FRB Proposes Enhanced Prudential Standards for General Electric Capital Corporation

The Board of Governors of the Federal Reserve System (“FRB”) requested public comment on the application of enhanced prudential standards and reporting requirements to General Electric Capital Corporation (“GECC”), a non-bank financial company that the Financial Stability Oversight Council (“FSOC”) has determined should be supervised by the FRB.

The proposed enhanced prudential standards are similar to those that are applied to large bank holding companies, and include requirements regarding risk-based and leverage capital, capital planning, stress testing, liquidity, and risk management. Under the proposal, GECC would be subject to the enhanced supplementary leverage ratio, which is applicable to the largest U.S. banking organizations, and would be required to file reports with the FRB that are comparable to those which large bank holding companies are required to file.

However, the proposal also would apply certain additional standards to GECC, including additional independence requirements for GECC’s board of directors and restrictions on intercompany transactions between GECC and General Electric Corporation.

Comments on the proposal will be due 60 days after its publication in the Federal Register.

Lofchie Comment: We have commented numerous times that FSOC’s power to designate entities as systemically significant grants too much discretion to FSOC. The designation of GECC as systemically significant offers a good example of the fact that a similar result (giving the FRB more authority over large bank-like institutions) could have been achieved with a statute that was more formulaic. In the case of GECC, the FRB could have been given power over savings and loan holding companies of a certain size, just as it is given authority over bank holding companies. Similarly, if FSOC believes that the FRB should have authority over insurance companies of a certain size, then FSOC should propose an amendment to the law to that end instead of being given permission to exercise discretion as to which companies the FRB should regulate.

See: Text of Proposed Enhanced Prudential Standards; FRB Press Release.


GAO Recommends Further FSOC Action to Improve Designation Process of Non-Bank SIFIs

GAO issued a report that examines (i) FSOC’s process for designating systemically important non-bank financial companies (“non-bank SIFIs”) for enhanced supervision by the Board of Governors of the Federal Reserve System, and (ii) the extent to which this process has been transparent and systematic.

GAO stated that its reason for compiling the report was because these designations could have “significant implications for the companies as well as the stability of the financial system.” In the report, GAO recommended that FSOC (i) track key evaluation information, including additional details in public documentation about the rationale for determination decisions, and (ii) establish procedures to evaluate companies under both statutory determination standards for designating SIFIs.

According to the report, FSOC has designated three non-bank entities as systemically important to date, but the publicly released documents surrounding the designations have not clearly established the criteria involved in the designation process. GAO determined that making FSOC’s designation process more systematic and transparent could improve both public and market confidence and, in the process, help FSOC to achieve its intended goals.

Upon the report’s release, Senate Banking Committee Ranking Member Mike Crapo (R-ID) issued a statement saying that “the non-bank SIFI designation process has proved immeasurable and unclear, with serious regulatory consequences for firms that receive the designation. . . . Threatening to subject firms to a new regulatory regime without clear and objective standards is not only contrary to the long established principles of our regulatory framework, but doing so will lead to legal uncertainty that will undermine the very objective of FSOC.”

Lofchie Comment: The statutory provision that forms the basis of the designation of SIFIs is problematic. It affords regulators discretion to impose substantial regulatory burdens on the companies that it selects by using an arbitrary process (or, as FSOC might put it, “using judgment”). On matters of such importance, government regulators should be subject to clear standards. The GAO report is critical of FSOC for its own failure to be transparent and to establish such clear standards.

The GAO report criticizes as random, FSOC staffing determinations. “FSOC uses a volunteer staffing practice for selecting and assigning staff to conduct and lead company evaluations.” The report notes that the volunteers (or, more precisely, the persons volunteered by the agencies for which they work), are heavily drawn from the banking regulators. Accordingly, this practice is inconsistent with Congress’ intent for FSOC to draw on a broad range of expertise from a number of government organizations. It may also explain the outcomes in some of FSOC’s most questionable decisions – e.g., to investigate whether investment advisers are systemically significant – and whether they reflect an over-reliance on staffers who are outside of the banking world and/or who may be unfamiliar with the capital markets.

Treasury’s characterization of the GAO report is interesting. According to the GAO report, “Treasury staff noted that the report’s findings largely were positive, yet the findings associated with the recommendations appeared exaggerated” (i.e., negative) (at page 60). A more accurate description of the report is that its’ findings were generally negative, particularly given the importance of the subject matter. If FSOC disagrees with GAO’s assessment of whether FSOC can and should be more transparent, then FSOC should say so. Direct disagreement could allow for an open discussion of how FSOC works, which could result in either continued support for FSOC or revisions to its mandate. By glossing over the issues of the absence of transparency and standards, FSOC makes it difficult to have a full and reasonable discussion of the agency’s mandate and conduct.

See: Text of GAO Report.
See also: Senator Crapo’s Statement about the GAO Report on FSOC.
Related news: FSOC Updates FAQ on Non-Bank Financial Company Designations Process (November 18, 2014); FSOC Releases Q&A on Nonbank Financial Company Designations (September 26, 2014); GAO Issues Report on FSOC (September 18, 2014); FSOC Proposes Preliminary Designation of MetLife as a Non-Bank Systematically Important Financial Institution (September 4, 2014);  Representative Maloney Recommends Changes to FSOC Designation Process (August 4, 2014); House Financial Services Committee Approves FSOC Reform Legislation (June 23, 2014); House Financial Services Committee Hearing: “Examining the Dangers of the FSOC’s Designation Process and Its Impact on the U.S. Financial System” (May 22, 2014); SEC Commissioner Gallagher Submits Comment Letter in Opposition to FSOC Process (May 16, 2014); House Financial Services Subcommittee Chairmen Send Letter to FSB and FSOC Requesting Information on Methodologies Used to Designate G-SIFIs (May 12, 2014); Representative Garrett Questions the SIFI Designation Authority Granted to FSOC by Dodd-Frank (May 6, 2014).


CFTC Commissioner Giancarlo Discusses Best Principles for Financial Regulation, Financial Markets and Job Creation

CFTC Commissioner J. Christopher Giancarlo delivered remarks before the U.S. Chamber of Commerce in which he laid out a set of principles that he plans to follow as Commissioner, and stated his belief that these principles are “well suited” to maintaining healthy financial markets and encouraging job creation.

According to Commissioner Giancarlo, it is the CFTC’s duty to promote financial markets for their own health and for them to be of service to the American economy, since they are “key to American economic growth and job creation.” Commissioner Giancarlo voiced his continued support for the “core tenets” of Dodd-Frank Title VII. However, he stated that he also believes that excessive regulation can affect adversely the economy and job creation.

Commissioner Giancarlo laid out a set of six principles that he plans to follow in order to ensure that the CFTC takes a “more measured” approach to the regulation of the derivatives markets than it has in the past:

  1. Regulation Must Not Restrain the Economy. In Commissioner Giancarlo’s view, federal regulations have become a “major drag” on the U.S. economy, costing more than ever and hindering U.S. economic growth. In derivatives markets, he stated, the CFTC should avoid increased compliance costs if possible, since those costs “will surely work their way into the everyday costs” for Americans.
  2. Regulation Must Not Threaten American Jobs. One particular action that Commissioner Giancarlo identified as a “serious threat” to jobs in the U.S. financial services industry is the CFTC’s “Staff Advisory,” issued in November 2013, which imposes complex U.S. trading requirements on swaps trades between non-U.S. businesses on U.S. soil. According to Commissioner Giancarlo, this advisory is “causing many trading firms to consider cutting off all activity with U.S.-based trade support personnel” and should be withdrawn.
  3. Regulation Must Be Impartial and Balanced
  4. Regulation Must Be Competent. According to Commissioner Giancarlo, there is a direct link between “a government trying to do too much and a government doing things incompetently.” He cited the CFTC’s customer protection rule as an example of “flawed regulation rushed through in the wake of a crisis” and stated his intention to make sure that future CFTC rules solve “real problems, not invented ones.”
  5. Regulation Must Be Accountable. Commissioner Giancarlo referred to a recent Mercatus Center study, which argued that the informal mechanisms through which the CFTC regulates have undermined public confidence and “aggravated compliance burdens.” According to Commissioner Giancarlo, regulatory shortcuts must be curtailed and regulations “must not be produced in a vacuum with no oversight.”
  6. Regulation Must Not Create the Next Crisis. Commissioner Giancarlo voiced his concern that, in attempting to recover from the counterparty credit risk crisis, regulators could be setting up the industry for a future liquidity crisis.

See: Commissioner Giancarlo’s Speech.


FRB Governor Tarullo Discusses Liquidity Regulation and Supervision

Speaking at the Clearing House 2014 Annual Conference in New York, Board of Governors of the Federal Reserve System (“FRB”) member Daniel Tarullo discussed the evolving role and impact of post-crisis bank liquidity regulation and supervision in the United States.

Governor Tarullo stressed that liquidity regulation complements and is dependent on other regulatory initiations, namely capital buffers, resolution procedures and lender-of-last-resort (“LOLR”) practice. While LOLR is needed to prevent firms from hoarding liquidity in times of stress, and “underhoarding” liquidity under normal market conditions, LOLR, when used to prop up weak or insolvent institutions, may result in moral hazard. Liquidity regulation, according to Governor Tarullo, is necessary to limit the use of LOLR and serve both as a tax and a mitigant to offset such externalities.

Examples of the significant milestones in liquidity regulation that were discussed by Governor Tarullo included the Liquidity Coverage Ratio (“LCR”) adopted by the FRB last September, as well as the Net Stable Funding Ratio (“NSFR”) adopted recently by the Basel Committee on Banking Supervision (“Basel”). Governor Tarullo indicated that the FRB would be issuing a proposed rule next year to implement the NSFR in the United States, and that this rule would differ from the Basel standards by, for example, imposing regulatory surcharges on maturity mismatches within the contemplated 30-day stress scenarios.

Governor Tarullo concluded by discussing developments in the FRB’s supervisory approach to liquidity regulation and indicated that the FRB has rejected automatic sanctions for firms who fall out of compliance with the LCR or NSFR in times of generalized stress. Out of concern that mandatory sanctions would encourage liquidity hoarding, he said, the FRB is developing a context-dependent approach that will enable such firms to come back into compliance with the LCR and NSFR without becoming exposed to greater stress.

See: Governor Tarullo’s Speech.


IOSCO Issues Report on Post-Trade Transparency in CDS Market

The International Organization of Securities Commissions (“IOSCO”) published a consultation report, titled “Post-Trade Transparency in the Credit Default Swaps Market,” which analyzes the potential impact of mandatory post-trade transparency in the credit default swaps (“CDS”) market.

The report is based on a review of relevant works of academic literature and by international standards-setting bodies, as well as an examination of publicly available transaction-level post-trade data about CDS transactions before and after the introduction of mandatory post-trade transparency in certain CDS markets in the United States.

According to IOSCO, the data does not suggest that this introduction of mandatory post-trade transparency had a substantial effect on market risk exposure or market activity for those CDS products. Additionally, IOSCO stated that it believes that greater post-trade transparency in the CDS market would be valuable to market participants and other market observers. IOSCO encouraged each of its members to take steps to enhance post-trade transparency in the CDS market in its jurisdiction.

See: Consultation Report on Post-Trade Transparency in the Credit Default Swaps Market; IOSCO Press Release.

Shriveling Shadow Banking Limits Liquidity and Damages the Economy

The Center for Financial Stability (CFS) Divisia monetary aggregates and components often reveal nuances surrounding future moves in the economy and markets as well as a real time perspective of the US financial system. The November release is no exception.

– “Market finance” (or what some like to call “shadow banking”) is shriveling to the detriment of the economy and financial market liquidity.

– Access to market finance has shriveled by 45% in real terms since 2008 – the largest cyclical drop in the last 40 years.

For Shriveling Shadow Banking Limits Liquidity and Damages the Economy:

For October Divisia Monetary and Financial Data Release Report:

CFS Monetary Measures for October 2014 & Divisia on Bloomberg

Today we release CFS monetary and financial measures for October 2014. CFS Divisia M4, which is the broadest and most important measure of money, grew by 1.7% in October 2014 on a year-over-year basis versus
1.9% in September.

For Monetary and Financial Data Release:

For more on Divisia methodology and past releases for the United States:

Accessing CFS Divisia Data via Bloomberg

We are delighted to announce that our monetary and financial statistics are now available via the Bloomberg terminal.

Bloomberg users can access the CFS data 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’

CFS Divisia indices can also be found at Broad aggregates are available in spreadsheet, tabular and chart form. Narrow aggregates can be found in spreadsheet form.

FSOC Updates FAQ on Non-Bank Financial Company Designations Process

The Deputies Committee of the Financial Stability Oversight Council (“FSOC”) held a series of meetings on November 12, 2014 regarding FSOC’s non-bank financial company designations process.

The meetings followed FSOC’s directive to staff at its October 6 public meeting, and are part of its ongoing effort to seek input from relevant stakeholders regarding potential changes to the process. Discussions focused on proposals presented to FSOC’s staff in three broad categories:

  1. “engagement with companies under review during Stages 2 and 3 of the process;
  2. “the annual reevaluations of previously designated companies; and
  3. “the balance between informing the public of the Council’s work and protecting confidential, market-sensitive information relating to individual companies under consideration.”

FSOC’s set of frequently asked questions regarding its non-bank financial company designations process was updated and is available here

Lofchie Comment: Regardless of how many Qs are included in the FAQ, the process of designation is ultimately discretionary. This is not the optimal way for the government to administer financial markets (or, indeed, any activity). Here is the key Q. and A. from the linked FAQ:

“[Question:] What standards or metrics does the FSOC use to determine if a company should be designated?

“[Answer:] The Dodd-Frank Act establishes the standards for whether the FSOC may designate a nonbank financial company, and also includes a list of factors that the FSOC must consider in its designations. Under the statute, the FSOC may designate a nonbank financial company only if the FSOC determines that the firm’s material financial distress, or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the company, could pose a threat to U.S. financial stability. Factors the FSOC must consider include, among others, leverage, size, interconnectedness, and existing regulatory scrutiny.”

See: U.S. Treasury Press Release.

CFTC Commissioners Discuss and Differ on CFTC’s Swaps Trading Rules

In a speech at the Swaps Execution Facilities Conference (“SEFCON V”) hosted by the Wholesale Markets Brokers’ Association Americas (“WMBAA”), CFTC Chair Timothy Massad discussed the transparent trading of swaps transactions on regulated platforms. Chair Massad stated that regulated platforms “can bring greater integrity to the trading process and can facilitate straight-through-processing,” adding that more work needs to be done, and that the CFTC is working to fine-tune its rules. In a separate statement, Commissioner Giancarlo suggested that the worldwide swaps marketplace has “started to unravel,” and criticized the CFTC for imposing ill-advised transaction level rules.

Chair Massad outlined the following three principles, which guide his approach to current issues concerning regulated platforms:

  1. The CFTC’s duty is to implement the law and be faithful to it.
    • Dodd-Frank, Chair Massad reminded his audience, created the trading mandate, prescribed core principles, and directed the CFTC to write rules to implement the trading mandate and those core principles.
  2. Market development takes time.
    • Noting that SEF rules are barely a year old, and that the first made-available-for-trade (“MAT”) determinations are only eight months old, Chair Massad pointed out that this is a work in progress – that participants are still adapting and the technology, evolving.
  3. Markets don’t develop simply as a result of government directives.
    • The CFTC, Chair Massad said, must create a regulatory framework that not only implements the statutory trading mandate, but also creates the conditions in which participants wish to trade on SEFs.

Chair Massad stated that his goal is to build a regulatory framework that meets Dodd-Frank’s Congressional mandate and creates a foundation on which the market will thrive. He also spoke about issues that the CFTC intends to address relating to general oversight, products and methods of execution. Lastly, Chair Massad counseled patience, noting that the CFTC is focused on the cross-border implications of its trading mandate rules and that he is committed to harmonizing the CFTC rules as much as possible.

Chair Massad concluded by calling for additional resources. Without additional support, he said, “markets cannot be as well supervised, participants cannot be as well protected, and market transparency and efficiency cannot be as fully achieved.”

In a separate prepared statement, Commissioner Giancarlo suggested that the worldwide swaps marketplace has “started to unravel,” and criticized the CFTC for imposing “ill-advised transaction level rules worldwide” that he said are based on market participants’ U.S. personhood or employee location and the wrong template of the structure of the U.S. futures markets. He also remarked that the CFTC rules included a host of unprecedented swaps trading restrictions, including pushing block trades off platforms.

Commissioner Giancarlo called for a return to the clear framework of Dodd-Frank Title VII and suggested that such a return would:

  • “promote healthy global markets by regulating swaps execution in a manner well matched to the underlying market dynamics”;
  • “reduce the enormous legal and compliance costs of registering and operating  a[n] SEF that is closing the doors of smaller platforms”;
  • “encourage technological innovation to better serve market participants and preserve the jobs of U.S. based support personnel”;
  • “free up agency resources and save taxpayer money at a time of Federal budget deficits”; and
  • “undo much of the global fragmentation in global swaps trading and the resulting increased systemic risk.”

Commissioner Giancarlo stated that such a return also would attract the global trading community to the CFTC’s swaps regime.

Lofchie Comment: Chairman Massad’s comment – that the swap trading rules are mandated by Congress and all the CFTC can do is implement them is worth considering in a number of ways. One implication is that, at some point, the regulators should go back to Congress and insist (to paraphrase William Congreve) that what is legislated in haste must be repented at leisure; there will come a time to fix at least some of the problems created by Dodd-Frank. Not all of the damage done to the markets can be blamed on the hurried legislation of the statute; some of it must be ascribed to rulemaking that was nearly as hasty. In that regard, suggestions should be put forward as to how to improve the rules. Whether they are made by Commissioner Giancarlo or market participants, those suggestions should be given meaningful attention. While it might be true that the swaps trading rules have been in place for only a year, it is also true that they were criticized broadly before adoption; thus, their problems did not in fact emerge out of the blue.

See: Text of Chair Massad’s Speech; Text of Commissioner Giancarlo’s Speech.

Comptroller Thomas Curry Discusses the Globalization of Bank Supervision

Speaking at the 25th Special Seminar on International Finance in Japan, Comptroller of the Currency Thomas J. Curry discussed the challenges to bank supervision and risk management that are posed by an increasingly interconnected global banking environment.

In his remarks, Mr. Curry addressed the threat of cybersecurity, as well as U.S. efforts to implement the latest Basel III standards in harmonization with the requirements of Dodd-Frank. Praising the collaboration between regulators in Japan and the United States in implementing Basel capital standards for interest-rate risk, Mr. Curry stressed the importance of the two countries maintaining a “constructive relationship” in an ever more interconnected world.

Lofchie Comment: It is not difficult to find differing (and far more negative) views on the success of the liquidity risk rule, given the significant costs that it imposes on the securities markets. If there is a branch of government that should double in size, it is the Government Accountability Office, with its (mostly) impartial studies of the costs and benefits of various rules.

See: Text of Comptroller Thomas Curry’s Speech.