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Capitol Report

Coverage of legislation and regulatory activity that affects higher education

Financial Reform Takes Center Stage

Sweeping changes in the regulation of financial products and markets continues to move forward on Capitol Hill, with Senate passage of a compromise bill on May 20. The legislation will now need to be reconciled with House-passed legislation adopted in late 2009. White House and congressional leaders expect to have the legislation ready for the president's signature by July 4.

There are important differences between the original proposals made by the Obama administration and the bills passed by the House (H.R. 4173) and Senate (S. 3217). Nevertheless, the ambitious legislative ideas from the administration and the Congress share four central goals:

  • Create an independent consumer watchdog organization to regulate and oversee a wide range of consumer financial products.
  • Enhance transparency and accountability in various financial instruments by requiring the registration of hedge funds and the regulation of over-the-counter derivatives.
  • Reduce the likelihood of future bailouts of large financial firms by creating capital and leverage safeguards, requiring the establishment of “funeral plans” for large firms to provide for their orderly dissolution, and strengthening the Federal Reserve's authority over both major banking and other financial firms in the event of such liquidations.
  • Establish an early warning system through the formation of an entity designed to identify and address threats to the stability of the economy posed by large financial companies and complex financial products.

With health-care reform legislation complete, the financial markets bill now appears to be one of the most significant action items that Congress and the administration will attempt to finish before Election Day. The proposals' impacts on higher education are highlighted in this update.

Consumer Protections Are Top Priority

Notwithstanding the fact that the precise structure of any new consumer watchdog organization has been the subject of significant debate, both the House and Senate legislation would consolidate and centralize the regulation of a wide array of consumer financial products. Legislators have expressed frustration at the patch-work nature of current regulations and the way such oversight is allocated to numerous separate agencies. As a result, the new consumer-focused organization is given fairly broad authority to regulate, but relatively little specific direction from Congress. Therefore, the particular changes that might arise from this bill will be the result of new regulatory processes, rather than legislative mandates.

The legislation's focus on strengthening oversight of a wide range of consumer financial products means that some campus programs may face additional scrutiny and regulation. For example, stored-value cards—whether they operate like a campus debit card, or also extend credit in any form—will likely come under the jurisdiction of any new federal consumer financial protection agency. Similarly, institutionally financed loans, such as loans to students or employees, may be subject to new requirements. The scope of these new rules, and the extent to which they will apply to any campus-provided financial services, will be determined through the regulatory process.

Stronger Regulation of Derivatives

The Senate legislation includes more comprehensive changes to the regulation of derivatives than those made in the House bill. The requirements were drafted by Senate Agriculture, Nutrition, and Forestry Committee Chair Blanche Lincoln (D-AR) and subsequently blended with proposals made by Senate Banking, Housing, and Urban Affairs Committee Chair Chris Dodd (D-CT). The combined requirements go beyond those included in previous Senate proposals, the House bill passed in December 2009, or the administration's initial proposal on derivatives reform. It is expected that the final Senate provisions are likely to resemble those that will be included in any final compromise bill.

Unlike the general authority given to a new consumer watchdog agency, both the House and Senate legislative efforts are far more specific on the changes that will occur in the derivatives marketplace. The Senate legislation would require clearable swaps to be traded on an exchange or through a swap-execution facility, as well as mandate real-time public disclosure of pricing and other information for cleared swaps. Major swap participants and swap dealers would be subject to capital and margin requirements, required to register with the Commodity Futures Trading Commission (CFTC) or the Securities and Exchange Commission (SEC), and have a fiduciary duty to counterparties that are governmental entities, pension plans, and endowments.

Changes to Derivatives Trading

NACUBO is exploring whether or not there are circumstances under which a college or university might be deemed to be a major swap participant.

The House and Senate bills would impose mandatory clearing and trading requirements for many over-the-counter derivatives. The CFTC or the SEC would be required to review any swap that a newly created derivatives clearing organization (DCO) intends to list for clearing, and determine within 90 days whether the swap is required to be cleared. If either commission determines that clearing is required—and the particular swap or class of swaps appears on one or more DCO lists—then that swap or class of swaps would be subject to mandatory clearing. Under the House bill, transactions in standardized swaps do not need to be cleared if one of the counterparties, such as a college or university, is not a swap dealer or major swap participant.

A major swap participant is defined as “any person who is not a swap dealer, and:

  • maintains a substantial position in swaps (other than positions held for hedging or mitigating commercial risk, and positions maintained by an ERISA plan for hedging or mitigating risk directly associated with the operation of such plan) for any of the major swap categories as determined by the CFTC or the SEC, as applicable; or
  • whose outstanding swaps create substantial counterparty exposure that could have serious adverse effects on the financial stability of the United States banking system or financial markets; or
  • is a financial entity (other than an entity predominantly engaged in providing customer financing for the purchase of an affiliate's merchandise or manufactured goods) that is highly leveraged relative to the amount of capital it holds and maintains a substantial position in outstanding swaps in any major swap category as determined by the CFTC (or the SEC, as applicable).” (The CFTC and the SEC are directed to define the term substantial position as “the threshold prudent for the effective monitoring, management, and oversight of entities that are systemically important or that can significantly impact the financial system of the United States.”)

NACUBO is exploring with the relevant committees on Capitol Hill whether or not there are circumstances under which a college or university might be deemed to be a major swap participant, and thus subject to these new rules.

Disclosure, Registration, and Collateral Requirements

The Senate legislation requires public disclosure in real time of pricing and transaction information for swaps subject to mandatory clearing, and for other swaps cleared through a DCO. Such reporting would not identify the participants, and the DCO must take into account whether the public disclosure would materially reduce market liquidity.

Swap dealers and major swap participants would be required, under both bills, to register with the CFTC or the SEC, as applicable, regardless of whether they are required to register with other regulators. For such persons, both the House and Senate bills direct the commissions to adopt rules, which may include business conduct standards, reporting, and recordkeeping requirements, to protect investors. Swap dealers and major swap participants would also be subject to capital and margin requirements. The bills would permit the use of noncash collateral to satisfy the capital and margin requirements, subject to any restrictions adopted by the CFTC or SEC.

Fiduciary Duties

Under the Senate bill, a swap dealer or major swap participant would have a fiduciary duty to any counterparty that is a governmental entity, a pension plan, or an endowment, should the dealer or participant enter into—or provide advice regarding offers to enter into—a swap with that counterparty. However, it remains unclear what fiduciary standard would apply. The Employee Retirement Income Security Act of 1974 (ERISA) typically imposes a so-called prudent expert standard, while general fiduciary principles typically recognize a reasonable man standard.

Insurance Companies and Credit Rating Agencies

Both the House and Senate bills establish the Office of National Insurance within the Treasury Department to monitor the insurance industry and to coordinate cross-border insurance regulation. This new office would act primarily in a fact-gathering and advisory capacity, although it would also represent a new federal role in the regulation of the insurance business, a responsibility historically and by law reserved for the states. Both bills also create the Office of Credit Rating Agencies at the SEC, requiring credit agencies to register with the office and provide data and information to the SEC, to assure that ratings are provided with integrity and to avert potential conflicts of interest. While the House and Senate bills differ regarding the thresholds, they both create a private right of action on the part of an investor if a credit rating agency knowingly or recklessly fails to investigate information received from a third party.

Market Studies Commissioned

The Senate bill also requires the SEC to study the funding of the Governmental Accounting Standards Board. GASB is currently funded by voluntary contributions from states, local governments, and the financial community—and through the sale of its publications—to meet its annual budget of approximately $8 million. The Senate Banking, Housing, and Urban Affairs Committee, which drafted this provision, expressed concern that this funding model “can cause undue uncertainty and potentially lead to the compromise of the GASB standard setting process.” Earlier concerns in 2002 over a similar funding model for the Financial Accounting Standards Board led to the creation of a steady funding mechanism defined in the Sarbanes-Oxley Act of 2002.

Finally, the Senate legislation would create a working group comprised of the heads of eight federal agencies to study the oversight of existing and prospective carbon markets (spot and derivative markets) to ensure an efficient, secure, and transparent market.

NACUBO CONTACT Matt Hamill, senior vice president, advocacy and issue analysis, 202.861.2529