Congrats Randal Quarles on Fed Appointment…

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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 September 2018

Today we release CFS monetary and financial measures for September 2018. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.2% in September 2018 on a year-over-year basis versus 4.7% in August.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Sep18.pdf

For more information about the CFS Divisia indices and the data in Excel:
http://www.centerforfinancialstability.org/amfm_data.php

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

1) {ALLX DIVM }
2) {ECST T DIVMM4IY}
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’

Senate Banking Committee Considers State of Cryptocurrency and Blockchain

The U.S. Senate Committee on Banking, Housing and Community Affairs held a hearing on the state of cryptocurrency and blockchain. The two invited witnesses were Coin Center Director of Research Peter Van Valkenburgh and NYU Professor of Economics Nouriel Roubini.

Mr. Van Valkenburgh lauded the benefits of decentralized computing (i.e., blockchain) but criticized the surrounding “hype.” According to Mr. Van Valkenburgh, the terminology used to describe blockchain is often “vague and undefined,” leading to an overall lack of public understanding. In particular, he criticized the public perception that blockchain is the “solution to any number of social, economic, organizational, or cybersecurity problems.” However, Mr. Van Valkenburgh advocated for the continued exploration of decentralized computing, and advised regulators to take a “light-touch approach” in order to allow the technology to develop “unfettered.”

Conversely, Dr. Roubini criticized cryptocurrencies as the “mother of all bubbles,” and called the underlying blockchain technology the “most over-hyped – and least useful – technology in human history . . . nothing more than a glorified spreadsheet or database.”

In a statement given at the hearing, Senator Sherrod Brown (D-OH) expressed concern about the potential for fraudulent activity in cryptocurrencies and said that the malign effects of blockchain on our society are currently more prominent than the benefits. Senator Mike Crapo (R-ID) said that the “regulatory and oversight questions still remain,” but added that he wanted to better understand the opportunities and challenges regarding blockchain in order to regulate more effectively.

 

SEC Commissioner Advocates for Letting Investors Make Their Own Decisions

SEC Commissioner Hester M. Peirce advocated for a flexible regulatory approach that allows firms to experiment with new technologies and provides investors with a wider selection of investment choices.

In a speech at the Financial Planning Association 2018 Major Firms Symposium, Ms. Peirce expanded on her recent remarks discussing ways in which the SEC can “facilitate fund adaption of technological and other innovations” for the benefit of investors. To achieve this, Ms. Peirce stated, the SEC must change its approach to individual products and practices by giving firms the flexibility to utilize new technologies, products, fee structures and methods for disclosure. Such an approach, Ms. Peirce argued, would allow investors to make more informed decisions about whether and how to invest. As to the issue of the SEC deciding for investors, or depriving investors of the opportunity to decide for themselves, she chided the SEC again for its refusal to allow exchanges to list products based on bitcoin, saying that it should be up to investors (not the SEC) to decide whether such investments were good deals.

Ms. Peirce stated that, in order to permit investors to be sufficiently capable of assessing new technological innovations, the SEC must ensure that disclosures are written clearly. According to Ms. Peirce, changes to fund disclosure requirements in the last decade have not always factored in investors’ ability to understand the information. Fund disclosure forms are still “predominately paper-based,” “voluminous and . . . overwhelm[ing],” and “riddled with legalese and technical terms.” Ms. Peirce urged the SEC to consider “shorter document[ation] that contains only key information,” such as is required by the 2009 mutual fund summary prospectus.

Lofchie Comment: Commissioner Peirce’s arrival at the SEC is genuinely exciting to those who care about financial regulation, both its implementation and philosophy. She is not just staking out positive positions, which is obviously a nice-to-have; she is establishing the intellectual underpinning of those positions, which is an essential-to-have if the positions are to be enduring and to establish a framework for approaching issues on an ongoing basis. By conceding that there are limits to the knowledge of regulators, and by conceding that investors left to their own may make bad decisions, she acknowledges the possibility of failure – which is essential if we are to take risks.

While in the current regulatory environment, Commissioner Peirce’s views may seem radical, they would in fact return the SEC to its historical role as a regulator whose primary purpose is to mandate good disclosure, and then to step aside and let investors decide how to invest.

Bank Regulators Testify on Bank Deregulation Act

Federal banking regulators testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs on progress toward implementing the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Act”). As previously covered, the Act makes targeted changes to key areas of Dodd-Frank, which will primarily benefit smaller banking organizations with simpler business models. Testimony was provided by Comptroller of the Currency Joseph M. Otting; Federal Reserve Board (“FRB”) Vice Chair for Supervision Randal K. Quarles; FDIC Chair Jelena McWilliams; and National Credit Union Administration (“NCUA”) Chair J. Mark McWatters.

Mr. Otting, Mr. Quarles and Ms. McWilliams described various agency initiatives, including (i) the issuance of a notice of proposed rulemaking (“NPR”) that grants federal savings associations greater flexibility to exercise national bank powers without changing their charters, (ii) the issuance of a joint NPR to revise the statutory definition of a high-volatility commercial real estate exposure acquisition, development and construction loan, (iii) the adoption of interim final rules modifying the liquidity coverage ratio rule and (iv) the issuance of a joint agency proposal to raise the total asset threshold from $1 billion to $3 billion to allow well-capitalized insured depository institutions to be eligible for an 18-month examination cycle.

Mr. Otting noted that the Office of the Comptroller of the Currency also intends to:

  • implement an exemption from appraisal requirements for certain rural real estate transactions;
  • reduce the regulatory burden on banks for calculating and reporting regulatory capital;
  • reduce reporting requirements on Call Reports;
  • increase the required frequency of stress testing and reduce the required number of scenarios; and
  • revise the leverage ratio requirements for the largest U.S. banking organizations.

Mr. Quarles stated that the FRB prioritized:

  • issuing a proposed rule tailoring enhanced prudential standards for banks with assets between $100 billion and $250 billion;
  • reviewing requirements for firms with assets between $250 billion and the globally systemic important bank threshold; and
  • revisiting the threshold for the application of enhanced prudential standards to foreign banks.

Ms. McWilliams outlined the FDIC’s plans, which include:

  • rule amendments to reflect the exemption for certain loans secured by real property;
  • a proposed rule as to the community bank leverage ratio;
  • updates to Call Report Instructions to reflect the reporting change from brokered to non-brokered treatment of specified reciprocal deposits; and
  • reductions in reporting requirements for “covered depository institutions” with less than $5 billion total assets in the first and third quarter Call Reports.

Mr. McWatters discussed the NCUA’s recent actions and noted that the agency began to (i) update its examiner guidance and examination procedures, (ii) review credit union compliance in line with its risk-focused examination program and (iii) work with state supervisory authorities and other federal regulators to implement regulatory amendments.

Senator Sanders Proposes Big Bank Breakup

Senator Bernie Sanders (D-VT) introduced legislation that would break up the biggest U.S. banking and financial institutions. The bill is sponsored in the U.S. House of Representatives by Representative Brad Sherman (D-CA).

The bill, titled the Too Big to Fail, Too Big to Exist Act, would, among other things, require:

  • the restructuring of certain covered financial institutions (including banking organizations, insurance firms, broker-dealers and investment advisers) with a total exposure greater than three percent of the GDP of the U.S.;
  • insurance companies with more than $50 billion in assets to report total exposure to federal financial regulators; and
  • the Federal Reserve Board Vice Chair of Supervision and the Financial Stability Oversight Council to submit written reports on the status of financially significant institutions.

Entities that exceed the three percent cap (i.e., “too big to fail” institutions) would be given two years to restructure. According to the bill, these “too big to exist” institutions would not be eligible for a taxpayer bailout from the Federal Reserve Board and could not use customers’ bank deposits to engage in “risky financial activities.”

Lofchie Comment: Like some Cabinet newsletters, nice title, not much substance.

SEC Commissioner Urges Regulators Not to Impose Their Investment Judgment on Investors

SEC Commissioner Hester Peirce asserted that commissioners should not substitute their judgment for decisions made by investors, particularly with regard to (i) the decision to invest in a company that requires its shareholders to arbitrate any shareholder claims against the company (rather than go to litigation) and (ii) investments in bitcoin or other digital assets.

In remarks at the University of Michigan Law School, Ms. Peirce stated that (i) the SEC is no better than an investor at evaluating the investor’s best interest. She pointed to the SEC’s decision not to approve the public offering of the Winklevoss Bitcoin Trust. Ms. Peirce said that regulators should have allowed investors to decide whether a new investment is worthwhile.

Likewise, she said that the SEC should reject calls for it to become a “more activist regulator” and should not attempt to stretch SEC authority to limit mandatory arbitration between a public company and its shareholders. In this regard, Ms. Peirce questioned whether prior actions of the SEC, in discouraging corporations that were going public from requiring shareholders to arbitrate disputes, were actually within the scope of the SEC’s authority. Ms. Peirce observed that the SEC is required by the Federal Arbitration Act to “respect private contracts that favor arbitration.”

Lofchie Comment: Commissioner Peirce has become the voice of “liberalism” (in the very, very old-fashioned sense of the word): belief in limited government, government respecting the rights and abilities of individuals to make decisions, and government agencies not stretching the bounds of their authority to accomplish what officials decide is “good policy.” Note Commissioner Peirce’s views (and wit) in Motherhood and Humble Pie: Remarks before the Cato Institute’s FinTech Unbound Conference (summarized here). At a time when so many call for the government to expand its authority over private persons, Commissioner Peirce’s defense of the individual (including the individual’s right to screw up) is welcome.

CFTC Chair Proposes Alternative Cross-Border Framework

CFTC Chair Christopher J. Giancarlo proposed an alternative cross-border swaps framework to “better balance systemic risk mitigation with healthy swaps market activity in support of broad-based economic growth.”

In a new white paper, he previewed weeks ago, Mr. Giancarlo outlined his views on the current CFTC approach to regulating cross-border activities and suggested a new approach that would encourage greater cooperation with non-U.S. jurisdictions. Mr. Giancarlo recommended, among other things:

  • Non-U.S. Central Clearing Parties (“CCPs”): expanding the use of the CFTC’s exemptive authority for non-U.S. CCPs that are subject to similar regulations in their home country and do not pose risk to the U.S. financial system;
  • Non-U.S. trading venues: terminating the bifurcation of the global swaps market into separate U.S. person and non-U.S. person marketplaces by exempting non-U.S. trading venues, in regulatory jurisdictions that have adopted similar G20 swaps reform, from having to register with the CFTC as swap execution facilities;
  • Non-U.S. swap dealers: regulating non-U.S. swap dealers whose swap-dealing activity poses a material risk to the U.S. financial system;
  • Clearing and trade execution requirements: allowing non-U.S. persons to rely on substituted compliance as to swap clearing and trade execution requirements in comparable jurisdictions; and
  • Arrange, negotiate, or execute swap transactions: taking a “territorial approach to the U.S. swaps trading activity,” as non-incidental swaps trading activity in the United States should be subject to U.S. swaps trading rules.

Lofchie Comment: Market participants should be aware that while Chair Giancarlo is, in many respects, advocating for less U.S. regulation, and more deferences to home country regulators, he is not advocating for a deregulatory approach. In fact, in a number of regards, he would expand the scope of U.S. swaps regulation, perhaps most significantly as to swaps that are “arranged, negotiated or executed” in the United States by non-U.S. swap dealers. It is not clear what additional steps he would take in regard to the regulation of non-U.S. swap dealers whose activity pose a material risk to the U.S. financial system (or by what criteria he would determine which swap dealers posed such a risk).

Beyond the substance of what Chair Giancarlo is proposing, what is really fascinating is the manner in which he is pushing the direction of the CFTC, and how he prepared for that push even while being a Commissioner in the minority party; that is, through the publication of white papers, he has established himself as an intellectual and thought leader for the direction of regulation.  This has not only established his acumen – he has also freed himself from the constraints of the bureaucratic process.  There are probably not too many other regulators who would be able to exert influence in this manner, but one possibility is SEC Commissioner Peirce.

SEC Director of Investment Management Outlines Policy Initiatives

In testimony before the U.S. House Committee on Financial Services, SEC Division of Investment Management (the “Division”) Director Dalia Blass outlined the following underlying aims of the Division: (i) improve the retail investor experience; (ii) modernize the regulatory framework and engagement; and (iii) utilize resources efficiently. The Division is working on the following rule proposals or potential rulemaking areas:

  • propose Regulation Best Interest;
  • modernize fund disclosure both by reviewing the content of disclosures and by allowing funds to provide shareholder reports online;
  • improve disclosure as to variable annuities;
  • finalize a rule for the issuance of exchange-traded funds (“ETFs”), so that the SEC exemptive process can more efficiently process exemptive relief requests for ETFs not within the scope of the rule;
  • reduce obstacles to publishing research on investment funds in compliance with the Fair Access to Investment Research Act of 2017;
  • harmonize and improve registration and reporting requirements for business development companies and closed-end registered investment companies (“RICs”);
  • regulate the use of derivatives by RICs;
  • publish guidance regarding valuation procedures;
  • update investment adviser marketing rules;
  • improve investment company liquidity disclosures;
  • support fund innovation as to cryptocurrency-related holdings; and
  • review the proxy process.

Lofchie Comment: While the SEC talks the talk as to facilitating innovation, walking the walk is far more difficult. ETFs, for example, have become a significant product in the financial markets, and yet the SEC is only now considering a rule to routinize their issuance. As to cryptocurrency funds, one really has to question whether the SEC wants them to go forward, or is hoping that interest in the product is a bubble that will pop before the SEC is pushed to act. Compare SEC Rejects Another Nine Proposed Bitcoin ETFs with SEC Commissioner Peirce Calls on SEC to Embrace Innovation and Allow Cryptocurrency Risk-Taking.

Federal District Court Confirms that Cryptocurrencies are “Commodities” under CFTC Jurisdiction

The U.S. District Court for the District of Massachusetts ruled that cryptocurrencies fall within the definition of a “commodity” under the Commodity Exchange Act.

In a Motion to Dismiss, defendants argued that an allegedly fraudulent cryptocurrency, My Big Coin, is not a “commodity” since it does not deal in “contracts for future delivery” and thus is not within the CFTC’s jurisdiction over commodities. The plaintiff responded that there is future trading in cryptocurrencies and, as a result, My Big Coin falls under CFTC jurisdiction.

The Court denied the Motion to Dismiss and held that Congress defines a commodity by focusing on categories (e.g., cryptocurrency), not specific items (e.g., My Big Coin).

Senator Introduces Draft Bill Expanding the Community Reinvestment Act

Senator Elizabeth Warren (D-MA) introduced legislation intended to increase the supply of lower- and middle-income housing, incentivize communities to revise their zoning laws to facilitate housing construction, and provide substantial grants to first time home buyers with an emphasis on loans in formerly segregated neighborhoods. The bill would materially expand the scope of the Community Reinvestment Act of 1977 (the “CRA”). The CRA requires depository institutions to help meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods, consistent with safe and sound operations.

Senator Warren’s bill, titled the American Housing and Economic Mobility Act, would among other things:

  • Expand the Scope of Covered Institutions – The CRA currently applies to insured banks and thrifts. Under the bill, the scope of the CRA would be broadened to include U.S. non-bank mortgage originators, bank holding companies, savings and loan holding companies, and credit unions.
  • Revise the “Assessment Area” – Currently, a bank’s CRA performance is assessed on activities that occur in or that serve the institution’s assessment areas. An assessment area is generally limited to the area or areas surrounding a bank’s main office, branches and deposit-taking ATMs. Under the bill, the term “assessment area” would be expanded to include each community, including a state, metropolitan area and urban or rural county in which the institution: (i) maintains deposit-taking branches, ATMs or retail offices; (ii) is represented by an agent; (iii) issues a significant number of loans or other products relative to the total number of loans or other products made by the institution; (iv) has issued not less than 75% of the loans of the institution; or (v) has conducted not less than 75% of the business of the institution.
  • Require the Submission of “Community Benefits Plans” – The CRA does not currently require an applicant to a merger or other expansionary proposal to submit a community benefits plan, nor is such a plan required by the Federal Reserve under the Bank Holding Company Act or by any of the federal banking agencies under the Bank Merger Act. However, the CRA would, if amended by Ms. Warren’s bill, explicitly require the adoption of a community benefits plan and consultation with “community-based organizations and other community stakeholders” in developing such a plan.
  • Significantly Alter Procedures Applicable to Financial Holding Companies – The bill would amend notification procedures under Section 4(k)(6) of the Bank Holding Company Act to require prior notice filings and opportunities for public comment on certain acquisitions. In reviewing any prior notice filing, the Federal Reserve would be required to consider, among other things, the overall CRA rating of the financial holding company and any improvement plans.

Lofchie Comment: In her latest bill, Senator Warren takes aim at restrictive zoning policies that diminish the housing supply. (See Section 101(b).) San Francisco is commonly pointed to as a paradigm for such policies. The bill also provides for housing grants in areas where there is a shortage of housing and where rents have risen particularly fast over the last three years. (See Section 102(e) of the bill.) So what zoning policies should San Francisco adopt to be awarded some of the benefits provided for under the proposal? The bill could reward San Francisco by directing subsidies to ameliorate problems that – according to the bill – were created in the first place by the San Francisco zoning laws.