The Associated Press had reported: “Volker: US Oversight ineffective, seeks overhaul” on April 20, 2015. The Volcker Rule named after Paul Volcker sets limits on proprietary trading due to risk.
Is there any good example of effective risk oversight over trading accounts ?
Certainly. The margin departments of various broker-dealers effectively close our risk positions of their customers to insure the customers and not the firms absorb any losses incurred by customer trading activity daily. Large Brokerages such as Fidelity effectively manage risk for millions of customer accounts trading on margin by incessantly comparing positions versus customer equity. The owners of retail brokerages do not bailout customers because the margin group actively monitors risk.
It is then conceivable regulators should similarly be able to compare firm positions to regulatory net capital in at least one firm trading account. If it could be done effectively in one account with one scalable model, then it could be used for any firm willing to adopt this model.
If bank or broker-dealer were to make their positions fully transparent electronically in real-time, and the systemic risk regulator had the ability to circumvent trades at the time of transaction, then systemic risk would be contained.
The Fully Transparent Broker-Dealer:
Electronically disseminates all data but personally identifiable information to the regulator.
Allows for independent customer reserve and net capital computations.
Does not engage in derivatives trading for firm accounts.
Allows the systemic risk regulator to block risk based trades in real time.
In an ideal and modernized regulatory setting the prudential systemic risk regulator has supervisory authority to circumvent trades at the transaction which exceed the firm's ability to pay. Thus any losses are absorbed by the firm and have no systemic impact on taxpayers. If a member of margin department of a broker-dealer can work from home, then a regulator should be able monitor margin on firm trading accounts of New York or San Francisco firms from a desk in Washington DC.
Centralized Processing of Standardized Raw Data in Real-Time
The reason why regulation seems perpetually ineffective is there is a finite amount of examiners stretched to review reporting from a variety of systems on a historical basis. Examination of historical data by nature is not preventative. Volcker's call for simplicity and modernization is met when broker-dealers transmit raw data in real-time to just one independent systems organization who under the supervision of the regulator assembles that data in the reporting format established by regulation.
As the broker-dealer is alleviated of preparation, the broker-dealer can not be subject to audits and exams which they no longer control. The broker dealer is relieved with the expense of preparation. Also as there is only one system to review, then the federal tax dollars are saved on exams. Instead of sending examiners across the country, simply send the data to one data processing firm under supervision of the regulator. One system = one system to examine (simple and modernized).
This model is not just modernized and simplified but also effective and efficient. Executive Order 15576 Delivering Enabling, Effective and Accountable Government states “the Administration is committed to insuring that the Federal Government serves the American people with the utmost effectiveness and efficiency.” Reverence to the Executive Mandates requires less expensive and more accurate approach to regulatory reporting. No new legislation is required here.
Incentives for Transparency through Varying FDIC Coverage
In an ideal structure of systemic risk regulation, there is no need for FDIC or SIPC insurance because the systemic risk regulator receives reporting for customer segregation of assets and solvency in real-time, and has the means to ensure that customers will receive one-hundred percent of their assets before the entity goes into bankruptcy. The entity should not go into bankruptcy as the systemic risk regulator has the means to block risk based transactions at the time of execution.
The simple solution to “too big to fail” is to offer customers an attractive incentive for shifting their assets to a safe haven insulated from the derivatives markets. Double the coverage of firms which are accomodating with data as that data enables the regulator to prevent insolvency. Protection of customer assets is realized not by ring fencing the contagion of each and every reckless bank or country but to draw assets to an formidable fortress ring-fenced from derivatives toxicity: The Fully Transparent Broker-Dealer.
As Warren Buffet labels derivatives are “weapons of mass financial destruction” Is there any reason why firms knee deep in derivatives are insured at all ? If the government wanted to solve too big to fail, they should create incentives for purity and transparency such as varying the levels of insurance coverage. As assets would drift away from too big to fail banks, they would be compelled to be a trading firm or bank, they could not afford to be both.
Synergies of Public / Private Sector Collaboration
When both the regulator and regulated have visbility to the same set of books and records in realtime, and regulators have the means and authority to block risk befire becoming a systemic threat, regulation is in the state of harmony. When both sides have a common objective of protecting customer assets, everyone benefits:
The public sector should take a lesson the way private sector manages risk effectively. Broker-Dealers proactively close out risk positions of customers before they reach they become a realized loss for the shareholder. The American Taxpayer is a shareholder which who has unnecessarily taken too many losses due to regulation which Paul Volcker labels as ineffetive years after Dodd-Frank. Best to replicate the system which the private sector has been successful with for decades. This would truly eliminate bailouts and save the country tax dollars in the process.