CFS Monetary Measures for September 2017

Today we release CFS monetary and financial measures for September 2017. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.8% in September 2017 on a year-over-year basis versus 4.1% in August.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Sep17.pdf

For more information about the CFS Divisia indices and the data in Excel:
http://www.centerforfinancialstability.org/amfm_data.php

Bloomberg terminal users can access our monetary and financial statistics by any of the four options:

1) {ALLX DIVM }
2) {ECST T DIVMM4IY}
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’

Index Investing and Active Management…

The asset management industry has been disrupted by the trend toward increased index investing.  Over the years, CFS has explored this phenomenon.  As we look to dig deeper, we encourage members and friends to share insights, papers, or studies.

Although it is rare for us to distribute company research, BlackRock’s “Index Investing Supports Vibrant Capital Markets” is well worth a read.  The piece addresses many elements in the active versus passive debate as well as establishes useful concepts from a practitioners’ point of view.

Key themes include:

  • Index investing is still small or less than 20% of global equities,
  • Asset owners and managers sport different strategies and interests,
  • The balance between active and index management may ultimately be self regulating,
  • Passive owner corporate voting records are mixed between favoring both management versus activist investors.

As the trend will influence the future of the industry, many have raised questions regarding the impact of the move toward index investing in financial stability more broadly.

CFS welcomes and encourages view points and research on all sides of the discussion.  Please email any papers to Lauren Cooper, manager of communications (lcooper@the-cfs.org) or me.

“Index Investing Supports Vibrant Capital Markets” can be found at:
https://www.blackrock.com/corporate/en-us/literature/whitepaper/viewpoint-index-investing-supports-vibrant-capital-markets-oct-2017.pdf

CFTC, EU Make Comparability Determinations on Margin Requirements for Uncleared Swaps

The CFTC approved a comparability determination that European Union (“EU”) margin requirements for uncleared swaps are comparable in outcome to relevant CFTC Regulations. The European Commission announced a similar equivalence decision that the CFTC uncleared margin rules are comparable to the EU’s requirements.

The CFTC determination generally allows swap dealers that comply with the EU margin requirements, in circumstances enumerated in the CFTC Regulation 23.160, to be deemed to be in compliance with CFTC requirements. Such swap dealers would remain subject to CFTC examination and enforcement authority. CFTC Letter 17-22, which extended exemptive relief to certain swap dealers that are subject to both U.S. and European margin requirements for uncleared swaps, is no longer applicable.

In addition, the CFTC announced that the CFTC and the EC have agreed to a “common approach” for certain authorized trading venues. Under the common approach, the CFTC plans to grant relief to certain EU trading venues from the swap execution facility (“SEF”) registration requirement, provided they satisfy the “comparable and comprehensive” standard for exemptive relief under CEA Section 5h(g). The EU would propose a corresponding equivalence decision recognizing CFTC-authorized SEFs and designated contract markets as eligible venues.

CFTC Chair J. Christopher Giancarlo characterized the cooperative efforts as an important step in cross-border harmonization:

“These cross-border measures will provide certainty to market participants. It will ensure that our global markets are not stifled by fragmentation, inefficiencies, and higher costs. Indeed these measures are critical to maintaining the integrity of our swaps markets.”

 

Lofchie Comment: This is a significant step by the CFTC both in improving relationships with the Europeans and in accomplishing Chair Giancarlo’s goals of facilitating the ability of firms to transact globally and undoing the geographic market fragmentation that had resulted from the post Dodd-Frank regulatory regime.  One can guess that the Chair will next turn attention to improving the rules for trading on U.S. swap execution facilities, which will benefit the competitiveness of the United States as a financial center.

SEC Names Chief of Office of International Corporate Finance

The SEC named Robert Evans III as Chief of the Office of International Corporate Finance. The office operates within the SEC Division of Corporation Finance and is responsible for “outreach to non-U.S. issuers that access the U.S. capital markets.”

Prior to the appointment, Mr. Evans was Deputy Director of the Division of Corporation Finance. Before that, worked as a partner in the capital markets practice at Shearman & Sterling LLP.

Treasury Releases Recommendations for Capital Markets Regulatory Reforms

The U.S. Treasury Department (“Treasury”) released a second report pursuant to President Donald J. Trump’s Executive Order establishing core principles for improving the financial system (see coverage of first report). The new report details plans to reduce burdens of capital markets regulation (see also Fact Sheet on report).

The report recommends supporting and promoting access to capital markets, reducing regulatory costs, making changes to market structure and modifying derivatives regulation to facilitate risk transfer.

In a “Table of Recommendations” (beginning on page 205), Treasury lists proposed recommendations. Some highlights include:

  • Public Companies and IPOs (e.g., decrease the cost of being a public company by eliminating the conflict minerals rule);
  • Challenges for Smaller Public Companies (e.g., increase the level at which a company may be considered “small”);
  • Expanding Access to Capital Through Innovation (e.g., allow accredited investors to invest freely in crowdfunded offerings);
  • Maintaining the Efficacy of Private Markets (e.g., expand the definition of accredited investor);
  • Market Structure and Liquidity, Equities (e.g., allow smaller companies to limit the exchanges on which they trade to facilitate the development of centralized liquidity);
  • Market Structure and Liquidity, Treasuries (e.g., provide greater support for the repo market);
  • Market Structure and Liquidity, Corporate Bonds (e.g., improve liquidity);
  • Securitization and Capital (e.g., simplify capital regulation of banks);
  • Securitization and Liquidity (e.g., treat certain securitizations as liquid assets);
  • Securitization and Risk Retention (e.g., provide exemptions from the risk retention requirements);
  • Securitization and Disclosures (e.g., reduce the number of required reporting fields for registered deals);
  • Derivatives and Harmonization Between the CFTC and SEC (e.g., the SEC should adopt its security-based swap rules);
  • Derivatives and Margin Requirements for Uncleared Swaps  (e.g., there should be exemptions from initial margin requirements between bank affiliates of a bank “consistent with the margin requirements of the CFTC and the corresponding non-US requirements”);
  • Derivatives and CFTC Use of No-Action Letters (e.g., rules should be fixed so it is not necessary to rely on no-action letters);
  • Derivatives and Cross-Border Issues (e.g., the U.S. regulators should work with global regulators on issues such as privacy);
  • Derivatives and Capital Treatment in Support of Central Clearing (e.g., required capital should be reduced on centrally cleared transactions);
  • Derivatives and Swap Dealer De Minimis Threshold (e.g., there should be no reduction in the de minimis threshhold for dealer registration);
  • Derivatives and Definition of Financial Entity (e.g., modify the definition, presumably with the goal of reducing the central clearing requirement);
  • Derivatives and Position Limits (e.g., adopt rules but provide hedging exemptions);
  • Derivatives and SEF Execution Methods and MAT Process (e.g., permit a broader range of trading mechanisms);
  • Derivatives and Swap Data Reporting (e.g., improve standardization of reporting requirements);
  • Financial Market Utilities (e.g., consider providing “Fed access” to certain clearing corporations);
  • Regulatory Structure and Processes, Restoration of Exemptive Authority (e.g., restore the SEC’s and CFTC’s plenary exemptive authority under the statutes that they monitor);
  • Regulatory Structure and Processes, Improving Regulatory Policy Decision Making (e.g., adopt clear rules);
  • Regulatory Structure and Processes, Self-Regulatory Organizations (e.g., better define the roles of the SROs in rulemaking); and
  • Internal Aspects of Capital Market Regulation (e.g., U.S. regulators should seek to reach “outcomes based non discriminatory substituted compliance arrangements” with foreign regulators to mitigate “the effects of regulatory redundancy and conflict”).

Lofchie Comment: The prior Administration viewed financial markets as creators of risk that had to be controlled; this Administration appears to view financial markets as creators of growth that would benefit from decreased controls. This is simply a tremendous difference in perspective and tone.

There will and should be a fair amount of discussion over these many and specific recommendations. One broad recommendation, however, stands out: restoring to both the SEC and the CFTC complete exemptive authority as to the requirements of the statutes that they enforce. Depriving the regulators of this authority in the wake of the Congressional enthusiasm for Dodd-Frank had limited the regulators ability to fix Congressional mistakes and over-reaches in drafting. The prior Administration had simply become so locked into defending Dodd-Frank against any criticism that it had become impossible for the regulators to consider, or even discuss, what aspects of it might be working or not. The new Administration does not bear the burden of justification.

SEC Chair Jay Clayton Updates House Finance Committee on EDGAR System Breach

SEC Chair Jay Clayton testified before the U.S. House Financial Services Committee providing an update on the EDGAR system cybersecurity breach (see previous coverage). He also outlined the SEC’s regulatory agenda reiterating previous testimony provided to the Senate Banking Committee (see previous coverage). His principal priorities include the facilitation of capital formation and encouraging initial public offerings.

From China / Market Implications from Unconventional Monetary Policies…

The Shanghai Development Research Foundation (SDRF) recently hosted a superb dialog on issues stretching from China, the international monetary system, re-thinking the nature of money, among others.  I had the pleasure of presenting on “Market Implications from Unconventional Monetary Policies.”

My remarks centered on:

The need to assess the normalization of monetary policies through the lens of major macro shifts over the last 10 years.

Specifically, three “never befores” need to be resolved.  For instance, “never before” has there been such 1) large scale intervention by central banks and governments; 2) growth in the financial regulatory apparatus and labyrinth of rules governing markets; and 3) distortions across a wide range of financial markets.

Here, CFS monetary and financial data illustrate why goods price inflation has remained subdued and – in contrast – asset price inflation has not.

Evaluation of long-term stock and bond market valuations reveal market distortions.

Speculative positioning has been actively influenced by the patterns of rise and restraint in balance sheet operations in recent years.

Going forward, officials would benefit by seeking balance among these three “never before” forces.

For slides accompanying the presentation:  http://www.centerforfinancialstability.org/speeches/ShanghaiDRF_090517.pdf

On a parenthetical note, I left China excited with advances in mobile pay.  It will redefine the nature of money.

SEC Clarifies Intent of Amendments to “Fully Paid Securities” Definition

In a letter to FINRA, the SEC clarified that an amendment to the definition of “fully paid securities” in Exchange Act Rule 15c3-3 (“Customer Protection – Reserves and Custody of Securities”) was not intended to expand the scope of securities that cannot be rehypothecated by the broker-dealer. Rather, the SEC said that the technical amendment was merely meant to “amend out-of-date” citations and “remove text that the Commission believed to be superfluous or redundant.”

Lofchie Comment: In a somewhat cryptically worded letter, the SEC staff clarified that securities that have no lending value for purposes of the broker-dealer margin regulations, but that serve to collateralize a margin loan, may be rehypothecated by a broker-dealer. Any such rehypothecation would of course remain subject to the limits set out in Rule 15c3-3, which are intended to ensure that even an insolvent broker-dealer be able to make its custodial customers whole.

President Trump Signs FSOC Bill Assuring Insurance Regulator Continuity

President Donald J. Trump signed into law the Financial Stability Oversight Council Insurance Member Continuity Act (H.R. 3110) on September 27, 2017.

The bill, introduced by Representatives Randy Hultgren (R-IL) and Maxine Waters (D-CA), permits an FSOC independent member with insurance expertise to remain past his or her term for the earlier of (i) 18 months or (ii) when a successor is confirmed.

Representative Hultgren explained the importance of the bipartisan bill:

“[I]t is now extremely important that we have someone with a deep understanding of our insurance markets, and how they interact with our entire financial system, to continue serving as a voting member of FSOC. The Financial Stability Oversight Council Insurance Member Continuity Act ensures that this key regulatory body is able to benefit from the perspective of a voting member with insurance expertise without any unnecessary lapses.”

 

Lofchie Comment: The realization of the “importance” of industry participation in the FSOC designation process is welcome. When FSOC designated MetLife as being systemically important, it generally ignored the views of the FSOC member with insurance industry experience. See FSOC Proposes Preliminary Designation of MetLife as a Non-Bank Systematically Important Financial Institution (with Lofchie Comment).  See also D.C. District Court Calls FSOC’s Review of MetLife’s Status “Fatally Flawed”.