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At the end of the first quarter of this year, we were introduced to a new plan of regulatory reform for financial markets and the various infrastructures that supports them.
Treasury Secretary, Henry Paulson, the former CEO of Goldman Sachs, has taken action in the wake of a meltdown of subprime mortgages. The problem is actually broader than just subprime mortgages.
The bundling of mortgage debt into traded securities that had been underwritten by reputable guarantors has largely failed. Add this to the failure of many other derivative securities called OTC derivatives and credit default swaps and you have a recipe of deep concern to the Federal Government.
These derivative investments, created for institutional trading, are complex products that have been fabricated by the institutional financial markets. It appears as though Wall Street figured that such derivatives were secure and could never collapse. However, investments in them seem to have come down like a house of cards and many waiting in the wings are nervous and concerned. It resulted in the Federal Government providing some relief to the investment banking firm of Bear Stearns (to the chagrin of many), in an effort to control the damage that these wild securities seemed to have caused.
Secretary Paulson has addressed the public to pronounce the new "Blueprint for Regulatory Reform." This blueprint could very well influence the electronic transactions industry.
"Payment systems are critically important for overall market stability," stated Paulson in a March 31st, 2008 public statement. "On a typical business day, U.S. payment and settlement systems
settle transactions [are] valued at over $13 trillion. Every American relies on a payment system in one way or another, everyday. Yet, our government is behind the curve in payment system oversight. I am not intending to raise an alarm here. There is no crisis, but we should be proactive and address this issue. In our blueprint, we recommend the creation of a federal charter for systemically important payment and settlement systems and that these systems should be overseen by the Federal Reserve. This will allow the Federal Reserve to guard the integrity of this vital part of our nation's economy."
Having the Federal Reserve take the lead as the regulator is intended to avoid duplication of effort and instill consistency. "Having one agency responsible for these critically important issues for all financial products should bring greater consistency to regulation where overlapping requirements currently exist," said Paulson.
Paulson said mortgage finance, where significant abuses occurred, has been unevenly regulated with the 50 states having their own rules. U.S. leadership in financial services, he believes, requires broadened, streamlined supervision.
"The premise of our optimal structure is a clarity of mission and objective that will lead to strengthened regulation and improved capital market efficiency," he said. Paulson added that he did not expect the proposal to become law anytime soon.
Part of Paulson's 212-page blueprint (http://www.treas.gov/press/releases/reports/Blueprint.pdf) is a charter specifically designed for payment and settlement systems (chapter V) in which it states:
Payment and settlement systems, especially the most important systems, have the ability to contribute to financial system risk, if either the system or the rules governing the system are not well-designed and well run. As a result, a poorly designed or poorly run system or series of rules governing such systems can contribute to financial crises, rather than reduce them, thereby imperiling the stability of U.S. and foreign financial markets. It is important that all participants in a payment or settlement system have a clear understanding of the system's impact on the financial risks they incur. Moreover, participants must have confidence that the system is highly reliable, without detracting from its convenience or price. As a result, the establishment of high degrees of safety and efficiency of systemically important systems is an important element of U.S. financial policy.
In the United States, and in most of the world, almost all economic transactions involve some form of payment. The U.S. financial system also involves substantial trade in financial instruments such as futures, securities and derivatives. Payment and settlement systems enable these transactions and trades to settle through the transfer of bank deposits and financial instruments. The United States has various payment and settlement systems, including large-value funds transfers, settlement systems for securities and other financial instruments, central counterparty systems and retail payment systems. Depository institutions often play important roles in the functioning of these systems.
It is hard to discern where the Secretary's proposed blueprint would fit relative to card associations and exactly how issuers, acquirers and ISOs will be affected by the blueprint if it comes to fruition. Paulson seems to say that the blueprint is about structure and stability for the new world in which we live. He downplays it as regulation and does not explain it as a reaction to the recent financial market scares.
The blueprint has become a political football with many Democrats in the Senate saying it did not quite go far enough. In fact, Senator Christopher Dodd, Chair of the Senate Finance Committee called it a "wild pitch–not even close to the strike zone."
"Secretary PaulsonÕs blueprint for regulatory reform is a good step toward putting better controls in the U.S. financial systems," says Mandeep Khera, Vice President, Marketing for Cenzic Inc., a web application security firm who serves the card industry and is based in Santa Clara, California. "However, this might be a good opportunity to expand the proposal to include some security aspects for the U.S. commercial sector in general."
"Right now, it appears that the focus of the blueprint is primarily around the securities and mortgage industry which is a reaction to the recent meltdown," Khera adds. "I think the government needs to also provide some guidelines for "securing" this information from a technology perspective. There's a lot of sensitive information held in the databases and applications of these industries, which are not properly protected. The existing payment systems with MC/VISA/AMEX [all] have been left untouched but should be addressed due to the overall impact of the millions of transactions performed electronically now. Security is still not a top priority and hacking has become a norm. While PCI is one regulation that's trying to establish some controls, it still falls short of what's required. By including these issues in the new regulations, we can further strengthen some of the standards around the payment infrastructure."
All of Paulson's recommendations will have to eventually go under the microscope of the U.S. House of Representatives and Congress. The new rules must be approved by Congress and Paulson says they will generate "controversy and healthy debate."
Let us not forget that whoever our new President may be might also have to live with them if they ever get that far. In fact, most of the implementation of PaulsonÕs plan wouldnÕt take full effect until after the elections, leaving a new administration to implement it.
"Given the current economic environment, whoever takes office must focus more on the needs of the true working American – the small business owner," Mitch Jacobs, Founder and CEO of On Deck Capital, a firm who provides loans to small business owners. "This is where jobs in this country come from. The challenge is that no political party or politician has a real means to access this very fragmented market. The Card Industry has the most aggregated network of small businesses in the U.S. and could be a great asset to helping bring programs that promote growth to this vital segment of our economy."
"My biggest fear is that the public and legislators have short memories and forget about the dark days before electronic transactions," says John Berlau Director, Center for Entrepreneurship for the Washington DC-based Competitive Enterprise Institute.
"All the visible costs in terms of fees pale in comparison to the costs of not having these technologies," he adds. "The cost of a ruined evening when you discovered you needed food and last-minute items for a party, and the bank was closed, or the cost of not having cash after hours for a financial emergency, such as bailing someone out of jail." So what will we see in the second half of this year regarding electronic transactions and concern for them, that we did not see last year at the same time?
"I think we will see more modifications to existing breach notifications laws to augment their scope," explains Michael Petitti, Chief Marketing Officer at Trustwave. "For example, California recently updated S.B. 1386 [on the state level] to cover medical and health insurance information. I believe other states will follow suit – especially in an election year when this type of consumer protection could generate appeal among the voting public."
Says John Berlau for the Competitive Enterprise Institute: "My greatest concern is that present gripes might prevent future innovations that could really improve our lives." 
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