By Jonathan Spicer
MONTREAL (Reuters) - Policy makers reacting to the global financial crisis should avoid overstepping with harsh new rules that would have adverse economic effects and resist the urge to score political points, industry heads warned on Thursday.
The world's policymakers and regulators are working on a package of new global rules governing banks, derivatives trade, hedge funds and other parts of the complicated capital markets, aimed at avoiding future crises.
Banks and other industry players blamed in part for setting off the global recession could see their profits crimped, particularly if the most aggressive proposals in the United States and Europe become law.
"You have to make choices as regulators between those elements of weakness in the financial system that need to be and should be corrected by the private sector itself, and those where you have to intervene," Malcolm Knight, Deutsche Bank AG's vice chairman, told a conference of financial regulators here.
Knight, addressing the International Organization of Securities Commissions (IOSCO), warned against creating an environment in which financial institutions have no incentives to securitize "even the plain vanilla" products.
The conference comes as a U.S. congressional panel prepared to convene its first meeting on Thursday to craft a final bill on financial regulatory reform.
The Obama administration is pushing for tough reforms, which it hopes to hold out as an example to other nations. The United States is further along than the European Union in implementing changes pledged last year by the Group of 20 countries.
The G20 will hold a summit in Toronto in two weeks, just as the U.S. congressional panel is due to be winding up its work on financial reform.
Knight was concerned about the G20's approach to regulating the securitization industry. Securitization, which has been blamed for contributing to an implosion in the U.S. mortgage market triggered the global financial meltdown, involves bundling together debt in a package by banks, which they then sell to investors.
Knight said the G20 "paid lip service" to understanding the economic importance of securitization.
Another target of regulatory reform are complex over-the-counter derivatives, another culprit in the financial crisis, which likely will be funneled through clearinghouses and even exchanges once new rules are adopted.
The G20 has called for greater standardization and central clearing of the privately arranged contracts by the end of 2012 to cut risk. The market is now unpoliced.
Tim Ryan, head of the securities industry's main lobbying group, the Securities Industry and Financial Markets Association (SIFMA), said a U.S. proposal under the bill passed by the Senate that requires banks to spin off derivatives divisions "makes absolutely no sense" because it would push capital out of banks and would ultimately cost consumers.
"Politics has crept into this debate over reform. It's a very attractive political issue," Ryan told the conference.
"It's very easy to turn the financial service industry into the boogeyman, and because of that we have proposals that have crept into this legislation that make little sense if the standard is responsible reform."
It is unclear whether the controversial swaps proposal by U.S. Senator Blanche Lincoln will become law as the congressional committee hashes out a compromise bill. The final bill must be approved by both the Senate and the House of Representatives before being sent to President Barack Obama to be signed into law.
Knight said that while OTC markets have attracted substantial blame, there may also be problems with exchange-traded securities when exchanges do not harmonize their rules -- as evidenced by the May 6 "flash crash" on Wall Street, which drove the Dow industrials down by almost 1,000 points in the space of minutes.
But even as industry officials warned about the consequences of overly harsh regulation, a top Australian regulator said that reform is critical.
Jurisdictions globally must maintain a sense of urgency or risk missing the opportunity to make smart reforms, Tony D'Aloisio, chairman of the Australian Securities and Investments Commission, told IOSCO.
The financial crisis exposed "fundamental flaws in the conventional wisdom" of financial markets such as the "deregulation mind-set" and the so-called efficient market theory, he said.
"As regulators, now is the time that we really have to maintain a sense of urgency to have these changes ... implemented in each jurisdiction, to move from the principles to implementation with a minimum of divergence," D'Aloisio said. "Otherwise we're really going to miss the opportunity for much needed reform."
(Editing by Leslie Adler)
