The 75th anniversary of Bretton Woods … and Atlantic City

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The Bretton Woods conference, which established the International Monetary Fund and the World Bank, was held from July 1-22, 1944 and remains widely known today, 75 years later. Far less known is the smaller conference that immediately preceded it in Atlantic City, New Jersey, from June 15-30, 1944. Only 17 countries attended, as opposed to 44 at Bretton Woods, and the conference was closed to the press, whereas at Bretton Woods dozens of journalists were present. Not much has ever been written about the Atlantic City conference, in contrast to a number of books and hundreds of articles that have examined Bretton Woods and its legacy.

To commemorate the 70th anniversary of Bretton Woods, in 2014 the Center for Financial Stability held a conference in the same location, the Mount Washington Hotel in Bretton Woods, New Hampshire. The conference featured papers that can be found elsewhere on the CFS Web site and the presentation of The Bretton Woods Transcripts, a book of previously unpublished conference material that I edited with Andrew Rosenberg and that the CFS published.

For the 75th anniversary, the CFS later this year will issue a book edited by me and Gabrielle Canning, a young scholar who, conveniently, is my neighbor. The book, Just before Bretton Woods: The Atlantic City Financial Conference, June 1944, collects American and British archival documents that present a detailed picture of what happened at Atlantic City. The Atlantic City conference developed the draft agreements for the IMF and the World Bank from which the Bretton Woods conference proceeded. It is accurate to say that Atlantic City made the World Bank possible. Whereas there was already an internationally agreed statement on the principles to govern the IMF before Atlantic City, no similar statement existed for the World Bank. At Atlantic City, the two leading delegations, from the United States and Britain, found that their ideas about the Bank were close enough to assemble quickly a draft that was also broadly agreeable to the other countries present.

Aliber’s “Reflections on Bretton Woods”

Robert Z. Aliber offers his “Reflections on Bretton Woods.” Bob is professor emeritus of International Economics and Finance at the University of Chicago, co-author of Manias, Panics, and Crashes: A History of Financial Crises, and a good friend of CFS.

Bob covers much ground. Topics include:

  • The White Mountains, Cog Railroad, and Mount Washington Hotel.
  • Bretton Woods Conferences.
  • How the Founders of Bretton Woods might view the last 75 years.
  • Trade and Tariffs.
  • The IMF.

The full report is available at http://www.CenterforFinancialStability.org/research/Reflections_on_Bretton_Woods_101719.pdf.

IRS to Ask Taxpayers about Virtual Currency Transactions

The IRS proposed an amended draft of the 2019 Form 1040 that includes a question about taxpayer virtual currency transactions.

As previously covered, the IRS provided updated guidance in the form of a revenue ruling and an FAQ on the tax treatment of virtual currency transactions. The FAQ addressed (i) when a cryptocurrency on a distributed ledger undergoes a protocol change that permanently divides the legacy from the existing distributed ledger (i.e., a “hard fork”) and (ii) when units of a cryptocurrency are delivered to the distributed ledger addresses of multiple taxpayers (i.e., an “airdrop”), typically following a hard fork.

The IRS proposed adding the following question to the 2019 Form 1040: “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

Comments on the revised draft must be submitted to the IRS within 30 days after October 11, 2019.

CFS Monetary Measures for September 2019

Today we release CFS monetary and financial measures for September 2019. CFS Divisia M4, which is the broadest and most important measure of money, grew by 5.9% in September 2019 on a year-over-year basis versus 5.4% in August.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Sep19.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’

FRB Vice Chair Randal Quarles Reviews FSB Activity

Federal Reserve Board Vice Chair Randal K. Quarles reviewed Financial Stability Board (“FSB”) activity and raised issues that continue to affect the global financial system. In a speech at the European Banking Federation’s European Banking Summit, Mr. Quarles highlighted the following:

OTC Derivatives. The FSB focused on the following issues as to OTC derivatives: (i) central clearing of standardized OTC derivatives, (ii) trading standardized OTC derivatives on an exchange or through an electronic trading platform, (iii) “reporting to trade repositories” and (iv) capital and margin requirements.

Prudential Bank Standards. Mr. Quarles addressed the work done by the Basel Committee to improve prudential standards for internationally active banking organizations (a/k/a “Basel III”). Mr. Quarles said that each of the 24 FSB jurisdictions have implemented the fundamentals of Basel III to incorporate risk-based capital and liquidity measures.

Key Attributes for Effective Resolution. As a solution to the “too-big-to-fail” dilemma, the FSB published “Key Attributes for Effective Resolution.” Mr. Quarles explained that the guidance offered procedures for national resolution regimes to follow if an important financial institution is failing.

Nonbank Financial Intermediation (“NBFI”). To better understand NBFI, the FSB conducted a “global monitoring exercise” and concluded that the overall size of NBFI to the global economy was $184 trillion. The FSB report also contained categories of NBFI activity and identified potential vulnerabilities.

Mr. Quarles also emphasized two issues the FSB is monitoring concerning the future of the global financial system.

– Financial Innovation. Mr. Quarles said that in response to an “explosion of financial innovation” in recent years, the FSB published a report on the potential implications and benefits of FinTech for the global financial system. Mr. Quarles highlighted multiple regulatory issues, such as (i) operational risks from third-party service providers, (ii) cyber risks and (iii) macrofinancial risks that may arise from FinTech activity.

– Market Fragmentation. While noting that market fragmentation will never “disappear,” Mr. Quarles explained that since the financial crisis, there have been growing concerns that globalization in the markets is slowing down. Mr. Quarles said that the FSB is working to assess the possible implications of market fragmentation, such as (i) the potential for regulatory “arbitrage” and (ii) an increased regulatory burden on firms.

CFS Monetary Measures for August 2019

Today we release CFS monetary and financial measures for August 2019. CFS Divisia M4, which is the broadest and most important measure of money, grew by 5.4% in August 2019 on a year-over-year basis versus 5.0% in July.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Aug19.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’

FCM Settles CFTC Charges Resulting from Cybersecurity Failure

A futures commission merchant (“FCM”) settled CFTC charges for failing to enact sufficient cybersecurity measures and to notify customers of a $1 million cyber breach.

According to the Order, the FCM, Phillip Capital Inc. (“PCI”) failed to implement sufficient cybersecurity and customer disbursement policies and procedures that ultimately allowed hackers to access their email systems and withdraw customer funds. After discovering $1 million in customer funds had been withdrawn, PCI (i) approved reimbursement of the mistakenly wired customer funds, (ii) notified the CFTC Division of Swap Dealer and Intermediary Oversight the day of the fraudulent wire and (iii) implemented measures to prevent further fraudulent transfers. The CFTC found that PCI failed to disclose in a timely manner the material facts of the cyber breach and fraudulent wire to current and prospective customers.

The CFTC credited PCI the $1 million restitution as a result of its prompt reimbursement of the customer funds upon discovery of the fraud. PCI also agreed to (i) cease and desist from further violating CFTC Rules, (ii) report remedial efforts to the CFTC and (iii) pay a civil monetary penalty of $500,000.

LOFCHIE COMMENTARY

This enforcement action is an illustration of both (i) what can go wrong in connection with a cybersecurity failure and (ii) how much the task of compliance has changed as a result of the need to deal with cybersecurity, as well as other technology, issues.

The firm’s initial problems resulted from the fact that its employees were deemed not be up to their cybersecurity tasks. Allegedly, the firm’s IT Manager “had limited training in cybersecurity, and cybersecurity was not broadly within the IT Engineer’s sphere of responsibility.” Apparently, neither the firm’s CCO, who was responsible for maintaining the firm’s Information Systems Security Program (“ISSP”), nor the CCO’s staff was qualified to manage cybersecurity defenses or problems. Even when firm employees discovered the breach, they failed to respond adequately and the hacker immediately rebreached the system. (The firm was arguably lucky that the hacker was so impatient. Had the hacker bided his time following the firm’s initial discovery, it is certainly possible that a second breach might have gone undiscovered for a longer period.)

The firm’s cybersecurity weakness was exacerbated by the fact that it had very weak “change of address” and disbursement policy controls. That was not of itself a cyber failure, but had those policies been up to speed, it is very likely that the major damage from the cyber failure itself could have been averted.

Finally, the firm failed to provide timely notice as to the breach. These days, firms must anticipate the possibility of a breach. While it seems unattractive to go public with information as to the breach, it is also risky not to do so.

SEC Provides Proxy Voting Guidance, Clarifies Obligations of Advisers

In a three-to-two vote, the SEC approved (i) guidance on an investment adviser’s responsibilities in proxy voting and in vetting any advice that the adviser may itself receive from a proxy advisor, and (ii) an interpretation and related guidanceon rules for solicitation of proxies and proxy voting advice.

Proxy-Advisor Guidance

In the proxy-adviser guidance, the SEC clarified an investment adviser’s fiduciary duty and obligations under Advisers Act Rule 206(4)-6 (“Proxy Voting”) in connection with an adviser’s proxy voting for clients. In its guidance, the SEC:

  • recognized that the adviser-client relationship should not be handled with a “one-size-fits-all” approach; and
  • recognized the wide variety of ways that investment advisers can use proxy advisory firms’ services while fulfilling their fiduciary duty to clients.

SEC Commissioner Elad L. Roisman voted in favor of the guidance, asserting that it (i) conforms to the Proxy Voting Rule’s flexible, principles-based approach to investment advisers’ proxy voting responsibilities, (ii) modernizes the Staff Legal Bulletin 20 (“SLB 20”) and (iii) highlights the importance of serving a client’s best interests.

SEC Commissioner Robert J. Jackson, Jr. dissented, expressing concern that the guidance would further concentrate the “proxy-advisory industry” due to the additional costs of compliance. According to Mr. Jackson, smaller institutions may not be able to bear the necessary costs, which could lead smaller investors to opt out of voting. Mr. Jackson noted that although the “role of proxy advisors has been hotly debated for decades,” all sides know that a competitive market helps both investors and issuers.

SEC Commissioner Allison Herren Lee voted against the guidance, saying that it “creates significant risks to the free and full exercise of shareholder voting rights.” Specifically, Ms. Lee criticized the guidance stating it:

  • would increase costs and “time pressure”;
  • would require more issuer involvement, despite “widespread agreement” that it would “undermine the reliability and independence of voting recommendations”; and
  • should undergo a notice and comment period or a cost-benefit analysis.

Interpretation and Guidance on Proxy Voting Advice

The SEC also provided an interpretation of SEA Rule 14a-1 (“Solicitation of Proxies – Definitions”). The SEC stated that proxy voting advice by a proxy advisory firm generally constitutes a solicitation under federal proxy rules. The SEC clarified that solicitations that are exempt from proxy filing requirements nonetheless remain subject to SEA Rule 14a-9 (“False or Misleading Statements”).

Commissioner Roisman supported the interpretation of SEA Rule 14a-1, emphasizing that it reiterates previous SEC statements that proxy voting advice is generally considered a “solicitation” under the rule. Mr. Roisman said that the interpretation will not interfere with proxy advisory firms’ ability to rely on information and filing exemptions under the federal proxy rules. Further, Mr. Roisman stated that the guidance on Rule 14a-9 offers “helpful” information on proxy voting advice, such as what information proxy advisors should disclose.

Commissioner Lee opposed the interpretation of SEA Rule 14a-1, stating that the SEC is planning to review the solicitation rules and may soon change the underlying exemptions. Ms. Lee highlighted the potential compliance burdens, which would force market participants to implement processes to comply with a regulatory framework that may soon change.

Future Actions

SEC Chair Jay Clayton stated that the interpretation and guidance provided a “first step” toward modernizing the proxy system. Mr. Clayton added that the SEC is also considering recommendations to amend SEA Rule 14a-2(b) (“Solicitations to Which § 240.14a-3 to § 240.14a-15 Apply”), which provides information and filing requirement exemptions. These exemptions, according to Mr. Clayton, were “adopted decades ago and warrant a fresh look.”

LOFCHIE COMMENTARY

Investment advisers will need to take a close look, and a periodically ongoing look, at their proxy voting policies. Advisers should be mindful that nothing obligates them to vote their clients’ shares, as long as an adviser has made it clear in its agreement with its clients that it will not do so. For many advisers, voting shares will not be worth the effort.

Separately, the very interesting aspect of declaring that proxy advisors are subject to SEA Rule 14a-9 is that it imposes on proxy advisors a more significant burden to justify or support their advice and to disclose any conflicts related to that advice. Query whether the threat of liability under SEA Rule 14a-9 changes the way that proxy advisors go about their business?

CFS Monetary Measures for July 2019

Today we release CFS monetary and financial measures for July 2019. CFS Divisia M4, which is the broadest and most important measure of money, grew by 5.0% in July 2019 on a year-over-year basis versus 4.8% in June.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Jul19.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’

CFPB Highlights Analysis on the Use of Non-Traditional Data in Credit Process

The CFPB highlighted the results of an analysis comparing the uses of traditional and non-traditional sources of information by consumers in the credit process.

In 2017, the CFPB granted no-action relief from certain Regulation B requirements to Upstart Network, Inc. (“Upstart Network”) to use alternative data (such as education and employment history) and machine learning for the purpose of an underwriting and pricing model. The no-action letter was contingent on Upstart Network providing the CFPB with information about compared results between (i) its credit underwriting and pricing model (a tested model) and (ii) a more standard model. Upstart Network was tasked with answering:

whether the Alternative Model’s use of alternative data and machine learning would increase access to credit; and
if the Alternative Model’s underwriting or pricing results create greater disparities than the traditional model (i.e., race, ethnicity, sex, age).
Based on the information gathered by Upstart Network, the CFPB found that:

access-to-credit comparisons showed the Alternative Model approved 27 percent more applicants than the traditional model, in addition to yielding 16 percent lower average annual percentage rates (“APRs”) for approved loans;
the expansion of credit access increased the acceptance rates in the Alternative Model for all tested races, ethnicity and sex segments by 23-29 percent while decreasing the average APRs by 15-17 percent;
“near prime” consumers in the Alternative Model with FICO scores between 620 and 660 were approved nearly twice as frequently;
applicants under 25 years of age in the Alternative Model were 32 percent more likely to be approved; and
consumers in the Alternative Model with incomes under $50,000 were 13 percent more likely to be approved.

LOFCHIE COMMENTARY

Should the regulators be approving credit models based on whether they are happy with the results? What happens if another credit scoring metric produces different or less favored results: does that metric become illegal to use without regard to the process of its production or its accuracy?

Big data raises lot of important social/moral questions; and “disparate impact” is one of the more complex ones. For some background discussion of “big tech,” “big data” and credit scoring, see “Big tech in finance: opportunities and risks,” particularly the discussion of credit provision beginning on page 60, and Senate Banking Committee Considers Testimony on Consumer Data Vendors.

Global Regulators Express Concern with Libra Network’s Ability to Protect Consumer Data

Data protection and privacy enforcement regulators expressed concern with the lack of information provided by Facebook and other members of the Libra Network regarding the proposed cryptocurrency.

In a joint statement, the UK Information Commissioner’s Office and authorities from Albania, Australia, Canada, Burkina Faso, the European Union and the United States expressed doubt about the Libra Network’s ability to protect consumer data given the (i) current lack of transparency regarding the digital currency and infrastructure and (ii) Facebook’s recent misuse of consumer data, which “had not met the expectations of regulators, or their own users.” The regulators warned that once Libra is launched, it could give the network access to “millions of people’s personal information.” Given these issues, the regulators emphasized that they were “surprised and concerned” that more information has not been provided regarding the network’s data protection efforts.

To achieve some clarity, the regulators called on the Libra Network to answer a number of very broadly phrased questions regarding data protection and privacy, and the ability of individual consumers to protect their information, including by deleting their accounts.