Financial Market Reforms

June 2008

Moderator: Welcome to Research Insights, a series of occasional podcasts by the Federal Reserve Bank of Atlanta. Our guest is Atlanta Fed financial economist and associate policy adviser Paula Tkac. She's here to talk about the Atlanta Fed's most recent financial markets conference, which took place in May 2008. Paula, thank you for being here. Please tell me, how did you come up with the theme for this year's program: "Financial Market Reforms: Taking Stock"?

Paula TkacPaula Tkac: Well, thank you, Bill. The theme of this year's conference was envisioned as a broad umbrella under which we could explore and assess several forces that are shaping financial markets, both currently and in the future. You may recall the last two conferences, in 2006 and 2007, were focused more narrowly on hedge funds and credit derivatives, respectively. This focus did allow us to dig deep and explore these financial instruments and markets quite deeply from a variety of perspectives, but this year we felt is was a good time to step back and consider financial markets more broadly to assess some regulatory reforms of the past five to seven years and to look ahead at changing trends and practices that are shaping financial markets and potential regulation going forward.

To this end, we designed two policy sessions, which were retrospective in nature. One on the Sarbanes-Oxley Act (SOX) of 2002, and one on Regulation Fair Disclosure, sometimes known as Reg FD, which more broadly included the Global Research Settlement involving major investment banks. The idea in each of these sessions was to ask the question, "What have we learned?" SOX was designed to improve corporate governance in the wake of Enron and WorldCom, while Reg FD and the settlement attempted to level the playing field across investors with regard to the disclosure of information by corporations and the analysis of this information, via research and analyst recommendations.

In both cases, we've now had several years of experience with these regulations, and we wanted to promote discussion on whether they've achieved their stated purpose, the extent of the unintended consequences and costs, and what lessons we can take from these experiences to inform future regulatory debate. The other two sessions were more forward looking, involving not current regulation but trends that are shaping financial markets and may prompt a regulatory response in the future. The first of these topics was the changing nature of investor activism. Recent years have seen an increase in corporate activism by institutional and private investors, primarily hedge funds, and by individual investors and those with a socially responsible agenda.

Our panel for this session addressed the pros and cons of current proposals to open up the corporate proxy and make such activism easier, the likely effect on corporate governance and a corporation's strategic operations, and, in a larger sense, the efficiency of these corporations in the real economy going forward under some potentially new regime. Finally, our last session directly confronted the dynamic of globalization in financial markets. In particular, the panel illuminated the increasing complexity of securities and derivatives markets around the world and the challenges associated with regulation of exchanges, institutions, corporations, and traders as they merge cross lists and operate in a 24/7 marketplace.

Moderator: OK, well, your conference this year took place during a period of uncertainty in credit markets, and this is after the recent outbreak of financial turmoil related to subprime mortgages. How did this ongoing financial strain affect the content and tone of the conference?

Tkac: Well, it was most definitely a factor. While the conference was unrelated to credit markets per se, the current experience with turmoil in those markets provided a subtext that ran throughout discussions both in sessions and more informally. I will say it was quite interesting to hear the views and perspectives of the many financial markets practitioners in attendance. Most were not directly involved in the credit markets, mortgage backed securities, or subprime lending, and I found it quite valuable to hear how the turmoil has and has not affected their corporations, clients, and investors across the globe.

Chairman Bernanke chose to use his address to the conference to discuss recent events in detail; specifically, the Fed's multipronged and innovative approach to providing liquidity to financial markets during these turbulent times. This, of course, refers to the various lending facilities the Fed has created, known best by their acronyms: the TAF, TSLF, and PDCF.

In keeping with the theme of the conference, Chairman Bernanke's remarks looked back to history for some perspective on the role of a central bank and supplying liquidity, and forward to the ever-present concern about fostering moral hazard as the Fed seeks to promote financial stability.

Moderator: OK, given all of that discussion, what were some of the policy implications discussed at this conference?

Tkac: Well, I think we learned many things about the efficacy and implementation of policy, both in broad terms, and with respect to the specific reforms and topics that we were focused on. I'd like to just touch on two of these broad lessons here. First, while the intent behind a policy or regulation may be clear—to improve corporate governance and reduce malfeasance, as with Sarbanes-Oxley, or to increase access of individual investors to information as in Reg FD—the effects of such a broad regulation are quite difficult to characterize because these effects are felt differently across firms, with respect to Sarbanes-Oxley, large firms versus small firms, public firms versus private firms. All policies have unintended consequences, but here we saw quite vividly how complex and varied these consequences can be in the case of broad, one-size-fits-all regulation.

Secondly, at the heart of these varying effects is the dynamic nature of our financial markets. Firms are continually changing, adapting to regulation, forming and reforming partnerships and business models, and as we watch new forces take form—such as the activism or globalization—policymakers need to be keenly aware that the market they are regulating or the problem that they seek to correct is constantly changing shape. Regulation that is designed too superficially or too specifically is doomed to be irrelevant or ineffective very quickly.

Moderator: Very good. Thanks, Paula. Again, we've been speaking with Paula Tkac, financial economist and associate policy adviser with the Atlanta Fed. This concludes our Research Insights podcast on the Bank's 2008 Financial Markets Conference with the theme Financial Market Reforms: Taking Stock. You can find more information on the conference, including the agenda and papers by visiting the Atlanta Fed Website, Thanks for listening, and please return for more podcasts.