From China: It’s the “Never Befores,” Stupid…

I was delighted to speak at the Stronger Global Economic Growth Conference held in Shanghai this past weekend.  My remarks focused on the vital – yet poorly understood – space at the intersection of financial markets and the global economy.

Today, growth is constrained by three “never befores”:

– Large scale intervention by central banks (new CFS Divisia data reveal counter-intuitive trends),
– A swell in the size of the financial regulatory apparatus,
– Distortions across a wide range of markets.

We address each and offer solutions.  The result would be reduction in the drain on growth as well as opening new possibilities for international monetary coordination.

For the full remarks:

IOSCO Addresses Emerging Challenges in Global Securities Markets

The Board of IOSCO met to discuss emerging challenges and recent developments in the global securities market. According to the press release, Board members discussed “the implications for global securities markets of slowing economic growth, declining commodity prices, continuing low or negative interest rates and market volatility.”

The Board:

• “agreed on further research on financial technology subsectors with particular relevance for securities regulators, including blockchain”;

• “supported further work on the use and regulation of automated advice tools in securities markets and understanding the risks arising from the use of cloud technology”;

• “discussed a report on IOSCO’s work addressing the challenges of cyber risk”; and

• “heard updates on the work of the Growth and Emerging Markets Committee on digitization and fintech.”

As to capacity building and co-operation, the Board:

• “approved the framework for a Global Certificate Program to be run in conjunction with the Program of International Financial Systems at Harvard University and designed specifically for market regulators”;

• “welcomed the completion of an Online Toolkit for Regulatory Capacity Building to be launched in March”;

• “progressed work on the enhanced IOSCO Multilateral Memorandum of Understanding on cooperation and the exchange of information, with a view to seeking Presidents’ Committee approval in Lima in May”; and

• “supported further work on regulator powers to compel witness statements on behalf of a foreign securities regulator and another proposal about regulators taking enforcement action based on sanctions in foreign jurisdictions.”

SEC Commissioner Stein Offers Regulatory Priorities

SEC Commissioner Kara M. Stein discussed future SEC efforts to bring transparency and accountability to the markets. At a recent conference, Commissioner Stein identified the most pressing initiatives:(i) exchange-traded funds (“ETFs”); (ii) proxy rules; (iii) market structure improvements; (iv) shortened “T+2” settlement cycle for securities transactions; and (v) the “private/public market divide.”

Specifically, Commissioner Stein made the following recommendations:

  • ETFs: Commissioner Stein remarked that the SEC needed to: (i) “carefully review the roles of authorized participants and market makers in facilitating ETF operations and trading”; (ii) “continue looking for opportunities to enhance accountability as well as investor protection with respect to ETFs; (iii) “finish analyzing the events of August 24, and work with the exchanges and other market participants to take appropriate action”; and (iv) “think about a roadmap for holistic regulation of ETFs and other exchange traded products.”
  • Proxy Rules: Commissioner Stein stated the position that the SEC should not limit the voting rights of investors “based solely upon whether they are able to attend a meeting in person or vote by proxy” (known as the “‘bonafide nominee rule,’ which allows only nominees who have consented to be named in the proxy statement to be included on the proxy card”).
  • Market Structure Improvements: Commissioner Stein called for finishing the remaining rules under the Dodd-Frank Act, which “need to be completed prior to even initiating the dealer regime.” These include requirements for capital and margin, obligations for segregation and recordkeeping, and standards for business conduct. Commissioner Stein also discussed the Consolidated Audit Trail (“CAT”) as another area of focus in 2016, in order to “properly understand” flash crashes and the events of August 24, 2015.
  • T+2 Settlement Cycle: Commissioner Stein commented that “protracted settlement times are costly, increase risk, and are simply inefficient.” “Given the consensus behind T+2, [the SEC] certainly should be able to make it a reality this year,” she said.
  • The Private/Public Market Divide: Commissioner Stein said that “there are both risks and rewards that flow from private markets” and the SEC “should thoughtfully assess the sheer volume and dollar value of capital raising in the private realm and derive lessons from this space.” Commissioner Stein also pointed out the need for “an approach that rewards [private companies’] innovation but that also balances the need for transparency and accountability” by referencing the 2015 “hype” surrounding “so-called ‘unicorns'” (private start-ups valued at over $1 billion).

SEC Commissioner Kara M. Stein delivered her remarks at the “SEC Speaks Conference: What Lies Ahead? The SEC in 2016.”

Lofchie Comment: Commissioner Stein’s underlying preference for more regulation is the common thread throughout her remarks. It is implicit in, for example, her comments as to the private/public market divide, where she questions the “hype” that surrounds private companies. Her questions always point in the same predictable direction: where can we impose more regulation? Can we impose it on ETFs? Can we impose it on swap dealers, on trading markets, on capital raising?

Regulators should also ask: where could we have less regulation? Are registered investment companies overburdened with rules that impose costs on retail investors? Has Regulation NMS created market fragmentation? Why do issuers avoid the U.S. public markets as long as they are able to do so?

SEC Chair White Embraces Regulatory Initiatives beyond Disclosure

Chair Mary Jo White reviewed SEC progress on a number of prominent initiatives relating to: (i) asset management, (ii) equity markets structure, and (iii) SEC disclosure regimes. In remarks made at the annual “SEC Speaks” conference, Chair White stated that the SEC is “not only” a disclosure agency, and that SEC proposals reflect “careful consideration” of tools beyond disclosure. She said that complexity of products, changes in market participant behavior, pervasive network technology and systemic risks “call for additional protections.”

Regarding asset management, Chair White pointed to (i) a proposal to enhance reporting for investment advisers and mutual funds to improve the quality of information for investors; (ii) a proposal requiring that funds monitor and manage derivatives-related risks and provide limits on their use; and (iii) proposed reforms designed to promote stronger and more effective liquidity risk management across open-end funds and limit the adverse effects that liquidity risk can have on investors and potentially the broader markets. She stated that finalizing these rules will be 2016 priorities.

Regarding equity market structure, the Chair commented that the SEC proposed two rules to enhance the SEC supervision of markets: (i) a proposal to broaden the oversight of active proprietary trades, including high-frequency traders; and (ii) the first-ever major update to the regulations for alternative trading systems. Chair White noted that the SEC issued an advance notice of proposed rulemaking on transfer agents. She said that the SEC will look to finalize these proposals this year, as well as to advance order routing disclosures and trading algorithm risk controls.

Concerning disclosure effectiveness, Chair White said that the SEC will address the form and content of financial statements by entities other than Regulation S-X registrants.

Beyond the three core areas, Chair White discussed: (i) shortening the settlement cycle from T+3 to T+2 to reduce potential systemic risk; (ii) enhancing filings through the expanded use of structured data; (iii) finalizing rules updating the intrastate offering exemption; (iv) considering recommendations for a universal proxy; and (v) examining final rules for resource extraction.

Lofchie Comment: Chair White recognizes that the SEC imposes requirements that go beyond disclosure and makes a fair point that the SEC needs more tools. That said, it is important to question both the work that the SEC has done with the tools that it has, and who actually benefits from use of these tools. As to the SEC’s proposed requirements regarding risk management, these proposals have been sharply criticized by the Investment Company Institute as increasing risk for investors. As to the rules regarding resource extraction, it would be hard to make any serious argument that they can, in any way, really benefit investors.


Agencies Propose Orderly Liquidation Rule for Covered Broker-Dealers

Pursuant to Dodd-Frank Act Section 205(h), the FDIC and the SEC proposed a rule to govern the orderly liquidation of “covered brokers-dealers,” or large broker-dealers that are subject to liquidation under Title II of the Dodd-Frank Act and not dissolution under the Securities Investor Protection Act (“SIPA”).

According to the proposal, the rule would clarify (i) how the customer protections of SIPA will be integrated with the orderly liquidation provisions of Dodd-Frank, (ii) the role of the FDIC as receiver and that of the Securities Investor Protection Corporation (“SIPC”) as trustee of a failed broker-dealer, and (iii) the administration of claims in an orderly liquidation process. In addition, the proposal would address (a) the priorities for unsecured claims against a covered broker-dealer, (b) the administrative expenses of SIPC and (c) the treatment of Qualified Financial Contracts (e.g., repurchase agreements and security-based swaps).

Much of the proposal consists of procedural details on how the liquidation of a covered broker-dealer would proceed, and how the process and distribution of assets through orderly liquidation would differ from those aspects of the ordinary SIPA process. The proposal specifies that although a “Title II orderly liquidation is under a different statutory authority, the process for determining and satisfying customer claims would follow a substantially similar process to a SIPA proceeding.” Additionally, the calculations of the amount due and the actual amount paid to customers are not intended to be affected by the existence of the proceeding.

The most important aspect of the new liquidation process is the ability it gives regulators to create a new legal entity, which the proposal defines as a “bridge broker-dealer,” to which contracts of the insolvent broker-dealer may be transferred. This bridge broker-dealer is deemed to be registered as a broker-dealer with the SEC and a member of any self-regulatory organization of which the insolvent firm was a member.

The right of a counterparty to declare a default under a Qualified Financial Contract would be (i) delayed until the close of business on the business day following the appointment of the FDIC as receiver for the insolvent broker-dealer or (ii) lost if the counterparty is notified that the relevant contract has been transferred to a bridge broker-dealer.

The proposal requests comments on a number of questions relating to the orderly liquidation process for a covered broker-dealer.

For large broker-dealers that may be “covered broker-dealers” and so would be subject to orderly liquidation, the key question is this: whether any aspect of the proposed process could make them appear unattractive as parties to Qualified Financial Contracts, or raise the cost for them of entering into such contracts.

Legislators Say that “Doomsday Predictions” about Proposed Conflicts Rule Are at Odds with Industry Assurances to Investors

Senator Elizabeth Warren (D-MA) and Representative Elijah E. Cummings (D-MD) argued that “insurers and financial firms provide much more optimistic assessments when they speak to their own investors” than in their “dire and unsupported public predictions and official comments to the Department of Labor about the impact of the proposed Conflicts of Interest rule.” In a letter addressed to DOL Secretary Thomas Perez and Office of Management and Budget Director Shaun Donovan, Senator Warren and Representative Cummings demonstrated this contrast with excerpts of “statements to investors” from “nine of the largest insurance companies in the country” that opposed the proposal. The statements were published in an article titled “Department of Labor: Don’t Make It Harder for Americans to Gain Guaranteed Income in Retirement.”

Senator Warren and Representative Cummings asserted that despite the “doomsday predictions” voiced in “Washington op-eds and comment letters” by insurers and financial firms, their statements to investors provided “a much more sanguine view of the impact of the rule,” and explained that the rule “will have few, if any, negative impacts on their financial advisers, their clients or their bottom line, and may even create new business opportunities.”

Lofchie Comment: Financial institutions are fighting the rule because they believe it will do them damage. If firms were genuinely indifferent, as the legislators suggest, they would not oppose the rule.

CFS Monetary Measures for January 2016

Today we release CFS monetary and financial measures for January 2016.  CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.0% in January 2016 on a year-over-year basis versus 3.8% in December.

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

For Monetary and Financial Data Release Report:

Bloomberg terminal users can access our monetary and financial statistics 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’


Central bank policy is founded on flawed analysis

Professor Michael Wickens (University of York and Cardiff Business School) publishes a thoughtful letter in the Financial Times “Central bank policy is founded on flawed analysis” –

Professor Wickens illustrates how assumptions underpinning monetary policy actions actually damage financial stability.

Center for Financial Stability members and friends know how our Advances in Monetary and Financial Measurement (AMFM) data developed under the leadership of Professor William A. Barnett illustrate present day challenges to the conduct of monetary management and financial stability.

For instance, Fixing the Fed’s Liquidity Mess – – a Wall Street Journal piece that I wrote with Stephen Dizard highlights the specific challenge to financial stability from illiquid markets.  We offer three solutions.


Vice Chair Stanley Fischer Discusses the Function of the Federal Reserve as Lender of Last Resort

Board of Governors of the Federal Reserve System (the “Fed”) Vice Chair Stanley Fischer reviewed recent changes in regulation and supervision concerning the role of the Fed as “lender of last resort.” In remarks before the Committee on Capital Markets Regulation delivered in Washington, D.C., he outlined post-Dodd-Frank Act developments, including: (i) lending to insured depository institutions and discount window loans, (ii) the shadow banking system and the Federal Reserve’s broad-based emergency facilities, and (iii) the Federal Reserve’s preventative measures for lending to individual non-bank institutions.

Vice Chair Fischer highlighted the following “three major sources of concern about potential weaknesses in the new framework for financial crisis management”:

  • The Dodd-Frank requirement that the Fed publish information about discount window loans has exposed banks to the stigma of borrowing from the central bank. This requirement prevents the discount window from functioning properly as a backstop to ensure liquidity, since banks fear that accessing the discount window will signal weakness to investors.
  • The general failure to maintain regulatory flexibility makes it difficult to address unanticipated events that fall outside the framework established by Dodd-Frank. On this point, Vice Chair Fischer noted that the Fed’s broadbased emergency credit facilities were instrumental in providing flexibility as the financial crisis unfolded.
  • The lack of flexibility (above) is exacerbated by the fact that the new financial system has not undergone a stress test of its own. Vice Chair Fischer emphasized that this source of concern “is, in one sense, fortunate, for the financial system will undergo its fundamental stress test only when we have to deal with the next potential financial crisis.”

Vice Chair Fischer noted that Dodd-Frank reduced the probability that the lender of last-resort functions will be needed in the future. However, he expressed concern that the moral hazard should not eliminate the capacity of authorities to respond to unanticipated events or crises, and “[s]trengthening fire prevention regulations does not mean that the fire brigade should be disbanded.”

Lofchie Comment: As Vice Chair Fischer notes, banks (very correctly) dread showing any “signs of weakness.” In the aftermath of Dodd-Frank, there was a sudden burst of enthusiasm for “transparency” and “fuller disclosure,” as if absolute truth were a panacea. It is not. The opposite is sometimes true: too much disclosure of problems at a bank potentially can trigger a run on that bank (and a run on one bank may spread to others). Warning against the dangers of too much disclosure is not an argument for dishonesty. Rather it is just an acknowledgement that too much candor can be a two-edged sword. (This is a problem that regulators have acknowledged in connection with money market funds: the risk that sophisticated investors can quickly flee, leaving smaller and less-informed investors behind.)

Further, it is good of the Vice Chair to acknowledge that many of the supposed benefits that are derived from Dodd-Frank are untested. For that reason, it is inappropriate for regulators to constantly assert how much “safer” the system has become. At best, they might say that certain numbers have moved in a positive direction. Of course, other numbers have moved in a negative direction. For example, the numbers now point to more volatility in the market, fewer clearing firms and greater centralization of risk.

President Obama Directs Implementation of National Cybersecurity Plan

President Obama directed his Administration to implement a Cybersecurity National Action Plan. As described in a fact sheet issued by the White House, the plan “takes near-term actions and puts in place a long-term strategy to enhance cybersecurity awareness and protections, protect privacy, maintain public safety as well as economic and national security and empower Americans to take better control of their digital security.”

SIFMA President and CEO Kenneth E. Bentsen Jr. announced support for the plan. “The establishment of a bipartisan commission of thought leaders to recommend cybersecurity best practices will encourage a united front and meeting of the minds that will benefit national security,” he said.