on bills creating such a charter in the spring.

As for the systemic risk legislation, Title I of the House bill, prompted in part by the need for the federal government to bail out AIG, it creates a council of federal regulators headed by the secretary of the Treasury to recommend to the Federal Reserve Board stronger supervision of systemically risky institutions.

It grants authority to the Federal Deposit Insurance Corporation to create a fund that will be used to dissolve large, troubled financial institutions without federal assistance.

It also requires that financial institutions, including insurers, with assets of more than $50 billion contribute to a fund that would be used to liquidate troubled financial firms taken over by the FDIC.

At the request of the insurance industry, an amendment was added that says the assessments are to be based upon a "risk matrix" that "takes into account" the risks presented to the financial system.

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Another gives the Systemic Risk Council the authority to monitor international regulatory developments including those developments relating to insurance and accounting.

Another amendment mandates that the domiciliary state regulator be involved in any federal regulatory decision involving higher prudential supervision of an insurance company and whether or not to subject an entity that includes an insurance company to the FDIC's resolution authority.

The insurance industry also won an amendment that transfers authority over insurance companies that own thrifts to the Federal Reserve Board from the Office of Thrift Supervision.

The greatest industry concern is about language in what is now Title V of the House bill and is also included in draft legislation proposed by Sen. Chris Dodd, D-Conn., chairman of the Senate Banking Committee.

It would give the Securities and Exchange Commission discretionary rulemaking authority to harmonize the standard of care investment advisers and brokers and dealers must provide to their customers when selling investment products.

Agents’ trade groups, while winning some concessions in the language of the bill, especially the limitations on a proposed safe harbor for insurance agents, still believe it will have a major impact on sales of investment products by agents, and would provide little benefits to consumers.

Officials of the American College, which provides continuing education to investment advisers, including those who sell insurance products, called the provision “a radical departure from current law.”

In a letter to Dodd, officials of the American College said that, “A ‘one-size-fits-all’ approach has the potential to damage consumer choice and access while not enhancing consumer protections at all – an unintended outcome that could echo some of the legislative disasters the United Kingdom has enacted in financial services over the past few decades.”

At the same time, several insurance agents’ trade groups said Sec. 913 of the Dodd draft would force life insurance agents who already are qualified as registered representatives and supervised by the SEC and the Financial Industry Regulatory Authority to register as investment advisers -- and “thereby take on more responsibilities, more expenses, and more liability.”

The provision, if enacted “would force thousands of our members to limit the product choices available to their customers, the majority of whom are middle-market consumers who look to us for insurance and retirement products,” the letter said.

The letter argues that Sec. 913 “would force virtually all broker-dealers, including life insurance agents who qualify as registered representatives of broker-dealers for purposes of offering variable and other investment products, to register as investment advisers.”