Banque de France 18th Edition Financial Stability Review

Banque de France released its annual financial stability review this month.

“The focus of this 18th edition of the Financial Stability Review (FSR) is macroprudential policies; how they are implemented and their channels of transmission, and the way they interact with other policies, notably microprudential, fiscal and monetary policies.

The onset of the financial crisis and its consequences have led policymakers to take a more macroeconomic approach to financial system supervision, in order to safeguard its solidity and guarantee the financing and growth of the economy.

This 2014 edition of the FSR provides wide ranging views, emanating from most prominent international experts, and is also an opportunity for some of the pioneering countries in this field to share their experiences of macroprudential policy.”

– Macroprudential policies: rationale and objectives

Five questions and six answers about macroprudential policy
Jaime CARUANA and Benjamin H. COHEN, Bank for International Settlements

Governance of macroprudential policy
Klaas KNOT, De Nederlandsche Bank

From tapering to preventive policy
Charles GOODHART, London School of Economics, Financial Markets Group
and Enrico PEROTTI, University of Amsterdam and Centre for Economic Policy Research

Collective action problems in macroprudential policy and the need for international coordination
José VIÑALS and Erlend NIER, International Monetary Fund

A macroprudential perspective on regulating large financial institutions
Daniel K. TARULLO, Federal Reserve System

The impact of macroprudential policy on financial integration
Andreas DOMBRET, Deutsche Bundesbank

– Experiences regarding macro prudential policies

European macroprudential policy from gestation to infancy
Ignazio ANGELONI, European Central Bank

Macroprudential policy in France: requirements and implementation
Anne Le LORIER Banque de France

Implementing macroprudential policies: the Swiss approach
Jean‑Pierre DANTHINE, Swiss National Bank

The effects of macroprudential policies on housing market risks: evidence from Hong Kong
Dong HE, Hong Kong Monetary Authority

Macroprudential policies in Korea – Key measures and experiences
Choongsoo KIM, Bank of Korea

Framework for the conduct of macroprudential policy in India: experiences and perspectives
Kamalesh C. CHAKRABARTY, Reserve Bank of India

Learning from the history of American macroprudential policy
Douglas J. ELLIOTT, The Brookings Institution

Macroprudential policy and quantitative instruments: a European historical perspective
Anna KELBER and Éric MONNET, Banque de France

– Macroprudential policy interactions and transmission channels

Macroprudential policy beyond banking regulation
Olivier JEANNE and Anton KORINEK, Johns Hopkins University, Department of Economics

Principles for macroprudential regulation
Anil K KASHYAP, University of Chicago Booth School of Business,
Dimitrios P. TSOMOCOS, Said Business School, St Edmund Hall, University of Oxford
and Alexandros VARDOULAKIS, Federal Reserve System

Macroprudential capital tools: assessing their rationale and effectiveness
Laurent CLERC, Banque de France, Alexis DERVIZ, Czech National Bank,
Caterina MENDICINO, Banco de Portugal, Stéphane MOYEN, Deutsche Bundesbank,
Kalin NIKOLOV, Livio STRACCA, European Central Bank,
Javier SUAREZ, CEMFI, and Alexandros VAR DOULA KIS, Federal Reserve System

The housing market: the impact of macroprudential measures in France
Sanvi AVOUYI-DOVI, Rémy LECAT, Banque de France
and Claire LABONNE, Autorité de contrôle prudentiel et de résolution

Three criticisms of prudential banking regulations
Vivien LEVY-GARBOUA, Sciences Po and BNP Paribas
and Gérard MAAREK, EDHEC

Macroprudential policy and credit supply cycles
José‑Luis PEYDRÓ, Catalan Institution for Research and Advanced Studies, Universitat Pompeu Fabra

Interactions between monetary and macroprudential policies
Pamfili ANTIPA and Julien MATHERON, Banque de France

Banque de France’s financial stability report can be found on the CFS FSR page.

Financial Stability Reports from Japan, Korea, South Africa, Brazil, the Netherlands, and Iceland

The following financial stability reports were published and made available recently:

  • Central Bank of Iceland came out with volume 14 of its financial stability report.
  • De Nederlandsche Bank came out with its spring 2014 report.
  • Banco Central do Brasil came out with volume 13 of its report.
  • South African Reserve Bank released the March 2014 Financial Stability Review.
  • The Bank of Korea just came out with its financial stability report today. There is an English version of the executive summary currently. A full English translation will be uploaded shortly.
  • The Bank of Japan came out with the April 2014 Financial System Report. Below is the comprehensive assessment of the financial system from the Bank of Japan website:

    “Japan’s financial system as a whole has been maintaining stability.

    Judging from developments in financial markets and financial institutions’ behavior, there is no indication warning of financial imbalances such as excessively bullish expectations. The volatility of stock prices temporarily increased from the beginning of 2014, but volatility has generally been low in the Japanese government bond (JGB) and foreign exchange markets.

    Capital bases of financial institutions such as banks and shinkin banks have been adequate on the whole, and these institutions have sufficient funding liquidity. Thus, they generally have strong resilience against various economic and financial shocks, as they would maintain their capital adequacy ratios above regulatory levels even under stresses arising in scenarios involving a significant economic downturn and a substantial rise in interest rates. However, attention should be paid to the possibility that the impacts of an economic downturn and an interest rate rise spread to the financial system, depending on the speed and extent of the economic downturn and the rise in interest rates, as well as the factors behind them. Some financial institutions have relatively weak capital bases, and are behind the curve in improving asset quality following the Lehman shock. These institutions need to steadily strengthen their capital.

    Financial intermediation has operated more smoothly than it did at the time of the previous Report.

    Financial institutions have adopted more proactive lending attitudes at home and abroad, and some of them have increasingly taken on risks associated with securities investment, albeit to a small extent. Financial intermediation through financial markets has become prevalent. In these circumstances, financial conditions among firms and households have become more accommodative. Financial institutions’ loans have grown at a faster pace, particularly those to small and medium-sized firms, and these institutions have extended loans to a wider range of industries and regions.

    The recent economic recovery has had positive effects on the profits of financial institutions. The positive effects include an increase in profits related to stock investment, an increase in sales of stock investment trusts, and a decrease in credit costs. However, the core profitability of domestic business operations relating to deposits and loans has remained on a downtrend, mainly due to the continued narrowing of interest rate spreads on loans. Business conditions among regional financial institutions are particularly severe. The decline in core profitability does not immediately affect the stability or functioning of the overall financial system. Nonetheless, the declining trend in core profitability is a challenge that should be resolved because it may constrain financial institutions’ ability to absorb losses and take on risks in the medium to long term.”

  • Financial stability reports can be found here.

    House Subcommittee Chair Garrett Delivers Opening Remarks at Oversight of SEC Hearing, Focuses on FSOC and NMS

    The House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises held a hearing titled “Oversight of the SEC’s Agenda, Operations, and FY 2015 Budget Request.”  Subcommittee Chair Scott Garrett delivered opening remarks at the hearing and discussed SEC initiatives as well as the Financial Stability Oversight Council’s (“FSOC”) regulation of the asset management industry.  

    Representative Garrett thanked Chair White for directing her staff to prioritize the examination of the U.S. equity markets “long before the recent media outcry.” Additionally, he commended Chair White for posting the OFR’s study on asset management on the SEC’s website, allowing people around the country to correct many of the study’s “inaccuracies and falsehoods.”

    One item that Representative Garrett declared to be a top priority is the “recent push by some at FSOC and other international regulators to expand the government’s safety-net and prudential regulatory approach to those in the asset management business.”  Representative Garrett called this a “grave concern” and stated his hope that the Committee and the SEC would work together to send a strong message to the FSOC not to pursue actions in the asset management industry, such as the regulation of asset management firms as systemically important financial institutions.

    Regarding the need for Regulation NMS revision, he urged the SEC to make decisions based on data analysis and not a “sensationalized and over-hyped media narrative” (i.e., Flash Boys).

    Lofchie Comment: The FSOC’s assertion that it could deem asset managers, which have virtually no assets, to be “systemically significant” succeeded in drawing considerable attention to the decision-making process of the FSOC. The Financial Services Committee and Representative Garrett should push back not only on this single issue, but also as to the appropriate authority of the FSOC in light of the limits of its institutional competence; i.e., that it is part of a historical bank regulator now asserting control over areas which ordinarily would not have been viewed as strengths of the bank regulators, such as asset management and insurance.

    See: Representative Garrett’s Opening Remarks.
    See also: Committee Memorandum; Committee Hearing Page and Webcast.


    Comments on FRB’s Advance Notice of Proposed Rulemaking Regarding Physical Commodity Activities

    In January 2014, the Board of Governors of the Federal Reserve System (“FRB”) issued an Advance Notice of Proposed Rulemaking (“ANPR”) soliciting comments on various issues related to physical commodity activities conducted by financial holding companies, including the risks that such activities pose to the safety and soundness of depository institutions and the financial system generally. The activities covered by the ANPR included physical commodities activities that have been found to be “complementary to a financial activity” under section 4(k)(1)(B) of the Bank Holding Company Act (“BHC Act”), investment activity under section 4(k)(4)(H) of the BHC Act and physical commodity activities grandfathered under section 4(o) of the BHC Act.

    During the ANPR’s comment period, the FRB received a number of letters from various institutions, trade associations and individuals.  Among these were several letters from financial holding companies, including those from both the Goldman Sachs Group, Inc. (“Goldman”) and Morgan Stanley. Goldman’s letter noted the role that financial holding companies play as intermediaries in commodities markets, including serving as efficient means of providing financing and hedging products to producers and end users. The letter acknowledged that there are potential risks associated with such activities, but emphasized that those risks are manageable and not significantly different from those associated with other financial activities.

    Morgan Stanley’s letter reviewed the scope of the activities covered by the ANPR and acknowledged the importance of conducting each of them pursuant to a robust risk management framework. The letter then discussed the public benefits of physical commodities activities, which Morgan Stanley stated are “real and significant,” and highlighted the risks faced by firms that produce, distribute and consume commodities, concluding that financial holding companies are uniquely positioned to provide financing and risk management solutions to such firms. The letter cited several specific scenarios such as helping renewable energy producers build wind farms, or helping an airline reduce fuel costs that were enabled by Morgan Stanley’s ability to engage in certain physical commodities activities.

    See: Morgan Stanley’s Comment Letter; Goldman Sachs’ Comment Letter.
    See also: FRB ANPR on Complementary Activities, Merchant Banking Activities and Other Activities of Financial Holding Companies Related to Physical Commodities.
    Related news: Trade Associations Submit Joint Comment Letter to FRB Regarding Activities of Financial Holding Companies Related to Physical Commodities (April 21, 2014).


    SIFMA AMG Submits Comments on SEC Memo Relating to Money Market Reform

    The SIFMA Asset Management Group (“SIFMA AMG”) and the SIFMA Private Client Group submitted a joint comment letter to the SEC on four memoranda released by the SEC Division of Economic and Risk Analysis (“DERA”) regarding Money Market Fund Reforms. The four memoranda were: (i) Liquidity Cost during Crisis Periods (the “Liquidity Cost Memorandum”); (ii) Municipal Money Market Funds Exposure to Parents of Guarantors (the “Municipal MMF Memorandum”); (iii) Demand and Supply of Safe Assets in the Economy; and (iv) Government Money Market Fund Exposure to Non-Government Securities. 

    The comment letter focused on two issues: (i) if a liquidity charge were imposed on an investor making a withdrawal from a money market fund during a downturn, what should be the amount of the charge and (ii) what should be the portfolio diversification requirements? 

    Regarding the liquidity charge, the comment letter urged that any such charge be set at 1% of the value of redeemed assets (rather than 2%, as the SEC had proposed).  The comment letter argued against any change in the current concentration rules.

    See: SIFMA Comment Letter.


    Mercatus Scholar Hester Peirce on the GAO Report Concerning Information Security at the SEC

    Mercatus Scholar and former congressional staffer Hester Peirce published an article discussing a recent report by the U.S. Government Accountability Office (“GAO”) on SEC information security controls.  The GAO report identified a number of specific security weaknesses at the SEC.

    Lofchie Comment: One significant theme of Ms. Peirce’s paper is that the SEC tends to be harder on private companies than it is on itself.

    Click here to view the commentary by Hester Peirce.
    See: GAO Report.
    Related news: GAO Report: SEC Needs to Improve Controls over Financial Systems and Data (April 21, 2014).


    NASAA and CSBS Release Guidance on Virtual Currency

    The North American Securities Administrators Association (“NASAA”) and the Conference of State Bank Supervisors (“CSBS”) announced the development of model consumer guidance to assist state regulatory agencies in providing consumers with information about virtual currency and factors that consumers should consider when transacting with or investing in virtual currency.

    The model guidance explains what virtual currency is, provides a short list of risks that consumers should consider when investing, and reminds consumers to research what sort of regulation, if any, applies to virtual currency transactions or investments in their states.

    See: Model State Consumer and Investor Guidance on Virtual Currency.


    Commissioner Aguilar: Looking at Corporate Governance from the Investor’s Perspective

    SEC Commissioner Luis A. Aguilar delivered a speech, as a part of the Corporate Governance Lecture Series at the Emory University School of Law, in which he asserted that, in order to restore trust between Wall Street and Main Street, it is crucial to have corporate governance practices that foster the principles of (i) accountability, (ii) transparency and (iii) engagement. Framed within the context of the executive compensation process, Commissioner Aguilar stated that these principles should drive the establishment of an effective corporate governance regime, and highlighted a few of the ways in which the SEC incorporates these important principles into its rulemaking and enforcement programs.

    On the principle of accountability, Commissioner Aguilar commented that corporate governance can only embody accountability if shareholders know that performance will be measured: good performance will be rewarded, poor performance will not and misconduct will not be tolerated. Regarding both executive compensation and say-on-pay, the Commissioner suggested that SEC enforcement actions are a key mechanism for imposing accountability on “corporate officers and gatekeepers.” Commissioner Aguilar emphasized the importance of this in instances in which self-dealing or other breaches of duty result in violations of the SEC rules regarding fraud, reporting requirements, books and records, and financial controls. A robust enforcement program, he argued, helps to “reinforce the principle of accountability by punishing those in a position of trust and responsibility who cross the line.”

    The Commissioner also addressed the principle of transparency. Without it, he said, it is extremely difficult to have accountability. Commissioner Aguilar stated that the SEC promotes the principle of transparency by “requiring that public companies shine a light on the information that investors need to make good investment and voting decisions.” He remarked that this is accomplished through SEC rules which require the public disclosure of a description of a company’s business, its board and management, and financial and operating data, both historical and forward-looking, among other information. Commissioner Aguilar noted that access to audited financial information and other required public disclosure is particularly important when shareholders hold officers and directors responsible for corporate performance, and that all of these disclosures enhance transparency.

    Concerning the disclosure rules relating to executive compensation, the Commissioner cited the Dodd-Frank mandated rules, which include disclosures as to:

    • the relationship between executive compensation actually paid and the financial performance of the issuer;
    • company policies regarding the hedging of equity securities held or awarded to directors and employees; and
    • the ratio between the compensation of the chief executive officer and the total annual compensation of its average worker (known as “Pay Ratio”).

    Commissioner Aguilar urged the SEC to adopt rules requiring the mandated pay-for-performance and hedging disclosures which, taken together with the Pay Ratio Rule, he argued, will “foster accountability by making compensation decisions more transparent, and will help investors to make more informed investment decisions when they exercise their rights as shareholders and owners.”

    Lastly, Commissioner Aguilar addressed engagement. Traditionally, he commented, the primary opportunity for shareholders to communicate with a company was at the annual shareholder meeting, which was neither practical nor provided sufficient opportunity for shareholders to exercise their rights as owners of the company. Focusing on (i) informal engagement with investors, (ii) engaging retail shareholders, and (iii) shareholder proposals, Commissioner Aguilar urged the further development of mechanisms through which shareholders can communicate with their companies, which he believes will be mutually beneficial for shareholders and companies.

    Commissioner Aguilar concluded by stating that the underlying corporate governance issue regarding executive compensation is not simply about the amount of the compensation, but also about whether the decision-making process enables accountability through transparency and shareholder engagement.

    Lofchie Comment: Over time, the Pay Ratio Rule will almost certainly demonstrate that the pay ratio of successful companies reveals a greater discrepancy than that of unsuccessful companies, since people at the top receive a larger portion of their pay through bonuses. The various ratios cited in the Commissioner’s speech are not meaningful without significantly more underlying information. For example, pay ratios might be significantly different between domestic companies with a larger U.S. work force and global companies with a significant number of foreign employees earning locally appropriate though lower wages. Financial regulators should focus on adopting rules that are genuinely meaningful. The Pay Ratio may be a popular rule, but that does not make it meaningful disclosure.

    See: Commissioner Aguilar’s Speech.


    HFT Class Action Suit: City of Providence v. Bats Global Markets, Inc., et al.

    The City of Providence, RI, filed a putative class action complaint in the U.S. District Court for the Southern District of New York, naming as defendants 16 different national securities exchanges, 12 major securities brokers, and 11 high-frequency trading (“HFT”) firms. The Plaintiff, in the case titled City of Providence v. BATS Global Markets Inc., et al., claims to represent every class of investor who bought or sold stock on a U.S. exchange from April 2009 through the present.  The defendant class is only slightly smaller.   

    The allegations in the complaint are generally derivative of Michael Lewis’s recent book, Flash Boys: A Wall Street Revolt, and the complaint repeatedly cites that publication. The Complaint alleges that the named HFT firms engaged in a number of trading behaviors that distorted stock markets and disadvantaged other market participants. The complaint alleges that the broker defendants allowed the HFT defendants access to their clients’ trade orders, which gave the HFT firms an informational advantage when trading against the brokers’ clients in the market. The complaint also alleges that the stock exchanges and alternate trading venues allowed HFT defendants to “co-locate” computer equipment, which allowed an informational advantage that enabled them to disadvantage other market participants.

    The Complaint alleges three counts, all under the Securities Exchange Act of 1934: (i) violation of the anti-fraud provisions of Section 10(b) and SEC Rule 10b-5 promulgated thereunder; (ii) violation of Section 6(b) of the Act, as pertaining to registration of National Exchanges; and (iii) “insider trading” allegations for alleged violations of Section 20A of the Act.

    See: Complaint by the City of Providence.


    GAO Report: SEC Needs to Improve Controls over Financial Systems and Data

    The United States Government Accountability Office (“GAO”) released a report assessing the SEC’s information security controls as part of its audit of the SEC’s financial statements from fiscal years 2013 and 2012.

    The report noted that, while the SEC had implemented and made progress in strengthening information security controls, weaknesses limited their effectiveness in protecting the confidentiality, integrity and availability of a key financial system.  The report noted further that the information security weaknesses existed because the SEC did not sufficiently oversee and manage the implementation of information security controls during the migration of this key financial system to a new location.

    GAO recommended that the SEC take action to (i) more effectively oversee contractors performing security-related tasks and (ii) improve risk management.

    In a separate report for limited distribution, GAO will make specific recommendations to address weaknesses in security controls.

    See: GAO Report.