2016 Regulators’ Agenda

Published March 2, 2016

T H E Y E A R A H E A D I N F I N A N C I A L R E G U L AT I O N

22016 Regulators’ Agenda

In a Washington courtroom in early February, the attorney for one of America’s largest financial institutions issued a broadside against the country’s top regulators—and a core policy adopted in the wake of the financial crisis.

The government’s decision to impose burdensome new controls on MetLife Inc.—due to a belief the insurance giant could destabilize global markets—was heavy-handed, capricious over-reach, rooted in “unfettered speculation,” said Eugene Scalia, son of the late Supreme Court justice. He asked the judge to curb the regulators’ new powers, a ruling that could undermine the broad discretion officials have felt is necessary to fend off a new calamity.

At a Washington think tank six days later, a newly appointed financial policy maker delivered a widely cited speech also attacking the postcrisis framework built by the 2010 Dodd-Frank Act—not for doing too much, but too little.

“I believe the Act did not go far enough,” said Neel Kashkari, the new president of the Federal Reserve Bank of Minneapolis. Big financial institutions, he said, “continue to pose a significant, ongoing risk to our economy,” he added, vowing to launch a public campaign for still-stricter controls.

The dueling viewpoints underscore an unnerving reality facing the financial industry at the outset of 2016: a persistent disagreement of the real causes, and proper cures, of the last

disaster, coupled with continuing uncertainty over the immi-nence, and potential trigger, of the next one. It is a year of volatility—in global markets, in rulemaking and in the politics that will shape the landscape in 2017 and beyond.

In the U.S., banks are braced for more pressure, direct and indirect, to shrink their businesses, while asset managers and insurers face unprecedented federal oversight. America’s newest regulator, the Consumer Financial Protection Bureau, will craft rules for a range of sectors that have until now largely been left alone by Washington, from payday lenders to debt collectors.

In Europe, policy makers will struggle to push ahead with plans to unify oversight of banks and capital markets. In China, officials will try to find a way to create a modern regulatory structure while containing wildly flailing markets. Officials all over the world will wrestle with the transformative force of fin-tech, and how best to foster innovation while trying to preserve and extend core protections for consumers and investors.

The backdrop: the most unpredictable American election in memory, where the debate is driven by an ad-libbing, blunt-spoken billionaire with no clear policy track record or platform, and a Wall Street-bashing democratic socialist.

Read our roundup of the big questions for key sectors and regions for 2016. — BY JACO B M . SCH LE SIN GER

THE YEAR AHEAD IN FINANCIAL REGULATION

THE GLOBAL OUTLOOK FOR 2016 ACROSS KEY SECTORS AND ECONOMIES

32016 Regulators’ Agenda

More Pressure to Shrink

BY RYAN TR AC Y

Big banks are bracing for another year of mounting regulatory pressure aimed at forcing them to consider getting a bit smaller.

The Federal Reserve has a crucial decision to make, expected in the second half of the year, regarding its annual stress tests and whether it will incorporate a new capital requirement that will make it much harder for the big banks to pass at current asset levels.

U.S. regulators will also render their verdict on banks’ “living will” bankruptcy plans early in 2016, potentially creating another significant regulatory headache for the very largest institutions. Big banks must show they can do what many consider impossible: file for bankruptcy without causing mass financial panic. Any bank that can’t craft a “credible” living will during the next few years faces the threat of higher capi-tal requirements, forced divestitures or other sanctions.

Globally, regulators are negotiating changes to the calculation of capital requirements, including a “trading book” review that could raise the costs of running a trading operation at a large bank. Meanwhile, lenders of all sizes face new chal-lenges to standard business lines.

The Consumer Financial Protection Bureau is working on rules related to overdraft fees and financial dispute arbitra-tion that will have broad implications for lenders.

And banks are uncertain over how the rules will be enforced: How hard will examiners push them to tighten lending standards on commercial real estate and other sectors, given recent regulatory statements of worry about credit risk? How much more will they need to spend on costly upgrades to anti-money-laundering and cybersecurity systems?

Amid all this, there remains a group of regulators and politi-cians who question whether existing overhauls are sufficient to end the perception that some banks are “too big to fail” and that taxpayers will bail them out if they get into financial trouble. Crushing that perception has been a core goal of pol-icy makers since the crisis, but populist anger about the 2008 bailouts remains, as does a substantial debate about whether banks would be given a lifeline again.

Neel Kashkari, the new president of the Federal Reserve Bank of Minneapolis, began his term—and the year—with a bang, declaring in a February speech that the 2010 Dodd-Frank Act

“did not go far enough,” adding, “I believe the biggest banks…continue to pose a significant, ongoing risk to our economy.”

Mr. Kashkari announced a plan to use his organization for a study of new policies to do more to rein in the largest financial institutions, aiming to deliver a proposal by the end of the year—with the goal of keeping pressure mounting through 2016 and into 2017.

BANKS

42016 Regulators’ Agenda

Is Regulation a Solution or a Cause?

BY AN DR E W ACK ER M AN AN D RYAN TR AC Y

Sharp volatility and a series of dramatic trading glitches have marred global financial markets in recent months.

Now, regulators are wrestling with what, if anything, they need to do to make markets work better for investors, and keep the shocks from turning into systemic risks. Debate over these issues will consume the top market overseers in 2016.

Analysts generally attribute the swings to uncertainty trig-gered by China’s messy slowdown and the Federal Reserve’s slow pivot to higher interest rates.

But many also see additional causes outside the routine ups and downs of economies and central banks. Superfast trading has expanded beyond stocks and has come to dominate more asset classes. The size of the investment-fund industry has grown to unprecedented levels, while bankers who used to be at the center of financial markets are pulling back from their traditional role.

In short, markets appear to have changed in fundamental ways, and investors and regulators are trying to figure out what to do about it.

Complicating their calculations: Some say regulation, rather than fixing the problem, is making it worse. Critics say tighter limits on banks hamstring their trading, fueling price swings—and driving risk-taking into new and sometimes opaque unregulated corners of finance.

One incident drawing continued regulatory scrutiny: the events of Aug. 24, 2015, when automatic halts of stocks known as circuit breakers were triggered en masse after prices plunged that morning due to uncertainty over China’s economy.

Dozens of exchange-traded funds, or ETFs—a popular form of investment in which baskets of stocks and other assets are packaged to facilitate easy trading—also traded at sharp discounts to their components’ worth, worsening losses for many fundholders who sold during the panic. Nearly 20% of all ETFs trading on the morning of Aug. 24 exhibited abnormally high volatility, while over 40% of the 499 ETFs invested in U.S. stocks saw trading temporarily halted after sharp price swings, according to the Securities and Exchange Commission.

For some at SEC, these statistics beg for closer scrutiny and perhaps new rules.

“We need to take a holistic look at these products, their transparency, and how they interact in our capital markets,” SEC Commissioner Kara Stein, a Democrat, said at a securi-ties conference in February. She added the risks tied to some new ETFs “may not be fully understood by those who have invested in them.”

It’s unclear what policy changes, if any, the agency will embrace, though its staff continues to examine the volatility of Aug. 24. An advisory panel on market structure convened by the SEC about a year ago is also studying the incident.

Concerns about volatility and market shocks aren’t limited to the stock market. In January, U.S. officials asked for feedback about new monitoring and potentially new rules for the Treasury market, following their investigation into a highly unusual price swing in late 2014 that has been dubbed a “flash rally.” This year, they will likely make more formal decisions about what shape those changes should take.

Meanwhile, researchers and policy makers across the globe are probing the causes of similar sudden price swings, such as a selloff in German government bonds in May 2015.

The turmoil has continued into 2016. On Feb. 11, unusual volatility hit a popular derivative used to bet on central-bank interest-rate moves, the latest sign of markets reacting in unexpected ways under stress.

MARKET TURMOIL

52016 Regulators’ Agenda

Expanding the Regulatory Net

BY Y U K A HAYA SHI

The nation’s youngest financial agency is racing to beat the clock.

With the implementation of a pair of far-reaching rules aimed at better protecting mortgage borrowers in 2015, the Consumer Financial Protection Bureau completed its pri-mary tasks mandated by the 2010 Dodd-Frank law to upgrade basic rules for consumer protection.

Now the four-year-old agency is trying to shake things up in a broader range of sectors previously untouched by federal regulators.

The CFPB has a long list of rules it hopes to complete in 2016. Within the next few months, it wants to roll out the first com-prehensive federal rule to rein in high-interest payday loans.

Later this year, it plans to come up with a blueprint for polic-ing practices of debt collectors, and make it harder for banks to slap hefty overdraft fees on checking accounts.

Perhaps its biggest challenge comes with its effort to curb mandatory arbitration, a widely used tool designed to keep consumers from suing service providers like banks and mobile-phone companies. The bureau plans to issue an initial proposal on arbitration later in the year.

Speed is critical for the CFPB. The agency, created in the aftermath of the financial crisis as a brainchild of Sen. Elizabeth Warren (D., Mass.), a leading Wall Street critic, has been the target of attacks from the financial industry and Republican lawmakers, who see it as a symbol of overregula-tion and sometimes-questionable enforcement tactics.

A Republican victory in this year’s presidential election could significantly change the shape of the bureau and curb its powers.

And even before the election, the agency’s opponents have taken to the courts seeking to challenge its unusually broad authority. A closely watched legal battle is looming over the bureau’s handling of a decades-old mortgage law and the unusually wide latitude wielded by director Richard Cordray. The official sits atop the bureau’s single-director structure, which gives him considerably more power than his counter-parts at committee-run regulators such as the Securities and Exchange Commission. A hearing is scheduled for April 12 in a case that pits the CFPB against New Jersey lender PHH Corp. A broad coalition of business and conservative groups, from the U.S. Chamber of Commerce to home builders, have filed briefs in support of PHH, seeing the case as a chance to impose constraints on the CFPB.

Meanwhile, the CFPB continues to bring enforcement actions at a vigorous pace. In 2015, the bureau handled 59 cases in which companies settled allegations of wrongdoing and 11 cases that led to lawsuits. That was roughly double the caseload of 2014.

Friends and foes of the CFPB agree on one thing: The agency has done a lot in its short existence. Since its creation, it has handled more than 770,000 complaints and provided more than $11 billion in compensation for alleged damages to more than 25 million consumers

CONSUMER FINANCE

62016 Regulators’ Agenda

Bashing Wall Street

BY JACO B M . SCH LE SIN GER

When the 2016 presidential campaign was just getting under way, the smart money forecast a race between Republican Jeb Bush and Democrat Hillary Clinton. A contest between two veteran politicians friendly to Wall Street would have symbol-ized a kind of return to political normalcy for the financial industry, suggesting the public’s impassioned hostility had finally cooled eight years after the crisis.

Instead, the lingering embers of anti-Wall Street sentiment have burst back into flames, fueling a very different kind of campaign.

The former Florida governor’s candidacy is dead, crushed by billionaire businessman Donald Trump’s full-throated, populist appeal to millions of angry voters feeling left behind by the tepid postcrisis recovery. The former secretary of state has been put on the defensive by democratic socialist Sen. Bernie Sanders, who frequently attacks her ties to Goldman Sachs Group Inc., and whose popular stump lines include calls to break up big banks and a declaration that “the busi-ness model of Wall Street is fraud.”

At a minimum, that has created tremendous uncertainty over who the next president will be, and how his or her adminis-tration will approach the financial industry. A Wall Street nightmare would be an antagonistic President Sanders, or even a President Clinton forced to distance herself from the sector and backed into calling for a fresh financial crackdown

Much will hinge on who runs the new Congress. Even a landslide Democratic victory in November would likely leave the House under GOP control. And for all the anti-Wall Street feeling among the electorate, House Republicans remain inclined to support rolling back postcrisis regulations, not expanding them. They will be the financial industry’s firewall against expansive new rules.

But Senate control could swing with the presidential cam-paign, giving the next administration flexibility to win confirmation for nominees to carry out the president’s agenda, based on postcrisis rules that already give financial regula-tors tremendous discretion.

CAMPAIGN 2016

72016 Regulators’ Agenda

Volatility Accelerates Regulatory Overhaul

BY L IN GLIN G WEI

China faces the daunting task of ensuring coherent and efficient financial supervision to fend off rising risks in the country’s banking system and overall economy.

One of the top economic priorities for the Chinese leadership is better coordination among its various financial regulators, according to their new five-year blueprint, which starts this year and runs through 2020. The country’s slowing economy, volatile capital markets and mounting bad-debt levels have made it urgent for Beijing to overhaul financial regulation.

The authorities have so far disclosed scant details of how they will carry out the overhaul, which seems to parallel the regulatory shake-ups in the U.S. and Europe following the financial crisis.

According to officials close to the leadership’s thinking, the plan centers on giving the central bank the leading role in assessing and guarding against risks in the entire financial system. Already, the People’s Bank of China is in the process of rolling out a comprehensive risk-assessment framework to monitor a broader swath of credit and thereby manage the country’s overall financial stability, according to a cen-tral-bank statement in late December. Most recently, China’s leadership named a central-bank veteran as the country’s new securities cop, another sign of its intention to give the central bank the most prominent role in the regulatory refurbishing.

Currently, different regulatory agencies oversee Chinese banks, securities firms, insurers, asset managers and other financial institutions. Competition between those agencies and a lack of coordination contributed to a surge in risky lend-ing practices in the past few years and to both a stock-market rout and a ham-handed rescue effort this summer.

The best option for China’s regulatory restructuring is to “strengthen the central bank’s role” in supervising the financial system, wrote Li Bo, head of the central bank’s monetary-policy department, in a recent article. In doing that, China is nodding to the British model, where the Bank of England is responsible for ensuring overall financial stability.

Speculation also abounds that the leadership will create a new “super-regulator” by merging existing agencies. Some senior Chinese officials have dismissed that as impractical, at least in the near term, because it would require some powerful officials to cede turf and could create a bureaucracy too large to govern effectively.

The new assessment framework to be introduced by the central bank this year will expand significantly the variety of financial products under its supervision. The central bank is now mainly responsible for managing loan growth and market liquidity levels, leaving regulating specific products like stocks and bonds to other agencies.

The framework will shift the central bank’s focus “from loans, which are narrowly defined, to credit in a broader sense,” it said in the December statement.

CHINA

82016 Regulators’ Agenda

Fitful Moves Toward Banking, Market Unions

BY VIK TO RIA DEN DRINO U

European regulators hope this year to move toward comple-tion of a eurozone banking union, while advancing their goal of more unified capital markets across the continent.

They have already taken big steps on the first task, with two new bodies sharing responsibility for supervising major banks and winding them down when they get into trouble.

In 2016, the discussion will shift to the question of creating a joint deposit-insurance system, which inflames many of the same tensions between the bloc’s core countries and their indebted neighbors that have buffeted the continent through the sovereign-debt and banking crises of the past six years. The European Commission, the European Union’s execu-tive arm, launched a proposal in November that suggested eurozone countries should gradually pool their national deposit-insurance funds over the next nine years.

An agreement seems unlikely, given pushback from Germany and other rich countries, which fear joint deposit insurance would make them pay for the financial problems of their struggling neighbors.

The deposit debate has also forced discussion of another sticky matter: how to break the risky interdependence of Europe’s banks and sovereign borrowers. Germany and oth-ers say they are loath to insure continental banks that invest heavily in bonds from governments with shaky finances. But Italy and France worry that curbing such bank bond-buying may hurt the ability of their governments to borrow, under-mining their economies.

Under international capital rules, sovereign exposures are considered zero risk, allowing lenders to pile them up without holding extra safety buffers.

Jeroen Dijsselbloem, the Dutch finance minister who presides over meetings of his eurozone counterparts, told The Wall Street Journal in January that he would push for an agreement this year to cap the amount of government bonds eurozone banks are allowed to hold—a move that could lead banks to reduce holdings in coming years.

This year could also bring the first test of new EU rules governing bank failures that took effect in January and are designed to protect taxpayers and impose losses on investors, creditors and uninsured depositors.

While moving ahead with new banking rules, Europe could this year review some others proposed in the wake of the financial crisis, part of an EU effort seeking public feedback on the intended—and unintended—consequences the latest financial rules have had on the economy. Officials will decide in 2016 whether some of them need to be recalibrated.

The industry has largely focused on proposed legislation currently stuck in the European Parliament that could separate banks’ retail operations from investment banking, and on new financial-market overhauls aimed at curbing risky securities trading behavior. The industry says those rules could hinder market-making.

As part of the EU’s plan to boost capital markets across the continent—the Capital Markets Union—the bloc’s finan-cial-services chief, Jonathan Hill, will this year continue with a series of incremental steps, including proposing legislation aimed at aligning insolvency proceedings better across the EU. The November attacks in Paris have also pushed terror financ-ing to the top of this year’s agenda. By this summer, the EU will propose ways to better track and freeze terrorist financing across the bloc. Under the plan, anonymous payment methods including virtual currencies, such as bitcoin, and prepaid cards will be regulated so their users can be identified.

This year may also see the collapse of Europe’s plan to tax financial transactions. The governments that remain on board reached a compromise on some aspects of the levy in December and gave themselves six more months to agree on the remaining key issues, including the tax rate and how to use the proceeds. But trouble looms for the project, as Belgium has already signaled it wants out. The initiative will die if one more government drops out.

This year may also see the collapse of Europe’s plan to tax financial transactions. The governments that remain on board reached a compromise on some aspects of the levy in December and gave themselves six more months to agree on the remaining key issues, including the tax rate and how to use the proceeds. But trouble looms for the project, as Belgium has already signaled it wants out. The initiative will die if one more government drops out.

EUROPE

92016 Regulators’ Agenda

The Next Target

BY AN DR E W ACK ER M AN

The demise of a Third Avenue Management LLC junk-bond fund in December added fuel to regulatory concerns that the asset-management industry is vulnerable to stresses that could destabilize markets—and gave momentum to an effort by the Securities and Exchange Commission to boost oversight of the sector in 2016.

This is one of the main lingering holes in the net regulators have tried to weave since the financial crisis. Officials have imposed strict new oversight of big banks and insurers, but the $85 trillion asset-management industry, which includes mutual funds and exchange-traded funds, has largely been left alone. That will likely change this year—though not as much as some critics would like.

Observers say SEC Chairman Mary Jo White’s package of ini-tiatives is partly designed to protect the agency’s turf against the Federal Reserve and other policy makers who view the agency as acting too slowly to address potential risks in the markets it oversees. That gives the asset-manager initiative added impetus through a fractious commission.

On that goal, the SEC appears to have succeeded. For a period of time, the Financial Stability Oversight Council—a panel that includes the SEC and the Fed but is chaired by the Treasury Department—had indicated an interest in desig-nating large asset managers for stricter federal oversight, the way it did for big insurers. But that effort appears to have receded, and the group will likely this year affirm a decision to leave that sector to the SEC.

Ms. White’s plan would significantly boost the volume of data the agency collects from the industry. Under the SEC initia-tive, mutual-fund firms such as Fidelity Investments and BlackRock Inc. would have to give regulators more detailed and frequent information about the assets in their funds.

The SEC unanimously proposed the enhanced data require-ments in May. The final rules, which could come by this summer, are expected to include requirements that funds report on their use of complex and potentially risky deriv-atives products, data that aren’t frequently or consistently captured by the SEC.

While the SEC and the asset-management industry gen-erally back the additional data rules, it is unclear whether Ms. White will have sufficient support to advance two other rules the agency floated last year. One would require funds to create a plan showing they could meet a sudden surge in shareholder redemptions during a time of stress. The Third Avenue junk-bond fund’s inability to do so raised regulator concerns. Another would restrict the use of complex deriva-tives products in funds sold to the public.

The fund industry is opposed to aspects of both these proposals, saying they are too cumbersome. Michael Piwowar, the SEC’s lone Republican commissioner, has said the agency shouldn’t finalize them until after it completes the enhanced data-reporting rules and begins collecting the additional information from funds. That timetable that would likely push the tougher measures into 2017—and a new administration.

ASSET MANAGERS

102016 Regulators’ Agenda

Which Rules Apply?

BY RYAN TR AC Y

Financial technology is evolving by leaps and bounds, chal-lenging conventional banking institutions. Just ask the bank executive whose daughter is using PayPal Holdings Inc.’s Venmo app to send money to her friends, rather than relying on the app offered by her father’s employer.

So far, regulators have mostly taken a hands-off approach to the transformation roiling the financial sector, allowing inno-vation to play out while they watch from the sidelines. Will 2016 be the year they step in and regulate new entrants with the same rigor they apply to the traditional banking sector?

The banking industry, for its part, is stepping up its campaign for more scrutiny. “Payments should be subject to a consis-tent supervisory treatment, regardless of what entity handles them—and likewise for loans, deposits and any other financial product,” Rob Nichols, president of the American Bankers Association, wrote in the American Banker trade publication on Feb. 18. “Bank compliance with consumer protection laws is enhanced by the supervisory relationship with regulators, which nonbanks—even though subject to many of the same laws—do not have,” he added.

New entrants generally say that their innovations benefit consumers and that they comply with applicable rules.

A raft of new standards is unlikely in the U.S. during a presi-dential election year, when regulators may not want to issue major rules before a new administration takes office. But 2016 will still be significant as a year when precedents are set that will shape the industry’s reputation—and the next adminis-tration’s agenda.

President Barack Obama’s Treasury Department has been asking questions about marketplace lenders such as Lending Club, which have been making inroads offering loans online to consumers and small businesses, evaluating borrowers with advanced computer algorithms and selling the loans to Wall Street.

But the Treasury Department hasn’t recommended any new regulations. That could change under a new president if concerns emerge about whether these lenders offer sufficient protections against scams or hacking that regulators usually require from the financial institutions they oversee. Congress is already reviewing an online loan made to a California ter-rorism suspect. In the coming weeks, the Supreme Court will decide whether it will hear Madden v. Midland, a case with the potential to shape legal restrictions for marketplace lenders.

At the same time, some regulators are trying to offer assur-ances that they aren’t rushing to damp innovation. The Consumer Financial Protection Bureau will soon start accepting the first applications for “no-action letters” it has created to reduce uncertainty about whether financial start-ups will run afoul of consumer-protection laws.

The continued growth of blockchain and virtual-currency technologies, which use digital recordkeeping to quickly pro-cess electronic transactions, already has regulators’ attention, and that scrutiny could increase in 2016. Last year, as bitcoin and other currencies became part of the popular lexicon, reg-ulators extended their reach into the sector. Virtual-currency companies operating in New York now have to get a special license. Other states could follow suit, or adopt other new regimes for virtual currency companies, in 2016.

J.P. Morgan Chase & Co., the largest U.S. bank, is quietly test-ing blockchain technology on U.S. dollar transfers between London and Tokyo and may start using it for live transactions later this year. That would require regulatory approvals, which could take months.

At the federal level, rules unique to virtual currencies aren’t imminent and regulators are taking a “wait-and-see” approach. Instead, the key battleground is over the industry’s reputation. If the sector can convince policymakers of its value, it could potentially head off restrictive new rules. On this front, the perception that virtual currency can be used for money laundering is the industry’s biggest near-term hurdle. To avoid a crackdown, the industry will need to con-vince Washington that it is designing products that allow for the detection of criminals, rather than products that obscure illicit activity. In short, they will need to show they can follow the same rules as banks and other financial companies.

In 2015, the Treasury Department fined Ripple Labs Inc., a prominent bitcoin startup, for a faulty anti-money-launder-ing program. More enforcement actions of that sort could further hurt the industry’s reputation.

The Federal Reserve is also pushing ahead with its initiative to review and to speed up the antiquated U.S. payment system. It’s not clear yet whether this slow-moving initiative will include virtual currencies and blockchain, but the process will provide a basis for future federal policy.

FINTECH

112016 Regulators’ Agenda

New Curbs on Executive Pay

BY AN DR E W ACK ER M AN

One theme shaping the 2010 Dodd-Frank Act was the con-clusion that the financial crisis was partly fueled by distorted pay incentives. This year, the Securities and Exchange Commission aims to complete various rules mandated by the law that are meant to curb compensation packages some critics blame for encouraging excessive risk taking.

SEC Chairman Mary Jo White has said the rules, a com-bination of new investor disclosures and restrictions, are priorities in what is likely to be her final year at the helm of the U.S. markets regulator.

The rules include:

– Forcing companies to claw back, or revoke, some of their top officials’ incentive pay—such as bonuses tied to a firm’s performance—if the company has to restate financial results that led to the compensation

– Requiring companies to disclose whether employees and directors are allowed to hedge against declines in their companies’ stocks

– New disclosures designed to make it easier for share-holders to determine whether executive compensation is aligned with the firm’s financial performance

Another set of rules, which the SEC and bank regulators are expected to repropose after several year of dormancy, would require certain employees of Wall Street firms to hand back bonuses for egregious blunders or fraud. SEC staffer Thomas McGowan said at a securities conference Feb. 19 that the agency is “very actively” working on the rule with bank regu-lators. He offered no timetable for the expected reproposal.

The SEC has previously green-lighted “say-on-pay” votes that require companies to put executive-compensation packages to a nonbinding shareholder vote at least once every three years. The agency has also completed new rules requiring companies to disclose the pay gap between CEOs and their employees.

Critics say many of the rules are designed to shame executives rather than to provide investors with meaningful informa-tion about a company’s financial health.

The SEC is down to just three members—two less than its full complement—and advancing a handful of significant changes to corporate governance through a fractious commission will be difficult. In a January speech to a legal conference in California, Ms. White seemed to acknowledge it wouldn’t be possible to get everything done. “We’re obviously going to move as many of them as we can,” she said, according to a transcript of her remarks.

COMPENSATION

122016 Regulators’ Agenda

Battling Brussels and Washington

BY LE SLIE SCISM

Big American insurers face broad challenges this year from both Brussels and Washington.

Their most immediate concern is the European Union’s “Solvency II” regulatory approach, which kicked in Jan. 1 and

is rattling many U.S. insurers that operate internationally because it is unclear how the system will mesh with U.S. rules on a range of issues.

“It’s another layer of uncertainty” for American insurers, said Wallace Enman, a senior credit officer with Moody’s Investors Service.

In creating a unified framework across Europe, Solvency II aims to reduce insurers’ risk of insolvency by requiring them to have enough capital on hand to ensure they can cope with the worst expected losses with almost 100% certainty. Solvency II updates the decades-old Solvency I, which focused mainly on capital levels, and extends the regime to address governance, risk-management and public-reporting standards, among other features.

The EU is calling for “equivalent” regulatory oversight of non-European companies operating in its territory, but how and when it will address the equivalency of the U.S. system is unclear. U.S. insurers historically have been regulated by state insurance departments, which adopt model laws as crafted by a national standards-setting organization. Since the financial crisis, the Federal Reserve has taken on addi-tional oversight for some of the biggest insurers and those that own banks or thrifts.

“Thus far, the EU has not taken aggressive enforcement action on Solvency II, so we haven’t seen the real impact,” said Howard Mills, Deloitte’s global insurance regulatory leader and a former New York insurance superintendent.

U.S. insurers are in uncharted waters, whereas what they “really want and need is regulatory certainty,” Mr. Mills said.

The American and European industries aren’t really different. What’s problematic is that the U.S. has a well-established, complex, far-reaching, many-faceted state-based regulatory system, with the Fed layered in since the financial crisis. In some key ways, the goals across the Atlantic are similar, but the approaches are different enough that American insurers don’t want to be required to run two complex regulatory systems simultaneously.

“State insurance regulators regulate the largest, most vibrant and competitive insurance market in the world, and they have done so for over 150 years, constantly improv-ing it along the way,” said Thomas Leonardi, a senior advisor at investment bank Evercore and a former Connecticut insurance commissioner.

One possible solution: a negotiated settlement. On Feb. 23, the U.S. and EU said in a joint statement that their represen-tatives have agreed to move forward “efficiently and expedi-tiously” with talks to “improve regulatory and supervisory treatment for insurers and reinsurers operating on both sides of the Atlantic.” They didn’t set a timetable.

Meanwhile, the Fed, which historically has regulated banks, is expected later this year finally to begin unveiling rules for U.S. insurers that fall under its purview. That includes three that have been designated “systemically important financial institutions,” or SIFIs, under a process set up by the Dodd-Frank Act of 2010 to identify companies that could pose a risk to economic stability.

The rules are expected to include potentially stiff capital requirements for certain nontraditional insurance products, but the Fed has held its cards close to its vest so how they will shape up isn’t known.

The trio—American International Group Inc., MetLife Inc. and Prudential Financial Inc. MetLife—is challenging the designa-tion in federal court and a ruling is expected later this year.

The rules are having an impact even before they take effect, as executives and investors anticipate the fallout.

In January, MetLife announced plans to divest itself of a big chunk of its life-insurance operations, a move it said was driven by strategic and regulatory reasons.

AIG, meanwhile, has already shrunk to about half its pre-financial-crisis size by selling dozens of businesses and focusing on insurance. By late 2012, thanks to those moves, the company had fully paid back its nearly $185 billion U.S. government bailout. But now, AIG is under pressure from big investors to split into still-smaller companies as a way to get out from under its “systemically important” designation.

INSURERS

132016 Regulators’ Agenda

Reviving the Mortgage Market

BY JO E L IGHT

In the immediate aftermath of the financial crisis, top federal housing regulators worried about helping struggling borrow-ers threatened with foreclosure and punishing lenders seen as recklessly irresponsible. In 2016, they are more focused on broadening access to mortgages and getting more private investment into the market.

Early in President Barack Obama’s presidency, his admin-istration unveiled programs that tried to give struggling homeowners relief by changing mortgage terms to lower monthly payments, or to refinance at lower rates even when they normally wouldn’t be eligible.

Now, the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, said that this year would likely be the last the mortgage-finance companies participate in the program. The FHFA said that before the program expires, Fannie and Freddie will come up with long-term options to replace them, but they are likely to be less generous to borrowers.

In the meantime, the FHFA and the Federal Housing Administration, an agency that guarantees low-down-pay-ment mortgages, are continuing to work to try to persuade lenders to make more mortgages to riskier borrowers.

After the housing crisis, Fannie, Freddie and the FHA hit lenders with billions of dollars in penalties for mortgage-re-lated errors. That made some lenders uncertain of whether and when they might face penalties in the future, and they reacted by eschewing loans to less-creditworthy borrowers, even if those borrowers were eligible for government backing.

Fannie Mae and Freddie Mac concluded an effort to clear up those concerns earlier this year, a move that some lenders have lauded. On the other hand, the FHA is still trying to address the issue, and some lenders, frustrated with progress, have pulled back significantly from lending to some borrowers as a result. The FHA plans to release final guidelines by this spring.

Also to broaden mortgage access, the FHFA has told Fannie and Freddie to study using new credit-scoring models that are friendlier to some borrowers than the model they cur-rently use. Some lawmakers have also proposed legislation for such a move, and the FHFA might decide on the issue in the first half of the year.

The U.S. Treasury Department and FHFA are also trying to bring more private capital into the mortgage market.

Before the crisis, many loans were made by private lenders without taxpayer backing and wrapped into private mortgage-backed securities. However, since 2007, that market has been mostly dead, in part because mortgage investors felt they were misled by lenders and ratings agencies when those loans went bad.

For more than a year, the Treasury has led an effort to bring investors and lenders back to the table to hash out new private mortgage-backed securities, or MBS, documents and structures that both parties feel could restart the market. That effort is winding up early this year.

In lieu of a private-label MBS market, the FHFA has directed Fannie and Freddie to sell to private investors new securities that offload the risk of mortgage defaults from the mortgage- finance companies to private investors. In 2016, the FHFA is requiring Fannie and Freddie to sell to private investors the credit risk on 90% of the unpaid principal balance of new loans.

The agency this year is also planning to study whether Fannie and Freddie should transfer more risk to mortgage-insurance companies, a move that the insurance companies argue could save borrowers money.

Despite the FHFA and Treasury Department efforts, most observers believe taxpayers will remain on the hook for the majority of mortgage defaults for years.

HOUSING

142016 Regulators’ Agenda

Time Running Out on Punishing Individuals

BY ARU NA VISWANATHA

Barack Obama’s presidency has been shaped by the financial crisis and its aftermath. While his administration has won a steady stream of multibillion-dollar penalties against financial institutions—most recently a $3.2 billion settlement with Morgan Stanley in mid-February—it has pursued few criminal cases against individuals, coming under intense criticism from politicians and investors.

Now, as officials look to close the books on big mortgage-re-lated fines and settlements in 2016, they are also making a final push this year to see if they can bring charges before the statute of limitations for alleged crisis malfeasance essen-tially expires in 2017. Several U.S. attorneys’ offices have used funds from the bank settlements to hire additional temporary staff for investigations into mortgage-backed securities.

At the same time, Mr. Obama’s Justice Department has vowed to conclude his term by stepping up efforts to prosecute individuals for any cases of corporate misconduct on Wall Street and elsewhere. The department told prosecutors last September to step up pressure on companies to turn over information about the actions of individuals who engage in wrongdoing. This will be a key year in determining whether that policy shift leads to increased prosecutions.

Financial firms are also facing more heat from courts increasingly pushing back on settlements with the Justice Department and the Securities and Exchange Commission, asking whether they are aggressive enough.

In January, a Brooklyn federal judge overseeing a deferred-prosecution deal involving HSBC Holdings PLC ordered the government to make public a report from a monitor overseeing HSBC’s compliance with the deal, which resolved charges that the bank didn’t have proper controls to catch potential money laundering.

HSBC and the Justice Department appealed, and have argued that the reports provide too many details of the inner workings of their operations. The New York-based Second U.S. Circuit Court of Appeals is expected to decide whether reports detailing compliance by banks and other companies with government settlements should be disclosed.

One of the murkiest areas for financial law enforcement involves insider trading, and the Supreme Court opened 2016 offering to try to clarify it.

The government has been on the defensive in insider-trading cases since late 2014, when the Second Circuit limited such prosecutions in a way that upended more than a dozen such cases already under way, and left uncertainty within the legal community about what exactly constituted illegal insider trading.

In January, the Supreme Court agreed to take up the case of Bassam Salman, who was accused of trading on tips from his brother-in-law, who worked as an investment banker at Citigroup Inc. Oral arguments are expected in October, and the justices are likely to use the case to better define what kind of proof the government must show to prosecute cases involving confidential tips passed through friends and family members. The death of Justice Antonin Scalia in mid-Febru-ary could tip the scales toward favoring the government.

In a sign of how important developments in the area could be, the head of the SEC’s enforcement division, Andrew Ceresney, appeared in the audience at an insider-trading trial that began Feb. 16. The Justice Department had dropped criminal charges against the defendants in light of the 2014 Second Circuit ruling, but the SEC continues to pursue the civil case.

ENFORCEMENT

152016 Regulators’ Agenda

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