Congrats Randal Quarles on Fed Appointment…


Congratulations to Randy Quarles for his appointment and confirmation to serve as the Vice Chairman of the Federal Reserve Board.

CFS is thankful for Randy’s early and constant support of our organization. As an Advisory Board Member and Trustee, he has been a source of wisdom on a wide range of topics. In particular, his involvement in “Bretton Woods: The Founders and Future” was especially productive and meaningful. The inspiration and encouragement from Randy will continue to guide CFS especially as we plan to honor the 75th anniversary of the birth of the international financial system and think strategically about the future.

See “Summary and Next Steps  – Bretton Woods: The Founders and Future.”

Randy is uniquely experienced, remarkably learned, and thoughtful on virtually any monetary, regulatory, or related legal topic. Likewise, few to none are more honorable in character.

We wish him the best at the Fed.

CFS Monetary Measures for October 2018

Today we release CFS monetary and financial measures for October 2018. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.1% in October 2018 on a year-over-year basis, maintaining the same growth rate as in September.

For Monetary and Financial Data Release Report:

For more information about the CFS Divisia indices and the data in Excel:

Bloomberg terminal users can access our monetary and financial statistics by any of the four options:

3) {ECST} –> ‘Monetary Sector’ –> ‘Money Supply’ –> Change Source in top right to ‘Center for Financial Stability’
4) {ECST S US MONEY SUPPLY} –> From source list on left, select ‘Center for Financial Stability’

SEC Commissioner Peirce Reexamines Financial Reporting and Securities Disclosure

SEC Commissioner Hester M. Peirce described potential problems with expanding SEC financial disclosures requirements to include “soft issues,” such as environmental, social and governance (“ESG”) information. According to Ms. Peirce, “financial reporting loses its value when it is applied too broadly.”

In remarks before the 2018 Leet Business Law Symposium at Case Western Reserve University School of Law, Ms. Peirce argued that requiring companies to disclose information that does not relate to the long-term financial value of the company may harm shareholders. Ms. Peirce stated that the current federal securities laws have traditionally interpreted “material” disclosure as information that demonstrates the likelihood of a company providing a return on an investment. She pointed out that the more money a company spends on disclosures (which is a costly process), the less is available for shareholders.

Ms. Peirce also explained that the disclosure process was not designed to accommodate many “soft issues.” First, financial disclosures are intended to provide “material” information for the “reasonable” investor. According to Ms. Peirce, requiring companies to disclose information that “responds to interests unrelated to the investment’s profitability” (i.e., ESG issues) would make the term “material” meaningless. Second, Ms. Peirce contended that ESG issues are often not easily definable and the auditing process is not reliable. By way of example, Ms. Peirce pointed to the International Accounting Standards Board’s recently released framework, which focuses on the ill-defined term “stewardship.”

Lofchie Comment: Compare and contrast Commissioner Peirce’s skeptical statement on ESG disclosure with Commissioner Stein’s supportive statement (see also Cabinet commentary here). There are tremendous benefits to this open dialogue and the fact that the two Commissioners have clearly articulated opposing views.

FDIC Chair McWilliams Analyzes Migration of Financial Activity from Banks to Nonbanks

FDIC Chair Jelena McWilliams outlined the risks and benefits associated with the migration of financial products and services from banks to nonbanks.

In remarks at the Finance, Law and Policy Fourth Annual Financial Stability Conference, Ms. McWilliams stated that a substantial migration of mortgage origination and servicing to nonbanks occurred since the last financial crisis. Ms. McWilliams noted that the nonbank migration will, among other benefits, help consumers by expanding access to the banking system, lowering transaction costs and increasing credit availability.

Ms. McWilliams stated that while these activities migrated to nonbanks, some of the risks remain with banks and could adversely affect the stability of the banking system. The FDIC reported that bank lending to nonbanks increased by 636 percent from 2010 to June 2018. The FDIC also found that, based on supervisory experience, nonbank mortgage originators receive funding from bank loans. She said that a similar trend can be seen in mortgage servicing where 60 percent of outstanding mortgage loans guaranteed by Ginnie Mae are serviced by nonbanks.

Ms. McWilliams also advised regulators and policymakers to consider the potential risks and benefits of nonbank financial activity. She stated that regulators should encourage banks to innovate, and added that banks will attempt to keep pace with nonbank technological and service developments.

Lofchie Comment: This answers the question of why nobody starts a new bank.  And why the price of NYC taxi medallions has crashed.  It’s the Uberization of financial services.

How do, and should, regulators respond?  More specifically from a regulatory standpoint, should the banking regulators consider whether regulations have made starting or maintaining a bank so unattractive from a business standpoint that the exodus from the banking industry becomes a material systemic risk? It’s not an easy question to answer; it’s not even remotely obvious how one would approach the question.  That said, if you have a political mindset that treats banks as inherently bad, this is the way the markets will go. And that might very well be ok, or even better, but politicians and regulators should be mindful of the direction of change and of the extent to which they are accelerating that change.

Sandor on “Creation and Evolution of New Markets: The Case of Interest Rate Benchmarks”

Dr. Richard Sandor – CFS Advisory Board Member and CEO of the American Financial Exchange (AFX) delivered remarks “Creation and Evolution of New Markets: The Case of Interest Rate Benchmarks” at a recent CFS roundtable.

Richard discussed the new Secured Overnight Financing Rate (SOFR) and American Interbank Offering Rate (Ameribor) – which is a new transaction-based interest rate based on actual overnight, unsecured transactions. As a perennial financial entrepreneur, his comments on LIBOR, financial innovation and the seven stages of market creation were especially noteworthy.

For the presentation:

For more on the AFX and Ameribor, please request a briefing pack from Rafael Marques at

SEC Commissioner Calls for New Enforcement Approach toward Compliance

SEC Commissioner Hester M. Peirce called on the SEC to consider alternative methods when addressing compliance infractions rather than resorting to enforcement proceedings.

In remarks at the National Membership Conference of the National Society of Compliance Professionals, Ms. Peirce stated that enforcement resources should not be used on relatively minor compliance infractions, but should be saved for more serious matters. Ms. Peirce advocated for a more “subtle” approach to resolving compliance infractions, such as building norms that foster compliance, as opposed to initiating “formal enforcement action[s].”

Commissioner Peirce expressed concern that actions directed against a compliance officer can have a “chilling effect” and adversely impact the compliance industry and profession. Ms. Peirce said that the SEC should not bring enforcement actions simply because it disagrees with a compliance officer’s judgment.

Commissioner Peirce also stated that a compliance examiner should help firms to pinpoint issues and, subsequently, work with them to correct those issues in an efficient as well as collaborative fashion without resorting to enforcement proceedings. Conversely, Ms. Peirce emphasized the importance of firms’ cooperation with SEC compliance staff and asserted that, too often, firms “drag their feet” or provide inaccurate information. According to Ms. Peirce, while the SEC’s Enforcement Division has a part to play in countering violations of securities laws, managers and employees at firms are the “first line of defense,” followed by compliance officers.

FRB Vice Chair Considers Proposed Amendments to Stress Testing Program

Federal Reserve Board (“FRB”) Vice Chair for Supervision Randal K. Quarles considered proposed changes to the FRB’s large bank stress testing regime that would increase transparency and efficiency.

In a speech at the Brookings Institution, Mr. Quarles said that the FRB is seeking to improve the measurement of trading book-related risks, and that a “single market shock” approach in existing stress testing practice does not adequately capture risks in firms’ trading books. He said that the proposed changes “are not intended to alter materially the overall level of capital in the system or the stringency of the regime.”

Mr. Quarles discussed changes to the Comprehensive Capital Analysis Review (“CCAR”) indicating that the FRB will reconsider whether any part of the regulatory capital rule (the stress capital buffer or “SCB”) proposal will remain for the 2019 CCAR. He said that he intends to request that the FRB exempt firms with less than $250 billion in assets from the 2019 CCAR quantitative assessment and supervisory stress testing in light of the FRB’s recent tailoring proposal. In addition, Mr. Quarles expressed his support for “normaliz[ing] the CCAR qualitative assessment” by (i) removing the public objection tool and (ii) evaluating firms’ stress testing practices through “normal supervision.”

Mr. Quarles stated that elements of the proposal to integrate stress testing with the stress capital buffer will be amended after receiving public comment. As a result, the SCB, which was scheduled for the 2019 stress test cycle, will be delayed. Mr. Quarles said that the first SCB may go into effect after 2020.

SEC to Examine Operations of Certain Mutual and Exchange-Traded Funds

In a Risk Alert, the SEC Office of Compliance Inspections and Examinations (“OCIE”) provided information on a series of examination initiatives being conducted on industry practices and regulatory compliance of mutual funds and exchange-traded funds (“ETFs”) (collectively, the “funds”). The OCIE is interested in how the operation of these funds may impact retail investors.

The OCIE said it is investigating the following funds and advisers:

  • index funds that track custom-built indexes;
  • smaller ETFs and/or ETFs with little secondary market trading volume;
  • mutual funds with higher allocations to certain securitized assets;
  • funds with aberrational underperformance relative to their peer groups;
  • advisers who are relatively new to managing mutual funds; and
  • advisers who provide advice both to mutual funds and to private funds that (i) have similar strategies or (ii) are managed by the same portfolio managers.

The OCIE stated that it is evaluating whether the advisers’ and funds’ policies and procedures are designed to address risk and conflicts. The OCIE said it will examine disclosures and how the funds assess portfolio management compliance, and fund governance.

Lofchie Comment: It should be expected that the SEC will look closely at any situation where a public fund underperformed a private fund or managed account with a generally similar strategy. Any adviser who is managing clients that fit that description should carefully consider the reasons for the difference in performance.

SEC Commissioner Urges SEC Enforcement to “Resist” Numerical or Financial Targets

SEC Commissioner Hester Peirce called on the agency to “resist” the distraction of focusing on achieving numerical and penalty amount targets with respect to enforcement actions.

In remarks at the Annual Securities Litigation and Regulatory Enforcement Seminar, Ms. Peirce contended that the number of initiated or settled enforcement cases and penalty amounts is a “meaningless measure of the effectiveness of the enforcement program.” She stated that analyzing the different types of cases brought by the SEC would be a better indicator of the success of the agency’s enforcement work.

Ms. Peirce further advised the SEC to consider the entirety of the case – rather than just the potential penalty amount – when deciding on whether to divert resources to a specific enforcement action. According to Ms. Peirce, a case with a smaller penalty amount may set a more meaningful precedent than one with a larger penalty amount.

“Halting a Ponzi scheme or an affinity fraud that touched the lives of retail investors might be more meaningful than halting a practice in which one large financial institution gives a bad deal to another.”

Additionally, Ms. Peirce highlighted several issues the SEC should ask for help in pursuing. In particular, she suggested that the SEC:

  • revisit SEC rules that are implementing antifraud statutes to ensure the rules are accomplishing their intended mission;
  • consider rulemaking to alter the transfer agent rules and reporting requirements; and
  • help public companies build more effective Foreign Corrupt Practices Act programs.

Ms. Peirce also expressed concern regarding recent enforcement actions targeting suspicious activity report (“SAR”) filing errors, especially when a firm has an operational SAR program in place. According to Ms. Peirce, the recent SAR enforcement actions may cause (i) an increase in quantity, rather than quality, of SAR filings or (ii) legitimate firms to exit the “microcap space,” forcing investors to rely on “unsavory firms” instead.

Lofchie Comment: Commissioner Pierce makes a number of important points.

The SEC has treated its imposition of financial penalties as if the agency were a corporation that was under pressure to announce greater profits each year. The SEC’s mission is larger than that; it is, or at least should be, to create a capital market system that functions well and serves the economy. Catching and punishing bad actors is part of that, but a limited part. Rather than boast of fine amounts, the SEC would do better to consider the decrease in the number of initial public offerings.

Commissioner Pierce is absolutely right to point out that sanctioning firms for operational issues in filing SARs, or in other anti-money laundering procedures, is driving legitimate firms out of a variety of lawful activities.

SEC Amends Regulation NMS to Require Additional Order-Handling Disclosures

The SEC will amend Regulation NMS Rules 600(b) and 606 to increase the transparency of broker-dealers’ “handling and routing of orders in NMS stock.” The amendments (i) will require a broker-dealer, upon request by a customer, to provide such customer with certain standardized disclosures related to the broker-dealer’s routing and execution of the customer’s “not held” orders for the previous six months, and (ii) revise the current quarterly public order-routing report to include additional disclosures regarding the terms of any payment for order flow and any profit-sharing arrangements that may influence a broker-dealer’s order-routing decision.

The amendments will become effective 60 days after their publication in the Federal Register. The compliance date will be 180 days following the date of publication of the amendments in the Federal Register.

Lofchie Comment: This requirement is in line with the SEC’s historical policy of requiring disclosure and then allowing investors to make their own investment and trading decisions based on that disclosure. Questions remain as to whether the disclosures are sufficient for customers to make informed decisions and whether the requirement of making the added disclosures may motivate broker-dealers to improve their execution practices.

Trade Associations Request Extension of Comment Period for Security-Based Swap Rules

Several trade associations requested that the SEC extend the comment period for its proposed rules on capital, margin and segregation requirements for security-based swaps. The requests seek an additional 30 days to comment (comments are currently due on November 19, 2018).

As previously covered, the SEC reopened the comment period, and requested additional comments, on proposed new rules and amendments to (i) establish capital, margin and segregation requirements for security-based swap dealers and (ii) revise broker-dealer capital requirements relating to the use of security-based swaps. The extension requests came in two letters: one from SIFMA and the Institute of International Bankers, and the other from ISDA, the Investment Company Institute, the MFA and the Chamber of Commerce Center for Capital Markets Competitiveness. In requesting an extension, the trade associations cited, among other things, the long period between the initial comment period and the reopening, as well as the significance of the proposal for market participants.

Lofchie Comment: It is really difficult to see any justification for not extending the comment period by another month. The rule proposals have been sitting at the SEC for years. Not only are the proposals extremely complicated in their implementation, but much has changed since they were first proposed.