Chairpersons Gensler and White Testify on “Mitigating Systemic Risk in the Financial Markets through Wall Street Reforms”

The Senate Banking Committee held a hearing to discuss reducing systemic risk through Wall Street reforms, including the implementation of Dodd-Frank.

Link here to see a summary of the hearing produced by Delta Strategy Group.  Among the topics addressed in the questioning were the following:

Cross-Border Regulation
Rule Making Progress (and Volcker)
Cooperation between the Regulators
Money Market Funds
The Jobs Act
Physical Commodity Holdings by Banks
Fiduciary Duties for Securities Brokers
Corporate Voting Structures Where Some Shares Have Greater Voting Rights Than Others

The following witnesses testified:

See also: Hearing webcast

Three Federal Bank Agencies Seek Comment on Dodd-Frank Act Stress Test Guidance for Medium-Sized Firms

The FDIC, OCC, and Federal Reserve Board (“FRB”) are seeking comment on proposed supervisory guidance describing supervisory expectations for stress tests conducted by financial companies with total consolidated assets between $10 billion and $50 billion. These medium-sized companies are required to conduct stress tests beginning in the fall under agency-issued rules implementing a provision of the Dodd-Frank Act. The public comment period will be open until September 25, 2013.

See: Proposed Supervisory Guidance.
See also: FDIC Press Release; OCC Press Release; FRB Press Release.

Streetwise Professor Craig Pirrong: (“If the law supposes that …”)

Economist Craig Pirrong (“If the law supposes that…,”Streetwise Professor) argues that the CFTC’s defense of its stance on the residual interest proposal for FCMs in the face of industry opposition “is purely legalistic, and does not even attempt to address the fundamental economic issues,” which Pirrong argues includes “negative impacts of the regulation on liquidity, costs, and systemic risk.”  Pirrong asserts that the CFTC is hiding behind the legalisms in order to force through a proposal, despite the fact that it will increase costs and risks to users of futures. 

Lofchie Comment:  The specific CFTC rule proposal to which Professor Pirrong refers is the amendment to CFTC Rule 1.21(f), which reads as follows,

(f) Limitation on use of futures customer funds. (1) A futures commission merchant shall treat and deal with the funds of a futures customer as belonging to such futures customer. A futures commission merchant shall not use the funds of a futures customer to secure or guarantee the commodity interests, or to secure or extend the credit, of any person other than the futures customer for whom the funds are held.

That proposal would prohibit an FCM from using one customer’s funds to secure another customer’s clearing obligations even on an intraday basis.  Accordingly, on an intraday basis, either the FCM or each customer who is losing money that day will have to top-up its account on an intraday basis.  This will either require FCMs to maintain much more cash to support their customers (which expense will have to be passed on to customers) or require customers to keep much more margin at their FCMs in order to support potential intraday losses (which expense will be borne directly by customers).  As Professor Pirrong points out, this “improvement” in regulation is totally irrelevant to the losses at MF Global and Peregrine, neither of which were caused by customers’ losses.  Rather, if customers are required to post more margin to their FCMs, customers will be at more risk to their FCMs, thus exacerbating the MF Global and Peregrine problems. 

GAO Report on the Impacts of the Financial Crisis on the Insurance Industry

The GAO has issued a report examining the effects of the financial crisis of 2007-2008 on the insurance industry, finding that the negative effects of the crisis were quite concentrated, hitting primarily AIG and a number of other insurers involved in financial insurance or the mortgage market.  The report addressed the following issues:

  • What is known about how the financial crisis affected the insurance industry,
  • The factors that affected the impact of the crisis on the insurers and policyholders,
  • The types of actions that have been taken since the crisis to help prevent or mitigate potential negative effects of future economic downturns.

The report found that the crisis had a generally minor effect on policyholders, but some mortgage and financial guaranty policyholders – banks and other commercial entities – received partial claims or faced decreased availability of coverages. Additionally, the report found that insurance business practices, regulatory restrictions, and a low interest-rate environment helped reduce the effects of the crisis.

See: GAO Report; GAO Highlights.

CFS Congratulates Professor Steve H. Hanke for the “Doctor Honoris Causa” Honor Bestowed by the BAS

The CFS is pleased to announce that CFS Special Counselor and Johns Hopkins University Professor Steve H. Hanke was awarded the honorary title of “Doctor Honoris Causa” by the Bulgarian Academy of Sciences for his role in the introduction of Bulgaria’s currency board. Professor Hanke served as an advisor to the President of Bulgaria in 1997 when the country was in the worst financial, economic and political crisis in the modern history of Bulgaria.

During the award ceremony, the Prime Minister of Bulgaria, Plamen Oresharski, “expressed satisfaction with the decision of the Executive Council of BAS for the awarding of the title and said how much Prof. Hanke has contributed to financial stability in the country…”

“For more than 15 years our monetary system has been praised and criticized, but it is a fact that it has contributed to the economic progress of our country. I want to thank Prof. Hanke for the periodic reviews – sometimes critical, sometimes encouraging, but always in a positive style. I hope that he will always be predisposed to Bulgaria,” added the prime minister.

Click here for the announcement and an audio file of Professor Hanke’s comments.

U.S. GAO’s Report to Congressional Committees on Need to Further Consider Proposals’ Impact on Systemic Risk

The report was compiled in accordance with Dodd-Frank’s mandate in Section 202, paragraph (e) (“Study of Bankruptcy and Orderly Liquidation Process for Financial Companies”), that the GAO continually report on ways for the Bankruptcy Code to more effectively provide for a resolution to systemic risk. The principal recommendation made by the report was that the Financial Stability Oversight Counsel consider the benefits and disadvantages of various changes to the Bankruptcy Code with respect to financial institutions and qualified financial contracts.  The report did not express a view as to whether such changes were needed or not, and in particular noted that the persons whom it consulted were divided on the appropriate treatment of qualified financial contracts.

Lofchie Comment:  Interestingly, the report (from page 34 on) could be read as critical of the “orderly liquidation process” established by Dodd-Frank, actually increasing the uncertainty as to what will happen in the bankruptcy of a financial institution.

See:  GAO Full Report; GAO Report Summary.

CFTC Commissioner O’Malia Dissents from CFTC Cross-Border Guidance Statement

CFTC Commissioner Scott O’Malia has issued a Statement of Dissent to the CFTC’s interpretive guidance and policy statement regarding the cross-border application of the CEA’s swaps provisions.  

O’Malia argues that the CFTC’s Guidance:  (1) fails to articulate a valid statutory foundation for its overbroad scope and inconsistently applies the statute to different activities; (2) crosses the line between interpretive guidance and rulemaking; and (3) gives insufficient consideration to international law and comity. These shortcomings, he argues, are compounded by serious procedural flaws in the Commission’s treatment of international harmonization and substituted compliance, as well as in its issuance of the Exemptive Order. 

In addition to charging that the CFTC’s action constitutes “a regulatory overreach based on a weak foundation of thin statutory and legal authority,” Commissioner O’Malia’s statement argues that, because the CFTC’s action “has the force and effect of law,” it should have been promulgated as a legislative rule under the APA.

Lofchie Comment:  The procedural issue raised by Commissioner’s O’Malia’s dissent is not going to disappear.  In fact, if anything, the Commissioner understates the problems caused by the CFTC’s decision not to comply with the legislative rule procedure under the APA.  Even if no group determines to challenge the CFTC directly on whether its “guidance” is in fact a “rule,” any time that the CFTC seeks to bring an enforcement action that is based upon the guidance, the defendant will be able (and will have every incentive, not to mention a case) to argue that the guidance is not enforceable.  This is an issue that I expect to write more about (quite a bit more about).

Unfortunately, this is not just an argument about procedure.  One of the reasons that proposed rules are required to go through a public comment period is so that they may receive the benefit of others’ suggestions.  The ongoing debate about the process by which the guidance (that is not a rule) was adopted should also serve to spotlight the various deficiencies in the policy behind the guidelines (another topic as to which I expect to write more).


See: Commissioner O’Malia’s Statement of Dissent.
See also: CFTC Approves Cross-Border Guidance and Exemptive Order (July 15, 2013).

GAO Issues Report on Criteria for Qualifying as an Accredited Investor

As mandated by Dodd-Frank, GAO has issued a report regarding the SEC criteria for qualifying as an “accredited investor,” the standard that generally allows the person to participate in private placements.    

The report examines market participants views on the existing criteria for accredited investor status as well as alternative criteria.  Participants with whom GAO spoke identified adding liquid investments and use of a registered adviser as attractive alternative criteria.  The report discusses potential other criteria, such as education; e.g., having an MBA.  In addition, the report considers the possibility of altering the existing criteria, for example by raising or lowering the current income or net worth standards. 

In its conclusion, the GAO indicates that the SEC intends to consider the alternative criteria in reviewing the definition of accredited investor.

Lofchie Comment:  The discussion in the report reflects an attempt to weigh potentially conflicting policy goals: (i) on the one hand, raising the accredited investor standard may better protect investors; (ii) on the other hand, expanding the standard fosters capital formation, particularly for small businesses. 


See: GAO Highlights of Report; GAO Report.


IOSCO’s Final Report on Principles for Financial Benchmarks

IOSCO published its final report, “Principles for Financial Benchmarks,” which provides an overarching framework of principles for benchmarks used in the financial markets. The report establishes guidelines for benchmark administrators and other relevant bodies in the following areas:

  • Governance;
  • Benchmark quality;
  • Quality of methodology; and
  • Accountability mechanisms.

The report recommends that the application and implementation of the principles should be proportional to the size and risks of each benchmark and/or the administrator and the benchmark-setting process.

Lofchie Comment: One of the principal issues in the benchmark debate was whether benchmarks should be based on actual transactions, a position that had been strongly advanced by the CFTC. IOSCO rejected this position, albeit very gracefully, with the following language: “The Data Sufficiency Principle provides that a benchmark should be based on prices, rates, indices or values that have been formed by the competitive forces of supply and demand and anchored by observable transactions entered into at arm’s length between buyers and sellers in such an active market. The final report clarifies that this does not mean that individual benchmark determinations must be constructed solely or even predominantly by transactions or that data must be used in a certain order” (emphasis added). In response, CFTC Chairman Gensler declared victory, saying: “I am pleased that the IOSCO Principles issued today require that benchmarks be anchored by observable transactions. . . .”

See: IOSCO Principles for Financial Benchmarks Final Report.
See also: IOSCO Media Release.

CFS Money Measures Highlight Shift in Fed Stance

Today we release CFS monetary and financial measures for June 2013. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.2% in June 2013 on a year-over-year basis.

CFS monetary data provide particular insights regarding a shift in Federal Reserve policy and future policy moves. For special analysis, please contact LeAnn Yee at

For Monetary and Financial Data Release: