SEC Chair White Outlines SEC Disclosure Developments

SEC Chair Mary Jo White reviewed the development of SEC disclosure in corporate governance. She focused on board diversity, non-Generally Accepted Accounting Principles and sustainability reporting.

Chair White reported that the SEC staff is preparing recommendations to the Commission to amend the rule requiring companies’ proxy statements to include “more meaningful board diversity disclosures on their board members and nominees where that information is voluntarily self-reported by directors.” She emphasized that the SEC’s “lens on board diversity disclosure needs to be refocused in order to better serve and inform investors.”

Chair White discussed the reporting of non-GAAP financial measures, voicing “significant concern” over companies that take the flexibility of non-GAAP information “far and beyond what is intended and allowed.” She cautioned that “the non-GAAP information, which is meant to supplement the GAAP information, has become the key message to investors, crowding out and effectively supplanting the GAAP presentation.” Chair White urged companies to review SEC guidance on non-GAAP disclosures carefully.

Chair White reported that the SEC is addressing disclosure of sustainability information through a “materiality-based approach to disclosure, guidance on certain issues,” and through “shareholder engagement on a range of sustainability topics.” She noted that the disclosure of sustainability matters has increased, but affirmed that the SEC is taking a “more focused look at such disclosures, particularly [those that are] related to climate change, in [its] annual filings reviews.”

Chair White delivered her remarks at the International Corporate Governance Network Annual Conference in San Francisco, California.

Lofchie Comment: How much of the SEC’s focus on “disclosure” is driven by the interests of investors? Is it really true that corporations would better serve their investors if their disclosures spotlighted the risks of climate change, or does that proposed requirement reflect a political preference? If it is the latter, wouldn’t most investors be more concerned about the risks that might arise from Brexit, Zika and other pandemics, governmental defaults on both national and municipal levels, aging populations, regulatory burdens, and so on? How can the need for disclosure on global warming possibly take precedence over disclosure concerning other kinds of risks?

MRAC Reviews Agency Coordination in a CCP or Bank Resolution

The CFTC Market Risk Advisory Committee (“MRAC”) examined (i) the Central Counterparty (“CCP”) Risk Management Subcommittee’s draft recommendations for the ways in which CCPs can coordinate their efforts when preparing for the default of a significant clearing member, and (ii) the roles the FDIC and the CFTC play in the resolution of banks and central counterparties.

At an open hearing, FDIC and CFTC staff presented a number of topics including: (i) the Title II Process under the Dodd-Frank Act, (ii) special accountability for the company management of global systemically important banks, (iii) access to the orderly liquidation fund, (iv) international engagement, and (v) derivatives clearing organization (“DCO”) resolution.

CFTC Commissioner Sharon Bowen expressed support for CCP coordination in general terms, “since it is highly likely that the default of a significant clearing member would occur in an environment where multiple CCPs and clearing members are affected.” She encouraged the FDIC, as the resolution authority for CCPs, and the CFTC, as the primary regulator for CCPs, to communicate and coordinate efforts.

CFTC Chair Timothy Massad emphasized the CFTC’s leadership in promoting cooperation and coordination.

It has been a priority of mine since taking office, and it is also a priority of regulators around the world, as evidenced by the agreement between U.S. and international regulators last year, to implement a four-part workplan to examine clearinghouse resiliency standards, recovery and resolution planning, and interdependencies among clearinghouses and clearing members. I am pleased that the CFTC is leading much of this work.


Lofchie Comment: The need for so-called coordination between CCPs evidences one of the negative consequences of both Dodd-Frank and mandatory clearing: materially increased interconnected risk through clearing members. Dodd-Frank (and similar legislation throughout the world) has resulted in fewer clearing counterparties, and these remaining counterparties, which now are smaller in number and larger in size, are each more connected with the other counterparties through the increased mandatory use of clearing corporations. Even as regulators talk about reducing interconnectedness, the implementation of burdensome regulatory policies drives mid-sized firms away from certain activities. That, combined with government-mandated linkages through clearing corporations, likely increases interconnectedness, perhaps to a material extent.

Questions about interconnected risk are worth considering. Answers might demonstrate that the results of coordination are themselves questionable. Even assuming that the regulations are moving markets in the right direction (and that is an assumption), the specifics of coordination demonstrate that not all of the results are good. At best, they’re mixed.

FRB Reviews the 2016 Dodd-Frank Act Supervisory Stress Test Results

The Board of Governors of the Federal Reserve System (“FRB”) reviewed the results of their 2016 supervisory stress tests and determined that “the nation’s largest bank holding companies continue to build their capital levels and improve their credit quality, strengthening their ability to lend to households and businesses during a severe recession.” The supervisory stress tests are one component of the Comprehensive Capital Analysis and Review (“CCAR”), an annual exercise to evaluate the capital planning processes and capital adequacy of large bank holding companies (“BHCs”).

The 2016 Dodd-Frank Act stress test cycle (“DFAST 2016”) began January 1, 2016, and projected the performance of 33 BHCs in three scenarios over nine quarters (baseline, adverse, and severely adverse). The FRB stated that the results of the DFAST 2016 projections “suggest that, in the aggregate, the 33 BHCs would experience substantial losses under both the adverse and the severely adverse scenarios.” Through nine quarters of the planning horizon, the aggregate losses under the “severely adverse scenario are projected to be $526 billion.” These projected losses include:

  • $385 billion in accrual loan portfolio losses;
  • $11 billion in OTTI and other realized securities losses;
  • $113 billion in trading and/or counterparty losses at the eight BHCs with substantial trading, processing, or custodial operations; and
  • $17 billion in additional losses from items such as loans booked under the fair-value option.

Compared to last year’s severely adverse test scenario, firms that are active in trading and market activities saw smaller losses in net income as a result of less severe stress in the equity markets, but firms more focused on traditional lending activities were more affected by negative short-term interest rates and greater stress in the real economy. The FRB explained that the year-over-year changes in supervisory stress test results reflect several factors: (i) changes in BHCs’ starting capital positions; (ii) portfolio composition and risk characteristics; (iii) changing hypothetical scenarios; and (iv) model changes.

The FRB noted that the 2015 severely adverse scenario “assumed that corporate credit quality worsened even more than what would be expected in a severe recession,” which “amplified the widening of corporate bond spreads, decline in equity prices, and increase in equity price volatility.” By comparison, the 2016 severely adverse scenario “includes a more severe recession than last year’s scenario and also features negative short-term interest rates, which moderates the decline in equity prices and increases in market volatility relative to last year.”

The FRB highlighted that the Federal Reserve made “notable changes” in three models used for this year’s supervisory stress tests, namely: (i) the operational risk model; (ii) the market risk-weighted assets model; and (iii) the capital calculation model. The FRB observed that these changes had “moderate effects on the aggregate results but had varied effects on individual firms.”

FSOC Approves 2016 Annual Report

The Financial Stability Oversight Council (“FSOC”) approved unanimously its 2016 Annual Report containing recommendations on central counterparties (“CCPs”), cybersecurity and market structure. In open and executive sessions, the FSOC reviewed (i) updates on market developments, (ii) the Federal Reserve’s proposed rulemaking applying to certain insurance companies, and (iii) the annual reevaluation of the designation of non-bank financial companies.

The 2016 Annual Report offered the following recommendations:

  • Cybersecurity. Financial regulators should “strongly support” efforts to implement the Cybersecurity Act of 2015 in order to establish a “robust legal framework for sharing cyber-related information.” Regulators must maintain a “common risk-based approach to assess cybersecurity and resilience,” and develop “robust sector-wide plans” for responding to significant cybersecurity incidents.
  • Liquidity and Redemption Risks. Regulators should consider implementing the following measures:
    • robust liquidity risk management practices for mutual funds, particularly with regard to preparations for stressed conditions by funds that invest in less liquid assets;
    • clear regulatory guidelines that address limits on a mutual fund’s ability to hold assets with very limited liquidity in order to prevent holdings of potentially illiquid assets from interfering with a fund’s ability to make orderly redemptions;
    • enhanced reporting and disclosures by mutual funds of their liquidity profiles and liquidity risk management practices;
    • taking steps that would allow and facilitate mutual funds’ use of tools to allocate redemption costs more directly to investors who redeem shares;
    • additional public disclosure and analysis of the external sources of financing, such as lines of credit and interfund lending, as well as events that trigger the use of external financing; and
    • measures to mitigate liquidity and redemption risks that are applicable to collective investment funds and similar pooled investment vehicles offering daily redemptions.
  • Capital Liquidity and Resolution. Regulatory agencies should review the resolution plans of large, complex bank holding companies closely in order to promote resolvability under the U.S. Bankruptcy Code and ISDA’s 2015 Universal Resolution Stay Protocol.
  • Central Counterparties. The Federal Reserve, the CFTC and the SEC should continue to coordinate and examine ways to improve the supervision of all CCPs that are designated as systemically important financial market utilities.
  • Wholesale Funding Market Reforms. Regulators must monitor general collateral finance repo transactions and assess the risks that could be posed by cash management vehicles that are not money market funds.
  • Data Quality, Collection and Sharing. Regulators should (i) develop permanent data collection programs, (ii) adopt the legal entity identifier, where appropriate, and (iii) harmonize the reporting of derivatives data.
  • Financial Stability. Regulators should expand a recent Treasury Request for Information by examining the regulatory treatment of products that have “highly correlated underlying risk drivers.” In addition, they should utilize coordinated tools, such as “trading halts,” and enhance data and information sharing among member agencies.
  • Financial Innovation. Regulators should actively monitor and evaluate the risks posed by technological advances in practices and products, such as marketplace lending and distributed ledger systems, both of which “appear poised for substantial near-term growth.”

FSOC also noted that a federal court rescinded its designation of a non-bank financial company for Federal Reserve supervision and prudential standards. The government is appealing the court’s decision and stated:

[FSOC]’s authority to designate nonbank financial companies remains a critical tool to address potential threats to financial stability, and [FSOC] will continue to defend vigorously the nonbank designations process.


Lofchie Comment: While the FSOC Report provides good general background on the state of various types of financial institutions; e.g., broker-dealers, credit companies and banks, as well as an overview of regulatory developments, it seems to be at least as much a political document as an analytic one. Very little is said regarding the reasons why FSOC’s designation of an insurance company as “systemically important” was rejected by the court, or of the criticisms of the SEC’s proposed rules with respect to leverage at investment companies or even the reasons why the economic data regarding hedge funds is poor (Form PF is useless). Likewise, to the extent that risks seemingly have been created by regulatory policy, those risks are glossed over; e.g., discussions of clearing house risks are focused on claimed improvements, rather than questioning the limits of the concept. It is clear that FSOC is concerned with the risk of securities lending activities, but risks that seem far greater, such as the low funding of municipal pension plans, are given relatively short shrift. With respect to the pension plans, FSOC did note that the levels of underfunding are significantly greater than the official numbers because the plans are allowed to use extremely optimistic projections of their future revenues. FSOC made no attempt to further describe or quantify the extent of the underfunding or of the over-optimism. In short, it is not unreasonable to conclude that the political nature of the annual report is influenced by the FSOC’s political and structural makeup.

Financial Markets are More Forward-looking Than We Thought: Fed Funds Futures Prices Ahead of FOMC Decisions

Much of the literature related to Federal Open Market Committee (FOMC) decisions focuses on their post-announcement effects. There is ample evidence that asset prices and volatilities only respond to ‘surprises’ – that is, when the actual target decision differs from the market’s expectation (e.g. Bomfim 2003, Bernanke and Kuttner 2005, Gürkaynak et al. 2005), mirroring the findings of a substantial body of work considering the effects of macroeconomic announcements (e.g. Ederington and Lee 1993, Jones et al. 1998).

In addition, there is an equally large literature that investigates whether FOMC target rate decisions are predictable via macroeconomic announcements, Fed funds futures, or the yield curve (e.g. Lange et al. 2003 Hamilton 2008) or a combination of these, and literature on anticipation of Federal Reserve actions (e.g. Lucca and Moench 2015). Within this literature, there is some evidence that anticipatory effects develop gradually and that Fed funds futures may not fully capture the effects of FOMC decisions on this market.

For the most part, both sets of literature focus on the days immediately surrounding an FOMC decision. There is good reason for this, as is evident when considering extreme examples: first, the instant before the decision reflects all available information, hence providing the most accurate pre-announcement expectation; and second, the instant immediately after the decision is the point of fullest response, before the reaction begins to dissipate or is marred by reactions to other information. Such instant before versus instant after comparisons are the motivation behind much of the event study literature.

The view from the trading floor

Anyone who has been near the Treasury desk on a trading floor on the day of an FOMC decision knows the typical pattern surrounding such announcements. The minutes leading up to the announcement give meaning to the phrase “the calm before the storm”. And as soon as the statement is made, a frenzy of activity ensues – reflecting both the surprise reaction of some market participants and the position adjustment of those for whom the “future path of policy” (Gürkaynak et al. 2005) has suddenly been revealed.

Having been on a trading floor in 2004 when the Fed began a steady programme of tightening following a protracted period of being on hold at historically low levels, I know anecdotally that traders generally don’t wait until 2:14pm to adjust their positions in anticipation of a 2:15pm announcement. They ‘set up’ much farther in advance, both to handle any last-minute orders that customers might have and to be ready to respond to trade requests in the aftermath of an announcement.

It is for this reason that I and my co-authors, Dick van Dijk and Michel van der Wel, decided to investigate the extent to which financial market participants set up for Federal Reserve decisions (van Dijk et al. 2016). Our focus on anticipatory effects blends the future path of policy idea of Gürkaynak et al. (2005) with the foresight model specified in Leeper et al. (2013).

To consider this possibility of early anticipatory set-up, we design a comprehensive regression framework that enables us to investigate how the Fed funds futures market is shaped by scheduled FOMC announcements, as well as Federal Reserve communications in the form of speeches and testimony of members of the Board of Governors of the Federal Reserve System, and how those effects interact with announcements of macroeconomic variables during the six months preceding a scheduled target rate decision.

Quantifying the respective contributions of macroeconomic announcements and Federal Reserve officials’ communications to the evolution of daily changes in Fed funds futures prices is the main focus of our study.

We find that the anticipation (or ‘set-up’) occurs over a much longer horizon than previously thought. Furthermore, these effects decline as the FOMC meeting nears: earlier FOMC decisions and surprises in macroeconomic announcements affect Fed funds futures prices more strongly than more recent ones; and Fed funds futures volatility tends to be lower in the days leading up to an FOMC meeting than in the weeks or months preceding it. We argue therefore, that in order to identify fully how information shapes financial market expectations, it is necessary to look much farther back in time.

In contrast to the conventional wisdom that financial markets are reactionary and instantaneous, our work suggests a more methodical approach to digesting central bank communications and macroeconomic announcements, one that considers not only the latest news but how that in turn shapes the path of future policy decisions. In short, financial markets are more forward-looking than we had thought.

One of the challenges in quantifying how the financial markets are affected by Federal Reserve communications over longer periods of time is that other news, such as the release of major economic indicators, also plays a role. By looking at both items together, we find that macroeconomic indicators and central bank officials’ congressional testimony are of comparable importance.

We document that macroeconomic releases have stronger effects on days when Federal Reserve officials are silent (for example, during the ‘blackout period’ – that is, the 7-10 days preceding an FOMC announcement). In contrast, we find that congressional testimony is more important when it coincides with days when important macroeconomic information is released.

Our finding of large anticipatory set-up emphasizes the importance of clarity in central bank communications. The potential importance of these communications has been recognized by the Federal Reserve itself, through a series of decisions since 1994 designed to increase transparency.

An implication of our results, showing that Fed funds futures volatility declines as the FOMC announcement draws near, is that the Fed’s policy rate intentions have been well-understood by the financial markets.

In the paper, we also demonstrate that failure to look back far enough results in inferences that attribute much less significance to both Fed communications and macro announcements in shaping Fed funds futures prices, suggesting that previous studies’ effects may have been understated.


Bernanke, BS, and KN Kuttner (2005), “What Explains the Stock Market’s Reaction to Federal Reserve policy?”, Journal of Finance 60(3): 1221-57.

Bomfim, AN (2003), “Pre-announcement Effects, News Effects, and Volatility: Monetary Policy and the Stock Market”, Journal of Banking and Finance 27(1): 133-51.

van Dijk, D, RL Lumsdaine, and M van der Wel (2016), “Market Set-up in Advance of Federal Reserve Policy Rate Decisions”, Economic Journal 126 (May): 618-53; earlier version of available as National Bureau of Economic Research (NBER) Working Paper No. 19814.

Ederington, L, and J Lee (1993), “The Short-run Dynamics of the Price Adjustment to New Information”, Journal of Financial and Quantitative Analysis 30(1): 117-34.

Gürkaynak, RS, BP Sack, and ET Swanson (2005), “Do Actions Speak Louder than Words? The Response of Asset Prices to Monetary Policy Actions and Statements”, International Journal of Central Banking 1 (May): 55-93.

Hamilton, JD (2008), “Assessing Monetary Policy Effects Using Daily Federal Funds Futures Contracts”, Federal Reserve Bank of St. Louis Review 90(4): 377-93.

Jones, CM, O Lamont, and RL Lumsdaine (1998), “Macroeconomic News and Bond Market Volatility”, Journal of Financial Economics 47(3): 315-37.

Lange, J, B Sack, and W Whitesell (2003), “Anticipations of Monetary Policy in Financial Markets”, Journal of Money, Credit, and Banking 35(6): 889=909.

Leeper, EM, TB Walker, and SCS Yang (2013), “Fiscal Foresight and Information Flows”, Econometrica 81(3): 1115-45.

Lucca, DO, and E Moench (2015), “The Pre-FOMC Announcement Drift”, Journal of Finance 70(1): 329-71.


CFS Monetary Measures for May 2016

Today we release CFS monetary and financial measures for May 2016. CFS Divisia M4, which is the broadest and most important measure of money, grew by 5.2% in May 2016 on a year-over-year basis versus 4.9% in April.

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’

Wide Range of Companies Report More Difficulty in Accessing Needed Financial Services

The U.S. Chamber of Commerce Center for Capital Markets stated that more than three-quarters of American companies of all sizes report that it is harder to access the financial services they need due to the cumulative effect of the regulatory rules adopted over the past six years.

The report surveyed more than 300 corporate treasurers, controllers, CFOs and CEOs from a wide range of companies with gross revenues from under $100,000 to more than $100 million. The report found the following key impacts of financial regulations on Main Street companies:

  • 79% of the businesses’ respondents are affected by changes in the financial services market;
  • 29% have increased prices for customers and consumers as a result of changes to the financial services market (double the level seen in 2013);
  • 39% have absorbed the higher costs;
  • 19% have delayed or cancelled planned investments; and
  • 76% believe that the regulations on the financial services sector will not help their companies’ outlook over the next two to three years.

Lofchie Comment: The economy is a seamless web. This is not to say that all regulation is bad, but it is to say that the costs of regulation (good regulation, bad regulation, and punitive regulation) are inherently spread throughout the economy, not confined to the particular sector on which the regulation is directly imposed. The results of this survey demonstrate that the political rhetoric asserting that punishing Wall Street will help Main Street is nonsense.

FDIC Chair Gruenberg Asserts that Post-Crisis Reforms Strengthen the Financial System

FDIC Chair Martin J. Gruenberg asserted that despite the challenging economic environment for U.S. banks, relevant data suggests that post-crisis reforms have made the financial system more resilient and stable while strengthening the ability of banking organizations to serve the U.S. economy. Mr. Gruenberg discussed four broad areas that reflect the ability of banking organizations to serve the U.S. economy effectively:

Credit Availability

Mr. Gruenberg argued that despite post-crises reform, U.S. banks remain willing to lend. He noted growth in the mortgage and commercial loan sectors, stronger capital and better and more resilient lending practices.

Bank Profitability

Mr. Gruenberg emphasized that “despite significant headwinds” – particularly reductions in net interest margin – bank earnings have demonstrated a favorable trajectory generally. He asserted that this improvement reflects a return to profitable banking, but with improved capital levels that are better equipped to absorb losses compared to the levels in pre-crisis years.

Market Liquidity

Mr. Gruenberg stated that post-crisis market liquidity for bonds has improved according to “recent research.” He emphasized that:

  • effective prudential regulation should help promote sustainable liquidity conditions through time;
  • the reduction in the size of broker-dealer balance sheets in recent years might be the result of factors such as (i) the consolidated capital and liquidity of their parent banking organizations, (ii) the effective elimination of their access to intra-day credit from the clearing banks in the tri-party repo market, (iii) the risks of holding bonds, and (iv) lower bid-offer spreads, which make buying and selling bonds less profitable; and
  • “market-making” may not be retreating, but instead may be changing through “lower transaction costs, more frequent and smaller trades, and more trades conducted as agent or on order rather than as principal.”

Migration of Financial Activities to Nonbanks

Mr. Gruenberg expressed “the idea that the post-crisis reforms may be changing the distribution of financial activity between banks and nonbanks, in some way making banks less important financial players than before.”

Mr. Gruenberg delivered his remarks before the Exchequer Club.

Lofchie Comment: For other apparent “good news” from FDIC Chair Gruenberg, seee.g.FDIC Chair Gruenberg Says Financial Industry Better Prepared to Address Economic Challenges; Regulators Tout Progress in Bank Regulation; FDIC Chair Cites Progress in Development of Orderly Liquidation Framework.

Mr. Gruenberg states accurately that some measures of liquidity have in fact steadied or improved. He is, no doubt, aware that some measures of liquidity look materially worse. The question of which measures of liquidity are “better” might be the subject of some debate, but what should not be debated is the reality that the numbers are mixed. Anyone who is interested in a more balanced discussion of issues such as liquidity might wish to consider this report, which presents an alternative view even though it was produced by a governmental entity: IOSCO Staff Report Examines Potential Risks and Key Trends in Global Financial Markets.

The more serious issue to consider is this: nearly all regulation, even good regulation, is a double-edged sword. Even if the thrust of the net effect is good, the back-slash of increased regulation can impose costs and may prevent even more transactions. Devising economic regulations should be like determining speed limits: good regulators should weigh the benefits of road safety against the cost of taking too long to get home. There is no perfect speed, nor is there any speed with benefits and no costs. Ideally, regulators should pay constant attention to this cost/benefit balance; ideally, they should elucidate this balancing process for regulated persons and observers. Any message that leaves the impression that regulation is all good all the time will leave the regulated feeling doubtful as they pedal their way to profit.

Future and History of Global Capital Markets

CFS partner, Jack Malvey from BNY Mellon, created a wonderful guide to financial market history and factors driving change into the 21st Century.

We are grateful to Jack for allowing us to share his presentation with CFS friends.

Although we rarely distribute outside research, today, markets confront challenges of epic proportion. Simply put, a glance back at the last thirty years is insufficient.

Analytics, data, and an appreciation of history are in our DNA. Hence, CFS hosted “Bretton Woods: The Founders and the Future” with long-term takeaways for markets and economies. Similarly, Senior Fellow Kurt Schuler’s Historical Financial Statistics (HFS) database – with contributions from over 80 academics – is a treasure trove of information and a popular part of our website.

Most importantly, thanks again to Jack for sharing his outstanding work integrating the past with the future. It is no wonder that a recent Bloomberg story referenced him as “one of the most-respected figures in the bond market.”

Given the enormous scope of coverage, Jack would be grateful for any thoughtful commentary.

The full presentation is:

FINRA Appoints Next President and CEO

FINRA appointed Robert W. Cook as its President and CEO. His term will begin during the second half of 2016.

Mr. Cook will succeed Richard G. Ketchum, who has served in that capacity since 2009. Previously, Mr. Cook served as the Director of the SEC Division of Trading and Markets from 2010 to 2013.

Lofchie Comment: In Mr. Cook, FINRA has found a strong replacement for Mr. Ketchum.  Mr. Cook’s leadership will reflect significant private and governmental experience.