In a bid to quash Wall Street excesses that nearly caused the collapse of the U.S. financial system, the Obama administration will propose tough restrictions on financial firms, hedge funds and derivatives markets.
The U.S. Treasury will work with Congress to form a powerful systemic risk regulator with the authority to look deep into financial firms other than banks, such as hedge funds and private equity companies, administration officials said on Wednesday, speaking on condition of anonymity.
U.S. Treasury Secretary Timothy Geithner will outline the plans in testimony before Congress on Thursday, and the proposals will form the basis for discussions on regulatory reform when President Barack Obama meets with leaders from the Group of 2O rich and developing nations on April 2.
The U.S. plan does not specify which agency should take on the role of risk regulator to spot potential threats to the financial system. The decision on which regulator should play that role will be made in consultation with lawmakers, the officials said.
The proposals are part of a tough regulatory response by the Obama administration to the 18-month-long financial crisis. In coming weeks it will detail investor and consumer protection rules and plans to work with other countries to set global rules.
"The crisis has made clear that certain large, interconnected firms and markets need to be under a more consistent, and more conservative regulatory regime," one of the officials said.
On Tuesday, U.S. Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke told Congress they want authority to seize control of failing institutions such as American International Group to avoid bankruptcies. The government has the power to swiftly shutter commercial banks.
The proposals to be detailed on Thursday seek to shine a spotlight on hedge funds and other private pools of capital and are likely to prove controversial. The administration wants to require advisers to hedge funds, private equity funds and venture capital funds to register with the U.S. Securities and Exchange Commission if their assets exceed a to-be-specified amount.
These advisers should be subject to investor and counterparty disclosure requirements and regulatory reporting that would include information necessary to assess how much debt they are taking on and whether they pose a threat to financial stability.
The Obama administration also plans to regulate credit default swaps and over-the-counter derivatives for the first time, forcing all standardized OTC derivatives contracts to be cleared through central counterparties, officials said.
BIG, LEVERAGED, INTERDEPENDENT
Systemically important firms would be defined in conjunction with Congress, but among the determining factors would be size, leverage, interdependence with other firms, reliance on short-term funding and role as a source of credit for households, businesses and governments.
Capital requirements for such firms must be more conservative than for other institutions and be sufficiently robust to withstand a wider range of "deeply adverse" economic scenarios than is typically required, the officials said.
The systemic risk regulator would get powers to order prompt corrective action if capital levels decline -- similar to those the Federal Deposit Insurance Corp, a U.S. bank regulator.
Despite the strong prescriptions to increase scrutiny and capital requirements, the Obama administration signaled some flexibility on accounting, with the officials saying that fair value accounting rules should be reviewed with the goal of identifying changes that could reduce wild swings in profit and capital levels as markets move up and down.
Bank balance sheets have been squeezed as markets have fallen, reducing the value of investment holdings, while many complex securities on banks' books are now nearly impossible to value because there is no market for them.
The officials also said accounting for loan loss reserves should be revised to account for losses throughout the business cycle to ensure that they are adequate.