Thank you and good afternoon. I am very pleased to be here today to bring you up to date on some of the Commission's current initiatives that I know are of particular interest to you. At this point, let me give the standard disclaimer that the views I express here today are my own and not necessarily those of the Commission or my fellow Commissioners.
I use the word "current" to describe the Commission's focus, but in truth, these initiatives — international accounting convergence and mutual recognition — have been a long time in the making, as I am certain many in this room deeply appreciate. What is most exciting now, however, is that these long developing issues — driven by the realities and demands of a global marketplace — are finally coming together as the Commission prepares to consider two separate, but complementary proposals that promise significant benefits for investors and markets though out the world.
I know from the Commission roundtables on both these topics and, firsthand, from my recent travels in Europe and Asia, that the prospect of Commission action has been met with high expectation, especially by non-U.S. institutions and market participants. It will be the Commission's challenge to respond to these expectations in a meaningful, yet realistic manner, while dealing cooperatively and collaboratively with our international regulatory counterparts to ensure investor protection.
Before I continue, Larry asked me also to briefly touch on the SEC's role in the recent market turmoil, so let me start there. As you are well aware, a sequence of events occurring over the past year culminated this summer with stress in the subprime mortgage market. This led to a sharp decrease in liquidity — not only in mortgage markets, but more broadly, across credit-sensitive assets. The Commission has been monitoring the impact of these trends on financial institutions through our Consolidated Supervised Entities ("CSE") program as well as through our ongoing outreach to investment companies.
Under the CSE program, the Commission supervises five of the major U.S. securities firms on a consolidated, group-wide basis. We oversee not only the U.S. registered broker-dealer, but also its holding company and affiliates, including foreign registered broker-dealers and banks and unregulated entities such as derivatives dealers, on a consolidated basis. Our supervision of the CSEs is prudential in nature, whereby the Commission's Market Regulation staff engages in continuous monitoring of the CSE firms' risk management procedures and mark-to-market accounting to identify areas of potential weakness and act quickly in response.
Our focus in the current environment is liquidity. All of the CSE firms maintain pools of liquidity at the parent level, consisting of cash and highly liquid securities. Since access to high levels of liquidity is particularly important in times of market stress, we are monitoring the CSE firms' access to their usual sources of both secured and unsecured funding. Thus far, the firms have not experienced significant problems in these areas. We continue, however, to monitor for contingencies that might place additional strains on their balance sheets as well as potential funding requirements for certain leveraged lending commitments made by the CSE firms, typically to fund corporate acquisitions or restructurings. Should concerns arise, the Commission has broad authority to require changes to risk management systems or require more regulatory capital or liquidity at the holding company level.
The Market Reg staff is also engaged in a periodic review of the valuation processes at CSE firms. The CSE firms mark most positions to market, which involves a critical governance and risk management process. At diminished liquidity levels, valuation becomes more difficult. While we do not have special concerns about CSE firm valuations, we are continuing to review the valuation methods used to ensure a robust mark process.
Four CSE firms reported earnings in September for the August quarter end that were no worse, and in some cases better, than most market observers expected. Originating banks were able to more readily distribute certain leveraged lending commitments to institutional buyers than had been the case during July and August, and the term of many funding arrangements, which shortened sharply during August, grew longer during September, suggesting that the hording of liquidity may have begun to diminish. A fifth CSE firm, Merrill Lynch, announced a write-down last week in excess of $5 billion, although the firm continues to report ample capital and liquidity. We continue to keep a careful eye on the situation and are prepared to respond appropriately. During this period, our CSE staff has maintained its normal close working relationship with the New York Fed, and also has had contact with the FSA and Irish, German and Swiss regulators.
In connection with our oversight of investment companies, the staff of the Division of Investment Management has contacted fund representatives and pricing agents to determine the effect of the market turbulence on funds in terms of pricing portfolio holdings and maintaining sufficient liquidity to meet redemptions. Our staff is also carefully monitoring redemption levels, and its contacts with fund representatives are continuing.
The Commission is a member of the President's Working Group on Financial Markets ("PWG"), which is dealing with some of the broader policy considerations that have aroused concern during the credit market difficulties. One of the PWG's current focuses, with particular relevance for the SEC, is the role of credit rating agencies in lending practices, the use of ratings and how securitization has changed the mortgage industry. Pursuant to our new authority under the Credit Rating Agency Reform Act of 2006, the Commission has adopted new rules, registered seven rating agencies as NRSROs, and begun an examination of Moody's, S&P and Fitch, focusing on whether the NRSROs followed their procedures for determining credit ratings and managing conflicts of interest. The Commission also recently hosted an IOSCO meeting at which NRSROs described their involvement in structured finance products. All of which is to say, the Commission remains busy on many fronts. We continue, however, to remain focused. Indeed, I believe the Commission's consideration of eliminating the U.S. GAAP reconciliation requirement and its development of a framework for mutual recognition come at a critical juncture in the evolution of our global capital markets. Both reflect a changing marketplace that increasingly eludes geographic definition or constraint and compels new approaches by market regulators to effectively meet the their mandates of investor protection, capital formation, and fair, orderly and efficient markets.
One of the challenges in a global marketplace is to reduce the costs associated with access to, and comparability of, financial information that has historically been raised by differences in accounting standards, legal and cultural traditions, and regulatory regimes. To achieve this, a common accounting language is needed that can be translated and understood globally. That, in turn, requires greater convergence between the two major financial reporting systems in the world — U.S. GAAP and IFRS.
Consistent with our 2005 roadmap's final destination, in considering eliminating the reconciliation requirement, the Commission is signaling its continued commitment to the ongoing convergence efforts of the FASB and IASB with the ultimate goal of developing a single set of global accounting standards.
In March of this year, we held an extremely informative roundtable on the effects of eliminating the U.S. GAAP reconciliation requirement for foreign private issuers. The two messages I heard from both foreign and U.S. issuers and financial professionals who participated were: one, end the reconciliation requirement quickly, even before 2009, if possible; and two, establishing a global set of comprehensive, high-quality accounting standards will be extremely challenging, but it is the right goal and one worthy of our continued commitment to achieving.
In June, following the roundtable, the Commission issued a proposal to eliminate the reconciliation requirement for foreign private issuers preparing their financial statements in accordance with IFRS as published by the IASB. Shortly afterwards, the Commission issued a concept release seeking comment on whether U.S. issuers should have the same option as foreign private issuers of using IFRS. The comment period on the IFRS proposal has ended, and comments on the concept release are due in mid-November.
As we deliberate on the IFRS proposal, the Commission will give consideration to three key issues. First, there must be a robust process towards convergence. We are not looking for complete convergence, but rather continued progress towards convergence on the part of FASB and the IASB.
Second, we need assurance that IFRS as published by the IASB is being consistently and faithfully applied. Given that IFRS is still in its infancy and is being applied today in over 100 countries, with that number expected to increase over time, this presents a very great challenge. Encouraging and achieving consistent application will require communication and coordinated effort among international securities regulators. Our staff has reviewed the annual reports filed under IFRS for 2005 and is in the process of reviewing the 2006 annual reports to assess how closely IFRS filers are adhering to IFRS standards and whether there is consistency in its application. We are also participating in IOSCO efforts to promote consistency in the application and interpretation of IFRS and are engaged in a joint work plan with CESR to address similar issues.
Third, we must have confidence in the IASB and its oversight by the trustees of the IASC Foundation, which appoints the members of the IASB, oversees its activities and raises its operating funds. Of importance will be considering the transparency of the IASB's standard-setting processes and the strength of its governance procedures. Further, the IASC Foundation is also currently working to develop a new, broad-based funding mechanism by 2008 that would enable it to remain a stand-alone, private sector organization.
Since the IFRS proposal was issued, there has been debate as to whether eliminating reconciliation would encourage or hinder convergence efforts. My personal view is that ending reconciliation would facilitate the convergence process. Many commenters on the proposal shared the view that eliminating the reconciliation requirement should continue to provide incentives to investors and standard setters to further address significant inconsistencies and differences between the two reporting systems. Further, several commenters also believed that where differences result in competitive disadvantage, users and preparers would logically seek to minimize them. I would expect this input from the market to be complementary to the FASB-IASB convergence process, shaping and speeding the pace of convergence efforts.
Another concern that we have heard expressed since our IFRS proposal was issued, is the IASB's possible susceptibility to the rules-based approach of U.S. standard-setters. The FASB and IASB have agreed to use their best efforts to make their existing financial reporting standards compatible and to coordinate their work programs — first through the Norwalk Agreement of 2002 and more recently in a 2006 Memorandum of Understanding among the FASB, SEC and IASB that was supported by the EU. As they continue these joint efforts, the parties agreed that, where one system has a better approach than the other, both systems would adopt the better principle without having to conform all of the detailed rules. And instead of trying to eliminate differences between two standards where both are in need of significant improvement, FASB and the IASB agreed to develop a new and better common standard.
To my mind, this approach to the creation of high quality standards should allay concerns about the predominance of one accounting system or approach over another. It is in everyone's interest that any global standard be the superior standard and that we avoid U.S. GAAP or IFRS biases that would impede this worthy goal.
Just as our markets seek a common accounting language, electronic trading and innovation in information technology, the rise of for-profit exchanges, and increasing U.S. investor demand for international investment opportunities are driving pressure on the Commission to rationalize regulatory impediments to cross-border activity. Through a regime of mutual recognition, investors and market participants expect to see the elimination of the current impediments to international investing, lowered transaction costs and enhanced competition.
It was clear from the Commission's roundtable in June that we have many viewpoints to consider. Large U.S. financial institutions have had direct access to international markets for many years and, through the 144A market, non-U.S. issuers have access to U.S. investors at the QIB level. Although large institutions expect to benefit from mutual recognition, panelists agreed that the greatest potential benefits would likely flow to smaller U.S. institutions and retail investors. These investors do not have access to international markets today, except through the intermediation of U.S. broker-dealers and mutual funds, which raises transaction costs.
To maximize the benefits of international diversification for these investors without jeopardizing basic investor protections, some panelists suggested limiting initial mutual recognition efforts to world-class foreign private issuers whose financial disclosures are largely comparable to U.S. disclosures and are available electronically. Other panelists believed that retail investor participation should be limited, at least initially, due to concerns about the level of investor protection in non-U.S. markets. Obstacles to a mutual recognition approach were seen as including the bifurcated U.S. regulatory regime for securities and commodities, delays in the Commission's processing of rule filings and new product applications and the dangers of regulatory arbitrage for U.S. exchanges.
On the whole, however, panelists were positive. They were confident that there are more similarities than differences in world regulatory regimes, noting that the principle of providing best execution governs all markets, even where trading rules are different. They saw international accounting convergence as an important step towards facilitating mutual recognition and were convinced that as regulators begin to act more collaboratively, standards will come closer together. One panelist stated, "[W]hat mutual recognition allows for is an interactive process with foreign regulators, which I think effectively will bring them closer together just because of that dialogue . . . . It also adds to the ability to regulate and to enforce and to investigate fraud once you start having this interactive dialogue as opposed to these fortresses that literally don't interact with each other." I couldn't agree more.
I am obviously not in a position today to offer specifics, but what I can tell you is that moving forward on mutual recognition is a Commission priority. Our thoughts on the best approach to the many issues highlighted at the roundtable are still being formulated, but the Commission is actively considering the prospect of developing a mutual recognition framework that would facilitate greater cross border access for investors and market participants. Recognizing the realities of the market today, the challenge for the Commission will be continuing to strike the right balance between fostering choice for investors and protecting investors from unknown perils in other markets.
The Institute of International Bankers will have a critical voice in informing the Commission's consideration of these issues, and I look forward to your input as the Commission moves forward in this area. I recently met with several members of the IIB on a request for no-action relief from the SEC with regard to certain global custody activities, and I understand that it is an issue of particular importance for many of you. The issue touches many of the same considerations we are weighing in the context of mutual recognition and the interplay of Rule 15a-6, and I can assure that your request is being actively considered.
As our markets have become global, our historic regulatory approach has been increasingly challenged. The numerous competitiveness studies and reports that have been issued of late have served a valuable function in refocusing our attention on our role in the global marketplace. If we, as regulators, are to remain effective and relevant in meeting our mission of protecting investors, fostering capital formation and maintaining competitive, fair and orderly markets, we will need to be more nimble and responsive to market developments and rely more on cooperation and collaboration with our international counterparts.
I believe that the SEC has signaled an increased sensitivity to these market realities. We liberalized our deregistration requirements to make it easier for foreign private issuers to terminate their obligations under U.S. securities laws, demonstrating the SEC's willingness to embrace the global markets. We have facilitated the consolidation of U.S. and foreign exchanges. We have taken steps to reduce the burdens of compliance with Section 404 of the Sarbanes-Oxley Act. And, as I have discussed, we are actively considering the prospect of international accounting convergence and a mutual recognition framework to reduce barriers to cross border access for U.S. and foreign broker-dealers and exchanges. Just as importantly, we continue to be actively engaged on both a multilateral and bilateral basis with our foreign regulatory counterparts as we seek to address common problems and, increasingly, find common solutions. Indeed, when we talk about the cultural changes that will be needed to adjust to a global accounting system or a more converged capital marketplace, no one will be more challenged, perhaps, than the regulators themselves. We must back up the faith we ask you to put behind these new approaches, and we must follow through on our interpretation and enforcement of more principles-based standards and approaches in the regulation of our markets.
At the same time, our guiding principle remains the same. Just as investors demand greater global market opportunities, they also rightly expect high standards of protection. I am confident that we can continue to achieve both effectively.
Thank you, and I would be happy to take your questions.